Margin funding for IPOs

Margin funding is back in the focus with the mega public issue of NTPC soon to hit the market. Individuals keen on investing in an initial public offering (IPO) but not having enough funds or wanting to leverage their existing funds to apply for a larger number of shares can use this facility offered by select banks and non-banking finance companies for financing.

Why margin funding? Industry sources say that it is a known fact that the higher your application amount, the greater is the possibility of more shares being allotted to you.

Besides, investors going through margin funding get an additional view on the IPO from an independent agency. There is a flip side to this though; if the total subscription is very high as in the case of the recent TCS floatation, per-share cost is higher for investors who had invested via margin funding as the allotments are proportionately lower.

How does margin funding work?
An investor can apply for a larger number of shares by leveraging the funds that he or she has as margin with any of the institutions offering margin funding for IPOs.

The minimum margin that the investor will need to pay is 40 per cent as per the regulatory norms. What is important is that the investor needs to assess whether borrowing for the IPO would give positive returns. And, if so, to what extent.

Typically, the interest cost levied by financiers for funding ranges from 11 per cent to 16 per cent. Apart from the interest cost, investors will also have to pay expenses for dematerialisation, processing fees, documentation/franking charges, among others. Besides these costs, the investor will also have to incur dematerialisation charges and brokerage charges while selling the shares allotted.

Investors should also bear in mind that they will have to pay interest to the company or bank for the entire loan amount. In other words, if a public issue were oversubscribed by 10 times and an investor who has applied for 1,000 shares gets 100 shares, his gain on listing pricing will be for just 100 shares while his costs will be higher as he will have to shell out interest on the entire loan amount.

Investors also need to keep in mind that they will sell the shares allotted at the earliest on listing. In case an investor wants to hold on to the shares due to appreciation possibilities in the future, he or she will have to arrange for funds to repay the loan.

When does the investor gain?
The premium that the counter gets on listing "" over the issue price "" will determine the gains on the investment. If the listing price is equal to or below the issue price, the investor will have to wait for appreciation in that case.

But the interest cost on the loan will keep increasing or else he will have to sell at a loss as his costs for purchasing the shares are higher. Margin funding is good for an investor looking to get a larger allotment and has the holding capacity to wait for an upside if required or for an investor who is sure of a high listing premium for the share and is ready to take the chance.

Birla Global Finance, ICICI Bank, IDBI Bank, IL&FS Investmart, Kotak Mahindra group, L&T Finance are some of the players offering margin funding.