How IPO share allocation works?

Have you ever wanted to invest in a hot IPO as a retail investor? Or you previously attempted to participate in an IPO and didn't receive an allocation of shares and want to know why? If your answer is yes, then you need to know what IPO allocation is and how it works.

For each IPO the lead underwriters first allocate IPO shares to institutional investors, like pension funds and mutual funds. And the rest is allocated to individual investors. A typical split is 90/10 with only 10% of IPO shares going to retail investors. Brokers acquire shares through investment banks participating in the offering and make these shares available to eligible clients who request to participate in the offering.

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Almost for all IPOs an allocation applies no matter what broker you use. 

When you apply for an IPO it tells your broker the maximum number of shares you are interested in purchasing. Requesting a large number of shares doesn't improve your odds of receiving an allocation, so it's best to enter the amount of shares you actually want to buy. Brokers don't use pro-ration to allocate IPO stock, so there's no need to enter 1,000 shares if you really only want 100. It's also possible that the broker will be able to satisfy up to 100% of your request, so you may end up having too many shares.

After you submit an indication of interest, if accepted, you will receive a notification that the offering has been declared effective and has been priced on the evening of pricing. To have an opportunity to purchase shares, you must confirm your indication of interest by a stated deadline. By confirming your indication of interest, you are essentially turning your indication of interest into an order to buy shares.

While it's impossible to know in advance whether you will receive an allocation of shares, understanding how shares are allocated might help set expectations and explain why you were not allocated shares.

5 Tips how to predict share allocation for an IPO

To estimate how many shares may be available to retail investors, you can use the tips listed below. IPO details that can be found on the IPO profile page of the particular offering on IPObase or directly in the preliminary prospectus on SEC website.

  1. Check the number of shares the company sells. The larger the offering, the more shares available for allocation. Keep in mind, the shares are split between institutional and retail clients. A typical split is 90/10, in favor of institutional clients.
  2. Is this IPO trending? IPOs that attract media attention and that involves a well-known company means too many people will want to participate. This means that demand for IPO shares is likely to be high and allocation of shares may be reduced.
  3. Check how many underwriters in the IPO. In preparation for issuing their IPO, a company works with an underwriter (usually they are investment banks), to buy their stock for example, and then sells it to the public through brokerage firms. When looking at an IPO, the more banks that are listed means
    the more big players competing for shares which decreases the number of shares available for retail clients.
  4. Check if Direct Share Plan (DPS) is part of the IPO. In some cases, an IPO issuer may choose to direct a significant allocation of shares to existing investors, customers, partners, employees etc. of the company. It will reduce the number of shares available to
    retail investors.
  5. Evaluate your broker account rating. Each IPO broker has its own criteria how they distribute the shares. Clients who applied for an IPO are ranked based on their assets and transaction history of their trading account. Literally, customers who have a more mature account and actively use it, will receive higher priority than those with new relationships or a dormant account.

Conclusion

Several factors influence how IPO shares are allocated. Understanding some of the factors that determine share distribution can help you set realistic expectations for your chances of receiving an IPO allocation. It is also important to note that every IPO is different and market conditions can play a role in how shares are allocated.