HNI Investing in IPOs: The Game of Leverage

1. Introduction to IPOs and HNIs

An Initial Public Offering (IPO) is when a private company offers its shares to the public for the first time. Investors can subscribe to these shares in the hope of getting an allotment and benefiting from potential listing gains.

In the context of IPOs, High Net Worth Individuals (HNIs) are those who apply for shares worth more than ₹2 lakh in a single IPO. They fall under the Non-Institutional Investors (NII) category, which is different from retail investors (up to ₹2 lakh) and Qualified Institutional Buyers (QIBs).

2. IPO Allotment Categories and HNI Quota

• Retail Investors: Up to ₹2 lakh per application. Reserved quota: 35%.
• HNIs/NIIs: Above ₹2 lakh per application. Reserved quota: 15%.
• QIBs: Large institutions like mutual funds, insurance companies. Reserved quota: 50%.

HNIs are important because they bring in large sums of money, often influencing the overall subscription numbers of an IPO.

3. The Concept of Leverage in IPOs

Leverage means using borrowed funds to increase your investment size. In IPOs, HNIs often use leverage to apply for a much larger amount than their own capital allows.

Many brokers, NBFCs, and banks offer short-term loans specifically for IPO applications. The investor puts in a small margin (like 5–10% of the total application amount), and the rest is financed by the lender. The loan is usually for 7–10 days, and interest rates can range from 7% to 15% per annum.

For example, if an HNI has ₹10 lakh but wants to apply for ₹5 crore worth of shares, the broker offers 50x leverage. The HNI puts in ₹10 lakh, borrows ₹4.9 crore, and applies for ₹5 crore worth of shares.

4. Why Do HNIs Use Leverage?

• Maximizing Allotment: IPO allotment in the HNI category is done on a proportionate basis. The bigger the application, the higher the chance of getting a meaningful allotment.
• No Upper Limit: HNIs can apply for any amount, even in crores, unlike retail investors.
• Short-Term Strategy: Most HNIs aim for quick listing gains rather than long-term investment.

5. The Mechanics of the Leverage Game

1. HNI decides the amount and applies for shares using own funds plus borrowed funds.
2. Pays interest upfront or at the end of the loan tenure.
3. If allotted, shares are credited to the demat account.
4. Sells shares on listing day to realize profits.
5. Repays the borrowed amount to the lender.

Key factors include oversubscription, interest cost, and the quick turnaround time of 10–12 days.

6. Risks Involved in Leveraged HNI IPO Investing

• Interest Cost Risk: If the listing gain is less than the interest paid, the HNI can end up with a net loss.
• Market Risk: If the stock lists below the issue price, leveraged losses can be significant.
• Oversubscription Risk: High oversubscription means very small allotment, making the interest cost per allotted share very high.
• Liquidity Risk: Volatile markets may prevent selling shares at the desired price on listing day.
• Regulatory and Operational Risk: Changes in SEBI rules or delays in allotment/refund can impact the strategy.

7. Real-World Example

Suppose an HNI applies for ₹1 crore worth of shares in an IPO using ₹10 lakh of their own money and ₹90 lakh through leverage at 10% interest for 10 days (about ₹25,000 interest). If the IPO is oversubscribed 100x, they might get only ₹1 lakh worth of shares. If the stock lists at a ₹100 premium, profit is ₹20,000, but the interest cost is ₹25,000, resulting in a net loss. If the stock lists at a higher premium, the HNI profits after covering the interest.

8. Why Do HNIs Still Play This Game?

• High Reward Potential: Some IPOs offer significant listing gains, even after interest costs.
• Track Record: Many HNIs have made large profits in successful IPOs.
• Access to Large Capital: Leverage allows them to apply for big amounts without locking up all their own funds.

9. Recent Trends and Regulatory Changes

• SEBI has introduced rules to curb excessive leverage and ensure fair play.
• Some brokers have reduced the leverage offered due to regulatory scrutiny.
• Interest rates on IPO financing have increased, making the strategy riskier.
• Market volatility has made HNIs more cautious in recent years.

10. Tips for HNIs Considering Leveraged IPO Investing

• Calculate the minimum listing gain needed to cover your interest cost.
• Apply only in IPOs with strong fundamentals and high demand.
• Diversify your applications across multiple IPOs.
• Negotiate for the best possible financing rates.
• Be ready to sell immediately on listing day if needed.
• Stay updated on regulatory changes and market trends.