Allotment

What Is an Allotment?

An allotment commonly refers to the allocation of shares granted to a participating underwriting firm during an initial public offering (IPO). Remaining surpluses go to other firms that have won the bid for the right to sell the remaining IPO shares. There are several types of allotment that arise when new shares are issued and allocated to either new or existing shareholders.

Understanding Allotments

In business, allotment describes a systematic distribution of resources across different entities and over time. In finance, the term typically relates to the allocation of shares during a public share issuance. Two or more financial institutions usually underwrite a public offering. Each underwriter receives a specific number of shares to sell.

The allotment process can get somewhat complicated during an IPO, even for individual investors. That is because stock markets are incredibly efficient mechanisms for matching prices and quantities, but demand must be estimated before an IPO takes place. Investors must express interest in how many shares they would like to purchase at a specific price before the IPO.

If demand is too high, the actual allotment of shares received by an investor may be lower than the amount requested. If demand is too low, then the investor may be able to get the desired allotment at a lower price. On the other hand, low demand often leads to the share price falling after the IPO takes place.

Allotment can be tricky, so it is a good idea for first-time IPO investors to start small.

However, an IPO is not the only case of share allocation. Allotment arises when directors of a company earmark new shares to predetermined shareholders. These are shareholders who have either applied for new shares or earned them by owning existing shares. For example, in a stock split, the company allocates shares proportionately based on existing ownership.

Special Considerations

The number one reason a company issues new shares for allotment is to raise money to finance business operations. An IPO is also used to raise capital. In fact, there are very few other reasons why a company would issue and allocate new shares.

New shares can be issued to repay a public company's short- or long-term debt. Paying down debt helps a company with interest payments and changes critical financial ratios such as the debt-to-equity ratio and debt-to-asset ratio. There are times when a company may want to issue new shares, even if there is little or no debt. When companies face situations where current growth is outpacing sustainable growth, they may issue new shares to fund the continuation of organic growth.

Company directors may issue new shares to fund an acquisition or takeover another business. In the case of a takeover, new shares can be allotted to existing shareholders of the acquired company, efficiently exchanging their shares for equity in the acquiring company.

As a form of reward to existing shareholders and stakeholders, companies issue and allot new shares. A scrip dividend, for example, is a dividend that gives equity holders some new shares proportional to the value of what they would have received had the dividend been cash.