An IPO is oversubscribed when the number of shares that investors want is higher than the number of shares available. When investors have confidence in the fundamentals of the company offering the shares, there's more demand, and this can lead to IPO oversubscription.
Another reason for IPO oversubscription is that investors simply want to strike it rich. Most of the returns for IPOs tend to come on the first day of trading, and these far exceed the average three-year return. As Ben Carlson, CFA, writes, “More than 36% of IPO names since 1980 have seen a big pop on the first day in the range of 10%–60%. Nearly 7% of the time that first-day return is more than 60% right out of the gate.”
It can be quite difficult for individual investors to get in on an IPO at the offer price. How can investors buy an IPO when it's oversubscribed?
How an oversubscribed IPO is allocated
Allocation in an IPO depends on the underwriter and the company offering the IPO. Even if an IPO is oversubscribed, the SEC doesn’t regulate how the IPO shares are allocated. The underwriters and the company decide on the IPO's basic terms and structure, such as the percentage of shares going to institutions and individual investors. Underwriters often favor institutional and wealthy investors who can buy larger blocks of shares and are more likely to hold the investment for the long term.
Some of the most oversubscribed IPOs in the U.S have included the Lyft, Levi Strauss, Dropbox, Kraft Heinz, Facebook, Alibaba, Visa, and General Motors offerings.
What happens when an IPO is oversubscribed?
When a company's IPO is oversubscribed, the company can offer more shares, raise the price of the security, or do both. This will increase the amount of capital raised.
For example, in Lyft’s IPO, which was 20 times oversubscribed, the company raised its stock price and the number of shares on offer. The company priced the stock at $72 for the listing, which was at the upper end of its targeted range of $70–$72. The stock popped up more than 20 percent on its market debut. However, having an oversubscribed IPO doesn’t guarantee a higher share price for long. Lyft stock's rise was short lived.
How to get in on an oversubscribed IPO
For retail investors, getting in on an IPO can be very difficult, and becomes even more difficult when the IPO is oversubscribed. This is because the underwriters, or the middle-man between the companies and investors, decide who to offer the shares to. They usually prefer institutional clients or individuals with a high net worth.
Individual investors can try to get some allocation if they have an account with one of the investment banks underwriting the deal or with a broker who has received a part of the share allocation. Investors with this option would then need to indicate how many IPO shares they want to buy. However, to have such an option, you would need to be a frequent client and have a large account.