Is there anything more romantic than the moment a private company goes public?
Well, okay, maybe a few things. But only maybe. An initial public offering (IPO) is how a private company opens its ownership to the people of the world.
One reason IPOs get so much attention is because of the opportunity they present a certain class of investors. These are the ones who invest in the company just before it’s listed on the New York Stock Exchange (NYSE) or Nasdaq. These early investors usually get shares at lower prices. If the company they invest in becomes a big-time success, these investors can get very, very rich.
So you, the retail investor, are probably at least a little interested in getting involved in an IPO. Are IPOs a good investment for you? Where do you start? Who’s on the block?
Slow down, though. There are lots of factors about IPOs to consider before you dive in — if you’re even allowed in the pool at all.
About the IPO Process
An initial public offering is the most important moment in the history of a private company that chooses to offer ownership shares to outside entities.
It’s a massive undertaking in terms of time and expense. Some private companies that are cash-rich choose not to go through with it—their owners prefer to maintain total control. Others go public using structures other than an IPO.
The typical IPO process takes around six months. Private companies hire financial underwriters to evaluate their value and draw up the initial paperwork. Once the Security and Exchange Commission (SEC) approves, they begin setting the price and amount of shares they’ll offer to the public. Company leaders usually go on a “roadshow” to promote their company to institutional investors.
In the first stages of the IPO, shares are sold to investment banks, which release them for sale to institutional investors. They set the final share price for the stock’s first day on the stock market. On the day after, the stock appears on the exchange and the public can officially buy them.
How to Get Into IPO Investing
The first few days of an IPO are dominated by institutional transactions. You won’t find many individual investors taking part in these rounds. Those few individuals who do get in at the early stage are usually active traders with high net worth.
Retail investors generally don’t get in on the early rounds of investing. That’s unfortunate for them because share prices in the early stages are usually extraordinarily cheap. When the stock finally debuts on the exchange, its price is likely to go up sharply if a lot of shares are traded off the bat. It may only take a matter of minutes for the price to go up by 50%.
Owners, early investors, and private equity investors, therefore, make most of the money at this stage—on the backs of the retail investors creating the first-day activity.
Why do companies resist retail investing in IPOs? The earliest stages of a company’s public life can be volatile and risky. Using institutional and established investors is how a company grounds itself during those initial, vulnerable periods. Retail investors, alas, aren’t seen as stable sources of capital at this stage, deservedly or otherwise.
That said, there’s still a chance for individual investors to get into an IPO before the final public stage when prices are lower. A lot of conditions need to be in place, but strictly speaking, there’s still a chance.
Find an Accommodating Brokerage and Meet Their Standards
It starts with your investment brokerage. It must have a policy in place that allows its account holders to invest in IPOs. Not all of them do, but many of the biggest— Schwab, Fidelity, TD Ameritrade, E*TRADE— allow IPO investing.
However, even if your brokerage allows investing in IPOs, they don’t do so for all of their customers. An IPO investor must meet certain eligibility requirements. These prerequisites usually involve the investor’s personal net worth and trading activity—both must be high.
The requirements differ from broker to broker. Fidelity’s are tough: Someone looking to take part in an IPO must have $500,000 in assets in their Fidelity account and must have made 36 trades in the previous 12 months. TD Ameritrade is a bit less strict: $250,000 in assets or 30 stock trades in the last year.
E*TRADE is the only exception to the minimum requirements, but they do ask you to fill out a questionnaire provided by the underwriters. Since the underwriters are making the decision, you can expect the questions to be on the difficult side.
If you meet your brokerage’s requirements, you’ll ask them to release shares in the IPO to you. When possible, the number of shares you request should be fairly high. That’s because you might not get all the shares you ask for. The brokerage may not have enough shares on hand to accommodate everyone, and they’ll still give preferential treatment to institutional investors at this stage. To maximize your chances, give them a tall order.
You’ll also be placing a “limit order” for the shares. This is the maximum amount you’re willing to pay for them. When deciding this, remember that you’re probably not going to get the same low price first investors got when the IPO got underway. Your limit order should reflect that factor, so it pays to be as generous as you can afford. The price will move, probably dramatically once the stock is opened to the public—hopefully in an upward direction.
Order Your Shares
On the night before the shares are released to the public, your brokerage will let you know that your purchase offer is moving through. They’ll give you a deadline to finish your order. This is the point when you’ll find out for sure whether you’ll get any shares at all. No matter what, you’ll get no more than the number of shares you requested. But you also won’t pay more than the amount you set with your limit order.
Think Before You Buy
Investing in IPOs is not for everyone. The stakes are incredibly high in an IPO, so the risk is elevated. You can expect the price to fluctuate wildly once public trading starts. Some IPOs launch with high price points, only to see the share prices fall if initial trading isn’t heavy enough.
But if you have nerves of steel and the stomach to match, an IPO can be a very good chance to take. You’ll likely get the stock for a discount price. If your company’s solid and turns a profit long-term, its share prices may never return to that low point.
So, the first thing to think about is how much risk you can tolerate. The second is to consider your timeframe. IPO investing is best when it’s approached with a “buy and hold” strategy, not a “hit it and quit it” one. (In fact, you may be required to hold on to your shares for a minimum time. The company wants investors who won’t use their new shares to turn quick profits, at least in the early stages.)
If everything’s aligned in your favor and you decide to try IPO investing, it’s time to do homework—lots of it. Get to know everything about the company that you can. Pour through their S-1 prospectus that the company files with the SEC. It contains a wealth of information about company fundamentals, financial status, areas of potential growth, and other factors.
How to Find The Right IPO
So you haven’t been scared off yet? Great. Now, where do you find upcoming opportunities for IPO investing?
There are a few online sources that can help you out. The two major US stock exchanges, the NYSE and Nasdaq, have pages on their websites that address upcoming IPOs—respectively, the IPO Center and Upcoming IPO.
You can also find IPO lists on websites like MarketWatch, PO Monitor, Yahoo! Finance, and Stock Analysis. A simple Google search for “upcoming IPOs” will give you a list of IPO-related articles from trusted financial news sources. These include Kiplinger, US News & World Report, and others.
Keep in mind that IPO information can be very fluid. A company may make an announcement that they’re going to go public, then not say anything else for months. Or they may postpone their IPO if they haven’t been able to drum up enough interest from institutional investors.
Also, remember that not all companies that go public are going to go the IPO route. Some will eschew lining up private investors and head straight to the stock exchange (this is called a “direct listing”). Others may use special purpose acquisition companies (SPACs) who’ll merge with their company to get on the stock exchange. The company itself won’t have an IPO, but the SPAC will.
Finally, consider that it may just be best to wait a few days after the IPO finishes up to invest in shares. No, the prices won’t be as dirt-cheap as they were doing the IPO and may never be again. But if you truly believe the company’s headed for superstardom, then the price they’re at in the few days after the IPO may still be cheap enough to garner huge profits in the future.
However you decide to begin IPO investing, remember that due diligence, high risk tolerance, and ridiculous amounts of information are the weapons you’ll need the most.
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