Understanding the IPO share allocation process

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Example: Attempting to obtain IPO shares for Credit Suisse

IPO Total Offering Size= 7,000,000 shares

Lead Underwriters: Barclays (30%),
Credit Suisse (30%)
Underwriters: RBC (10%), Baird (10%),
Wells (10%)
Co-Managers: STRH (5%), Raymond James (2.5%), Stephens Inc (2.5%) 
RetailRetentionGraphic3  

Participating in an initial public offering (IPO) provides an opportunity to invest in a newly public company’s stock. But the process of purchasing shares of an IPO is not as simple as entering a trade to buy stock. If you are new to investing in IPOs, read on to learn more about the process of participating in an IPO, including some of the contributing factors that may determine whether you receive shares or not.

How to participate in an IPO

Before you can participate in an IPO, you must first meet your brokerage firm’s eligibility requirements. In addition, you must meet Financial Industry Regulatory Authority (FINRA) requirements, which generally can be accomplished by answering a series of questions asked by your brokerage firm.

Assuming you meet FINRA’s and your brokerage firm’s requirements, your next step is to review the preliminary prospectus of the offering to understand the risks involved. Once you have decided to request to purchase shares in the offering, your next step is to enter an indication of interest for the number of shares you are interested in purchasing. Keep in mind that submitting an indication of interest does not guarantee that you’ll be allocated any shares in the offering.

Your indication of interest tells your brokerage firm the maximum number of shares you are interested in purchasing. Requesting a large number of shares in your indication will not improve your odds of receiving an allocation of shares, so it’s best to enter the amount of shares you are comfortable owning. Very few firms use pro-ration as a means of allocating stock, so there is no need to enter 1,000 shares if you are only interested in owning 100. Your indication of interest quantity only assists with determining the maximum amount of shares you can be allocated.

After you submit an indication of interest, you will receive a notification that the offering has been declared effective and has been priced on the evening of pricing. In order 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.

Factors that determine your share allocation

When contemplating investing in an IPO, you may want to know the likelihood of receiving an allocation of shares. Alternatively, perhaps you previously attempted to participate in an IPO and did not receive an allocation of shares and want to know why. While it is impossible to know in advance whether you will receive an allocation of shares, understanding the factors that determine how shares are allocated may assist with setting proper expectations and an explanation as to why you were not allocated shares.

Some of these factors are readily available by reviewing the deal’s preliminary prospectus, commonly referred to as the “red herring.”

Click here to learn about 5 questions you can answer using the red herring.

In addition to the information outlined in the red herring, several other factors may come into play when determining who receives an allocation of shares, including:

  • Retail versus Institutional Split - IPOs are typically broken into two tranches of demand: Institutional and Retail. Institutional investors typically receive the lion’s share of any IPO allocation. Historically, the institutional to retail split is 90/10. However, the retail percentage can be higher or lower on a deal-to-deal basis.
  • Media Coverage - A deal that receives a lot of media attention and that involves a well-known company is often significantly oversubscribed. This means that demand for IPO shares far outweighs supply. In such cases, your odds of receiving an allocation of shares are greatly reduced.
  • Type of Offering - Certain types of IPOs, such as Master Limited Partnerships (MLPs), Real Estate Investment Trusts (REITs) and Business Development Companies (BDCs) can be more retail focused, so institutional investors are not vying for as large a piece of the offering. Therefore, retail investors typically have a better chance of receiving an allocation of shares in these types of IPOs.
  • Directed Share Program Allocations - In some cases, an IPO issuer may choose to direct a significant allocation of shares to existing investors or “friends” of the company. When this happens, it typically reduces the number of shares available to retail investors.

In addition to these factors, your brokerage firm will have its own criteria for determining who receives an allocation of shares. Each customer who wants to participate in an IPO offering is evaluated and ranked based on his or her assets and the revenue they generate for their brokerage firm. Typically, customers with significant, long-term relationships with their brokerage firm will receive higher priority than those with smaller or new relationships.

As you can see, several factors influence how IPO shares are allocated. Knowing how to read the IPO prospectus (red herring) and understanding some of the other factors in play 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.

Click here to read Fidelity’s Viewpoint – IPOs: Land of opportunity or risky wager?
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