The Hindu Business Line : Leveraged IPO investments

With IPOs being aggressively priced, thanks to the rat race among the participants in the book-building exercise for hogging shares, investors on the fast-track are having to look for institutional finance in order to be able to leverage their applications for shares. And the finance sector is not complaining what with there being a huge liquidity overhang seeking investment outlets.

Margin money

Banks and NBFCs are, therefore, seizing the opportunity with alacrity to earn handsome interest ranging from 13 to 15 per cent per annum. As it is, a retail investor as per SEBI norms, is one who pitches in not more than Rs 1 lakh as subscription amount in an IPO. In case of oversubscription which more often than not is the case, a retail investor gets very few shares on allotment and, therefore, those playing for bigger kills don’t mind offering the same amount to the financier as margin money which is 10 per cent so as to be able to wangle a larger allotment by applying for larger number of shares.

In other words, by investing one’s own money as margin money, nine times such money is mobilised for an IPO investment. Thus Rs 1 lakh of margin money, begets one a fund of Rs 10 lakh that catapults him into the high net-worth individual (HNI) category from the tribe of retail investors with its garden-variety implications. Of course, the prospect of landing relatively greater number of shares, rather than shedding the belittling appellation ‘retail investor’, is the real motive for leveraged IPO financing.

Fraught with risks

Like with leveraged buyouts — one of the tools available to those looking for inorganic growth on the production or service front —leveraged IPO investment is also fraught with huge risks. The investor then is looking for an annualised return in the region of upwards of 40 per cent to justify such leveraged investment with a price tag of 13-15 per cent per annum as pointed out earlier. Should the pre-IPO hype not be shared or borne out by the secondary market, the investor may be left licking his wounds inflicted by the interest clock that starts ticking right from the moment he gets the loan.

If, however, the secondary market shares the enthusiasm of book-builders and gives a huge reward, the investor can always sell a part of his allotment and pay off the loan if he wants to staunch the flow of interest without, at the same time, selling more shares than necessary.

He would of course shudder to imagine the prospect of the IPO bombing on the bourses. He may in that event have to give a stop-loss order to his broker to staunch the haemorrhage in the form of outflow of interest unmindful of the loss staring at him. For good measure, the financier takes a power-of-attorney while sanctioning the loan so that the shares allotted can be disposed of in case of default in servicing the loan.

No set-off of losses

The interest paid on such loans can of course be added to the cost of the shares while calculating capital gains. This helps in reducing his capital gains or heightening his capital loss. If one sells his shares after one year of allotment in one of the recognised stock exchanges in India, this matters very little because the resultant gain or loss is long-term that is simply out of reckoning under our extant scheme of income-tax law because long-term gains are tax-free which means its obverse the long-term capital loss is not available for set off — that would have been permitted but for the exemption — against any taxable long-term capital gains.

(The author is a Delhi-based chartered accountant.)