Allocating Shares for an Initial Public Offering

In the last article, we went through the IPO process.  There are two major parties on the sellside that handle the deal:  equity sales and capital markets.  In the days leading up to the IPO effective date, salestraders are entering their indications of interest;  that is, the number of shares that their buyside clients want and any additional color that may help their clients get a larger allocation.  For a hot deal, buyside firms know that they will not get their number so they overbid i.e. I really want 100,000 shares but I'll order 200,000 to get it.  After the orders are placed, sales and capital markets management start allocating the IPO shares.  They will initially speak with the issuer company on some broad outlines.  The CEO may instruct the bankers to give minimal amounts of shares to hedge funds.  He may be afraid that they will "flip" the shares on the first day.  By "flipping", the fund makes a quick profit by selling the shares - providing that the IPO appreciates.  Or make sure that this fund gets a good allocation as they are a "friend of the firm".

Management will look at the following criteria (in no particular order) for the allocations:

• Amount of secondary commissions done with the bank
• For the last 3 months in the IPO's market (for example, for Netscape's IPO, management would look at US commissions)
• For the last 6 months in the IPO's market
• For the last year compared to the prior year in the IPO's market
• For the last year compared to the prior year global equity markets
• For the last year for derivative and convertible securities
• Amount of primary commissions done with the bank for the year compared to the prior year
• Amount of total commissions done with the bank (secondary and primary) for the year compared to the prior year
• Ranks for each of the commission categories above
• The fund promises to buy aftermarket shares
• The fund is a notorious flipper
• The fund's strategy is buy and hold

Primary commissions are equivalent to the selling concession from a deal.  Secondary commissions are from everyday trading of previously issued securities.  Note that the broker vote does not seem to hold much weight.