2020 has been an interesting year. On one hand we had the pandemic wreaking a havoc on economy & people of most countries. On the other hand, we saw so many IPO’s happen in such a choppy market. I would have imagined companies might be hesitant to go public earlier. But we have seen the exact opposite. With this in mind, I wanted to walk through all steps of an ipo process. This can help you to understand how IPO’s work. At the end I also discuss how to invest in IPO’s at offering price before it opens to everyone in market.
What is an IPO?
By default, most companies are privately held. They could obtain funding from family, founders, private equity investors, venture capitalists etc. Most companies start this way. Then they start growing, making more revenue year after year.
Eventually they reach a stage where they want to get more capital to grow further. Private investors until this point might want to cash out. Get rewarded for their initial investments etc. Sometimes it’s to just bring down debt, compete better, reward employees etc. At this point the private company would try to go public. This act of going public from a private status is the quintessential IPO process.
As part of ipo process, the private company can choose to issue/sell a portion(20-30%) of their company and raise cash/capital. Whatever be the reason and how much ever be the portion a company wants to list, they go through an ipo process which we will discuss next.
IPO Process Timeline
How do retail investors get in at Offering Price during IPO Process?
As you can see the IPO process is geared to sell shares to institutional investors. They have the biggest pockets and bring more fees to brokers and banks. Without them buying the large number of shares of the private company, there is not much demand us retail investors can fulfill. However, for some IPO’s underwriter might issue 90% of the shares for institutional and another 10% for retail investors. This completely depends on the underwriter, number of shares they want to issue, demand etc. When this happens there is a very small chance retail investors will get to buy some IPO stock at offering price. In the above-mentioned IPO process, this happens before and right after pricing stage. You need to make sure you do the following:
- Need to have an account with a broker that has access to IPO’s. Morgan Stanley, Goldman Sachs, Citi & J. P Morgan are the biggest underwriters. So, having a brokerage account at one of these places helps. Last I checked, Schwab doesn’t offer any IPO’s. Fidelity does have a deal to allow retail investors to get in with a few underwriters.
- After this, you need to check with your broker if you need to apply and what are the requirements to participate in IPO’s. Fidelity requires you to have from 100-500K in assets with them.
- If you are eligible, when the S-1 comes out, its possible your broker asks you to show your interest. At this point, you can say you want x number of shares. This is just expressing interest. Its not an order.
- Then on the pricing date/effective date, the broker can send you another notification with the offering price and asking you to confirm your interest. This is when it becomes an order. Then overnight the broker will try and get you the shares at offering price. You may or may not get same number as your order. All depends on how many shares your broker had available.
- You are still getting in before the stock is available to normal public next day. So, there is a chance you get to ride a pop that most people expect. But, remember its possible shares can go down if the IPO was a bust and then you are left holding your allotted shares with some loss.
Buying pre-IPO shares in secondary market with services like Equity Zen/SharesPost/Second Market
This is lesser known, way more risky way of obtaining shares in pre-ipo private companies on secondary market. In most cases, these 3rd party companies invest on your behalf. They have their own rules like you have to be an accredited investor, lock your money for 2-5 years. Some have a minimum like 10K USD to invest etc. Most of the times these also have 5+ % in fees etc. So be very aware of the risks when going this route. Here are some reviews of Equity Zen, Second Market.
Important dates to remember just after IPO
Quiet Period
Usually after the IPO, SEC requires analysts some of which might be of the underwriting banks to not publish any research reports for 20-30 days. This avoids any chance of them publishing rosy reports to drive the price higher in initial days of trading.
Lockup Expiration
During the ipo process, underwriters and management of the company might choose a 3 to 24 months period during which employees, insiders /early investors cannot sell their shares. Each IPO has its own lockup period. However, employees and insiders rush to sell shares as soon as the lock up window expires. This creates a selling pressure on the stock.
My thoughts on IPO’s
As we have seen through out the IPO process timeline, each stage is geared towards making as much money as possible for the private company. The more money they get, more commissions underwriters get. Institutional investors get the shares at offering price and very few high net worth individuals might get some allocation at offering price. Everyone like me and you will mostly have the option to only buy it in public markets on offering date at open price.
Not only this, but in recent years private equity investors have funded private companies for long without going public. They pump in millions and billions of dollars in companies to take their valuations to multiple billions of dollars. Uber IPO’ed at around 70 billion. Alibaba at 230 billion. Facebook at 104 billion. Most of these companies fell in value after their IPO’s. Then regained afterwards. Contrast this to CMG which IPO’ed at 540 million in 2006. IPO’ing at smaller valuation allowed investors to get in and reap rewards in the long run. Its grown more than 20 times its IPO valuation. But for BABA and FB to grow 20 plus times would mean them reaching more than 2 trillion in valuation.
So my approach with most IPO’s has been to pass on them especially in first few days/months. Let the lockup expire. Then see if I want to invest or not. What is your approach to IPO’s ? Let me know in comments below.
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