The illusion of demand: Why oversubscribed IPOs aren’t always a safe bet

Initial Public Offerings (IPOs) are transformative milestones for companies, symbolising their evolution from privately held entities to publicly traded ones. While large IPOs often capture media attention, Small and Medium Enterprise (SME) IPOs have emerged as silent yet powerful enablers of economic democratisation, allowing smaller businesses to tap into the capital markets.

However, beneath this growth lies a troubling undercurrent — artificial oversubscription driven by leveraged retail investments, speculative behaviour, and, at times, questionable practices by intermediaries. This undermines the very purpose of IPOs, turning them into speculative instruments rather than vehicles for genuine capital formation.

The SME IPO segment has gained traction due to its accessibility. With lower ticket sizes and perceived high-growth potential, these offerings attract retail investors looking for quick gains.

However, this very accessibility has become a double-edged sword. The ease with which retail investors can leverage their applications — often borrowing funds or using fintech-driven IPO financing — creates a mirage of overwhelming demand. Oversubscription, traditionally a sign of investor confidence, is increasingly being manipulated to project false market interest.

Also read | Why financial planning is essential for doctors & their families

The fallout of artificial demand

The mechanics of this manipulation are concerning. Retail investors, enticed by the promise of listing gains, often apply for shares beyond their financial capacity by taking loans or using third-party funding. Some resort to multiple applications through family accounts or even fabricated identities, despite regulatory prohibitions.

Merchant bankers, eager to showcase oversubscription as a success metric, sometimes turn a blind eye to these practices or, worse, indirectly encourage them to attract more issuers. The result is a distorted picture of demand, where inflated subscription numbers mislead genuine investors into believing that there is organic interest in the IPO.

The consequences of such artificial demand are far-reaching. Post-listing, leveraged investors rush to exit their positions to repay loans, leading to extreme volatility. Many SME IPOs, after an initial pop, see their prices crash within weeks, leaving retail investors stranded with losses.

This not only erodes trust in the segment but also harms the companies themselves, which face unrealistic valuation expectations and subsequent pressure to deliver unsustainable growth. Over time, repeated instances of such volatility deter serious investors, reducing liquidity and defeating the original purpose of these platforms—to provide smaller businesses with long-term capital.

SEBI oversight

Recognising these risks, the Securities and Exchange Board of India (SEBI) has taken commendable steps to restore sanity to the SME IPO market. The regulator’s interventions are both preventive and punitive. By mandating upfront margin payments for IPO applications, SEBI has reduced the reliance on borrowed funds, ensuring that only serious investors participate.

Enhanced surveillance mechanisms now detect and penalise multiple applications, curbing the misuse of retail quotas. Additionally, SEBI has tightened disclosure norms, requiring companies to justify their IPO pricing and the intended use of proceeds. This ensures that capital raised is aligned with genuine business needs rather than speculative hype.

However, while regulatory measures are crucial, the responsibility also lies with merchant bankers and other intermediaries. The role of investment banks in SME IPOs must evolve beyond mere facilitation to active guardianship of market integrity.

Oversubscription should not be marketed as a success metric if it is artificially engineered. Merchant bankers must conduct rigorous due diligence on investor applications, discourage leveraged bidding, and ensure that pricing is based on fundamentals rather than manipulated demand. Transparency in communication is key—investors should be made aware of the risks rather than lured by the illusion of easy gains.

Also read | Why income plus arbitrage funds are gaining popularity

Fixing the flaws

The broader market ecosystem, including brokers and fintech platforms offering IPO financing, must also exercise restraint.

While leverage can amplify returns, its misuse in IPOs distorts price discovery and harms market stability. SEBI’s proposal to rationalise retail quotas in oversubscribed IPOs is a step in the right direction, ensuring that allocations go to genuine investors rather than speculative traders.

The frenzy around SME IPOs, fuelled by artificial oversubscription, threatens the foundational principles of public markets. SEBI’s measured approach—balancing investor access with prudent safeguards—offers a blueprint for sustainable growth.

Oversubscription, when genuine, reflects confidence in a company’s prospects; when manipulated, it becomes a tool of deception. The path forward lies in fostering transparency, ensuring accountability among intermediaries, and reinforcing the idea that IPOs are meant for capital formation, not speculation.

As the markets evolve, the lesson is clear: true progress is not measured by the chaos of hype but by the stability of prudent governance. SEBI’s vigilance ensures that the soul of an IPO—raising capital to build businesses—is never lost to the noise of easy money.

For the SME segment to thrive, all stakeholders must prioritise long-term integrity over short-term gains. Only then can these platforms fulfil their promise of democratising capital markets while safeguarding investor trust.

Also read | The hidden financial burden of not having a claim-ready policy in place

The writer is MD and Founder of Highbrow Securities

Disclaimer: The views expressed by experts on Moneycontrol are their own and not those of the website or its management. Moneycontrol advises users to check with financial advisor before taking any decisions.