However, with most IPOs getting oversubscribed, securing an allotment has become increasingly challenging. To boost their chances, some investors are turning to IPO loan financing—a strategy that allows them to bid for a higher number of shares than their available capital would typically permit.
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While this approach can be tempting, leveraging to invest in IPOs carries significant risks. Before you jump in, it’s crucial to understand how this financing works, its potential rewards, and the pitfalls that can turn your investment into a costly gamble.
How IPO loan financing works
IPO loans are short-term borrowings that allow investors to bid for a higher number of shares than their available capital might permit. Typically, these loans come with a tenure of 7 days and interest rates of 8-15%. Lenders set both minimum and maximum loan limits, with ₹1 crore being the regulatory cap. However, for most investors, ₹10 lakh is sufficient to qualify for the big high net-worth individual (HNI) category, where chances of allotment are theoretically higher.
That said, in heavily oversubscribed IPOs, the allotment is often limited to shares worth ₹2 lakh or none.
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Lenders also require borrowers to pay a margin upfront, which is a portion of the total bid. The remainder is financed by the lender.
Loan dynamics
After you pay the upfront margin, the lender releases the remaining funds needed to bid for the desired number of shares. Both the margin and loan amounts are blocked under the ASBA (Applications Supported by Blocked Amount) process until the shares are allotted.
You will earn interest on the blocked amount at prevailing savings account rates (around 4%), which can offset some of the interest costs. However, the full interest rate on the loan is applicable, regardless of how many shares are ultimately allotted.
Low allotment poses a challenge for borrowers, as fewer shares mean you’ll need higher listing day gains to cover the interest cost and make a profit. For this reason, moderately oversubscribed IPOs are often more attractive than highly oversubscribed ones, as the chances of securing a allotment are better.
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Bidding in the big HNI category may improve your odds, but it’s not guaranteed. Simply bidding a large amount from one PAN and bank account may not be enough—investors often use multiple bids across different PAN numbers and accounts to maximize their chances of securing shares, especially for highly anticipated IPOs.
Risks involved
There are two major risks when taking a loan for IPO financing. The first is the risk of not securing any allotment. “If you have not got any allotment at all, you would have to pay for the interest from your own pocket,” explains Aamar Deo Singh, head-advisory at Angel One.
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The second risk arises if the shares trade at a discount on the listing day.
“Even if you repay the loan within 3-4 days, the T+3 timeline for IPOs requires you to pay interest for the full 7-day period. Your total loss would include both the seven days of interest and any losses from selling on the listing day. To hold the shares beyond this point, you’ll need to use your own capital, as the lender will demand the return of the loan principal on the listing day,” notes Mohit Mehra, vice president, primary markets and payments at Zerodha.
Should you opt for IPO loan financing?
Leveraged investments come with inherent risks. If the stock price moves in your favour, it can amplify gains, but if not, it can significantly increase your losses.
Securing allotment in the big HNI category has become more uncertain since the Securities and Exchange Board of India (Sebi) introduced a lottery system for this investor class in September 2022. This means leveraging your bids no longer guarantees an allotment, leaving you to cover interest costs out of pocket if you don’t receive shares.
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If market sentiment turns negative and the stock lists at a loss, your losses could be compounded by the interest payments. Given these risks, it’s crucial to exercise extreme caution when considering this strategy.