What it means
When a company issues new shares or a government issues bonds, it asks investors to apply for a certain amount. Each application is a subscription, a promise to buy at the offer price if the application is accepted.
If total applications equal the amount on offer, the issue is fully subscribed. If investors apply for more, which is common with popular offerings, the issue is oversubscribed and the issuer must decide how to share out the securities.
Allocation can be done in proportion to each application, by favouring certain types of investor, or by scaling back large orders. Oversubscription is usually seen as a sign of strong demand and can allow the issuer to price at the top of its range.
An undersubscribed issue is a warning sign that investors doubt the price, the business or the market conditions. The issuer may have to lower the price, extend the offer period or rely on underwriters, which are banks that agree to take up unsold securities in return for a fee.
Pricing methods affect how subscriptions work. In a fixed-price offer, every investor pays the same stated price, while in a book-building process the underwriters collect bids across a range and set the final price once demand is clear.
Heavy oversubscription in the book usually allows the issuer to price near the top of the range. For businesses, the idea also appears in a company's accounts as subscribed capital, which is the share capital that investors have agreed to take up.
Some of this may not yet be paid in, so the amount subscribed and the amount paid can differ.
In practice
Real-world examples.
Example
A fast-growing technology company lists on a stock exchange and receives applications for three times the shares on offer. The company sets the price at the top of its range and allocates shares in proportion. Small investors receive only part of what they requested, and unused application money is refunded.
Example
A city sells $100,000,000 of bonds, but investors apply for only $80,000,000. The city raises the yield on the bonds and its bank steps in to buy the unsold portion under an underwriting agreement.
Example
A private company raises capital from existing shareholders and hears that two investors have promised to take up their portions but have not yet paid. The finance director records the amount as subscribed and shows the unpaid portion as a receivable. The shares are not issued fully paid until the money arrives.
Formula
Calculation
The level of demand is shown by the subscription ratio:
Subscription ratio = Shares applied for / Shares offered
A company offers 10,000,000 new shares at $4.00 each, raising $40,000,000. Investors apply for 25,000,000 shares, so the subscription ratio is 25,000,000 / 10,000,000 = 2.5 times, meaning demand is two and a half times the supply. If the shares are shared out in proportion, each applicant receives 10,000,000 / 25,000,000 = 40% of the amount requested, so an investor who applied for 50,000 shares receives 20,000 shares and the unused $120,000 of the $200,000 requested is returned.Case study
Seen in the real world.
Skylark Energy is an illustrative, fictional company that planned to raise $60,000,000 by offering 20,000,000 shares at $3.00 each. The founders feared weak demand, so they arranged an underwriter to take any unsold shares in return for a fee. The fee was a cost of insurance that they hoped would never turn into a purchase.
When the offer closed, investors had applied for 30,000,000 shares, a subscription ratio of 1.5 times, and the book had filled within two days. The company allocated each investor two thirds of its request, and the underwriter was not needed.
In this illustrative story, the strong demand allowed Skylark to raise the offer price slightly for its next round. The founders said that the real value of the exercise was learning how many investors were prepared to back the business before they committed to the expansion. They also noted that the investors who did not receive a full allocation were prime candidates for the next offer.
Watch out
Common mistakes.
- Assuming a subscribed offer means the money has already been received, when payment may be due later.
- Treating oversubscription as a guarantee that the share price will rise after listing, when later trading depends on results and market conditions.
- Confusing subscribed capital with paid-up capital, which are not necessarily the same.
Questions
People also ask.
What does oversubscribed mean?
It means investors applied for more shares or bonds than were offered.
What happens when an issue is undersubscribed?
The issuer may lower the price, extend the offer or call on underwriters to buy the unsold part, and in the worst case the offer can be withdrawn.
Do applicants always receive what they asked for?
Not when an issue is oversubscribed, because the issuer may scale back orders to share out the available securities, and any money paid on application beyond the allocation is normally refunded.
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