What is Allotment?

What is Allotment?

The term allotment, in business, refers to the structured and systematic distribution of the business’ resources. Commonly, the term allotment is used in the context of equity distribution in finance.

A company that offers its shares to the public uses the process of allotment to determine the amount of stock offered to different entities. The entities include the underwriting firm that’s been chosen for the initial public offering (IPO) of the company and others that are given the right to sell IPO shares.

Other Forms of Preferential Allotment

1. Stock Split

Share allocation can occur in multiple other ways as well. One of the ways is known as a stock split. It is usually done when an existing public company needs to raise more capital. Under the stock split system, the directors of a company may decide to earmark stock to all or a limited number of existing shareholders.

They may be shareholders who previously applied for new shares or are existing shareholders of the company. The company may then use pro-rata allotment, or a proportionality principle, to distribute more shares among existing shareholders.

2. Rights Issue

A company may also opt for a right’s issue. In a rights issue, rather than allocating shares automatically, the company gives existing shareholders the option to buy new shares. For example, a company may announce that an investor may apply to purchase one new share for every ten shares held by the investors.

A company may also raise equity capital in order to fund a takeover or an acquisition of another company. In such a case, rather than raising capital on the stock market, the company may allot the shares to the existing shareholders of the company that is being acquired. It is an effective method for the investor to trade their old shares for equity ownership in the acquiring company.

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3. Employee Stock Options (ESOPs)

Companies may also use systems such as employee stock options (ESOPs). Under ESOPs, companies may allot shares worth part of the employee salary to their employees, rather than paying the full salary. It is an effective method of boosting employee ownership in firms and creating incentives for better performance.

The above allotment types are widely considered a good way to rewarding existing shareholders. They also enable companies to issue more shares without necessarily diluting share ownership. In some cases, dilution may be an effective way of overcoming the potentially adverse influence of outside forces or extremely large shareholders on the company.