The market for newly public companies is an exciting one. Who wouldn't want to enter the "ground floor" of a company with the opportunity to profit from its future growth?
But investing in an initial public offering (IPO) can be confusing, if not downright risky. If you're thinking about investing in IPOs, it's important to remember that many IPO stocks underperform broader market benchmarks in the long-run. Not all IPOs become unicorns.
But profits await for those who pick the right IPO stock. While financial institutions, company insiders, and wealthy clients typically have greater access to IPOs, the average retail investor can also get in on the action.
But just because you can invest in IPOs doesn't mean that you should. Here's what you need to know when deciding on an IPO stock.
With an IPO, a private company "goes public" by offering its stock for the first time on a stock exchange, like the NASDAQ or NYSE. In order to make a registered offering, a company must file a registration statement with the US Securities and Exchange Commission (SEC).
The IPO process differs from a direct public offering (DPO) in which a company directly lists its stock on the market.
Companies go public primarily to raise capital or expand operations. With traditional IPOs, businesses hire an underwriter — usually an investment bank — who leads and directs the IPO, drafting the company's prospects, setting the IPO price and drumming up interest from potential investors, known as an IPO roadshow.
IPOs have long been more accessible to institutional entities (eg. hedge funds, mutual funds, insurance companies) and high-net-worth clients with more capital to trade.
While company executives (and sometimes employees) also have access to IPO shares, investment bank underwriters typically give larger amounts of shares to institutional clients because they believe that they're better equipped to purchase the shares and assume any risk over the long-term, according to the SEC.
But several online brokerages have created ways for retail investors to get in on the action. If you don't want to wait until a company's IPO shares have listed on the exchange, you may be able to get in at the offering price.
Many discount brokerages have given retail investors more access to IPOs. These online platforms allow you to "participate in an IPO," but you'll usually need to meet several eligible requirements before you can request shares.
Some brokerages have minimum account size mandates, and most require you to read a company's prospectus and financial disclosures before you move forward in the IPO process.
IPOs can be intriguing for a number of reasons. For one, they afford investors the opportunity to get in on their favorite companies at the lowest price and capitalize off of first-day price surges. Once the shares are available to the public, they can also be financially rewarding to those who participated in the IPO and bought in at its offer price.
However, IPOs also carry notable risks and may not be ideal for beginner investors with long-term horizons. But if you're still interested in purchasing stock before it lists on the exchange, keep reading to see how to get started.
The SEC lists two ways for retail investors to to get in on IPOs. You can participate in an IPO, or, more commonly, purchase the shares when they are sold in the days following the IPO.
To better understand the two ways to buy IPO stock, it helps to know the difference between offering price and opening price:
* Offering price: Though typically set aside for accredited investors and institutional clients with more money to invest, you can also purchase shares of the stock at its offering price if you're a client of the IPO's underwriter. And though it's more difficult to get in as a retail investor, you may still be able to participate in the IPO, depending on your broker.
* Opening price: Also known as the go-public price, this price represents the value at which the public can purchase shares on an exchange. You can buy shares through your brokerage after they're resold to the public exchanges, or you can participate in the IPO if your brokerage allows.
If you wish to participate in the IPO at offering price, here's how to do it.
IPO research can be daunting since there isn't any historical data or market performance history behind the company at hand. But thanks to the SEC, all companies must file a S-1 form to register their offerings. This form basically provides background information on the company, financial information, and a prospectus on the offering itself.
You can also utilize resources like the Nasdaq calendar which provides the latest details on IPOs.
All brokerages have different requirements for participating in an IPO, so make sure to do your due diligence before getting started. For instance, when it comes to minimum account size, Fidelity requires individuals to have either $100,000 or $500,000 in household assets to qualify (see more information on Fidelity's process here).
Brokerages may also require you to fill out an indication of interest (IOI) form to determine how many shares you'd like to purchase. While the IOI window lasts for multiple days, brokerages like Fidelity require IOIs to be for a minimum of 100 shares.
After you've submitted and entered your IOI, you'll need to confirm the IOI in order to receive shares. Though the process varies per brokerage, you can generally do this by locating the IPO deal you're interested in and clicking "participate."
You'll then need to confirm any open IOIs to officially submit your order.
While 2020 was a big year for IPOs, 2021 has proven to be an even bigger year. There have already been 497 IPOs in the US (there were only 72 IPOs by the same time last year), according to StockAnalysis.com.
But it's important to consider the risks behind these investments. IPO stocks are extensions of companies that haven't had long-standing track records in markets, and many investors can confuse popular demand with intrinsic value. For this reason, you should do your research and analyze any company disclosures before moving forward.
In addition, when investing in these newly converted startups and private companies, it's important to ask yourself how much risk you're willing to take on. IPOs are generally volatile, so it's wise to exercise caution when it comes to the first-day pops and prices surges. Companies that are truly valuable will remain that way over the long-term.
That's not to say that IPO stocks can't be rewarding, but it's wise to consider the differences between these investments and blue-chip stocks (blue-chip stocks are popular companies with long track records of success in the markets and their respective industries).
Even though retail investors are getting more access to IPOs, it can still be difficult to get in game. However, there are three other ways to capitalize off new stock. These include (but aren't limited to) the following:
* Direct listings: A direct listing takes place when a company immediately makes its stock available on exchanges without consulting an investment bank to underwrite an IPO. In fact, popular cryptocurrency exchange Coinbase used this approach when it went public in early April 2021.
* Special purpose acquisition companies (SPACs): SPACs, on the other hand, are blank-check companies that raise funds by acquiring and merging with other private companies that want to become public.
* IPO ETFs: IPO ETFs contain a diversified blend of companies that recently transitioned into the public markets. This is generally safer than investing in a single IPO since IPO ETFs lower your risk by spreading your money across multiple IPOs. If you're interested in the hype and short-term demand of single IPOs, these may not be ideal. IPO ETFs make more sense over the long haul.
You'll have multiple options for investing in IPO stocks as a retail investor. If you'd like to participate in an IPO, make sure to compare the eligibility requirements between different apps and review company prospectuses if possible.
But while many companies utilize the IPO model, some private companies also go public through direct listings or with the help of a SPAC.
Nonetheless, it's wise to do thorough research before buying stake in a newly listed company. IPO investing can be risky even if it's with high profile companies who've recently crossed over into the public realm. But no matter which investment type you choose, experts recommend only investing what you can afford to lose.