Initial public offerings (“IPOs”) have been around for hundreds of years. When a company conducts an IPO, it goes from private ownership to public ownership. When a company “goes public”, its shares begin trading on a stock exchange and are available for purchase by the general public.
Conducting an IPO allows companies to raise capital to pay off debts from a broad range of investors, fund growth initiatives, enhance liquidity for existing shareholders by allowing them to sell their shares as part of the IPO and possibly exit the company, raise the company’s public profile, and gain access to the public equity markets.
When is the right time to go public?
When a company believes it is mature enough to enjoy the benefits and responsibilities of public shareholders and can withstand the oversight rigors of the U.S. Securities and Exchange Commission (SEC), it will advertise its interest in going public. This typically happens when a company reaches a private valuation of approximately $1 billion. Private companies at lower valuations may still qualify for IPO status if they have strong fundamentals, proven profitability potential, and can otherwise meet the listing requirements.
What is the IPO process?
- Advisors: Companies hire financial and legal advisors, such as investment banks, law firms, and accounting firms, to assist with the IPO process. These advisors help with valuation, due diligence, and navigating the regulatory requirements.
- Preparation and Evaluation:
- Proposals: Underwriters present proposals and valuations discussing their services, offering price, amount of shares, and estimated time-frame for the market offering. The company chooses an underwriter.
- Financial Readiness: As noted above, the company must meet minimum requirements to go public, including having a strong financial track record, with audited financial statements, and a history of profitability or a clear path to profitability.
- Proposals: Underwriters present proposals and valuations discussing their services, offering price, amount of shares, and estimated time-frame for the market offering. The company chooses an underwriter.
- Preparing the IPO Prospectus: This document details the company’s financials, operations, risks, and business plan. The company submits the prospectus to the SEC for review and approval. The SEC ensures the prospectus complies with all relevant regulations and provides adequate information to investors.
- Roadshow: The company creates marketing material and its management team and advisors promote the IPO to potential investors through meetings and presentations to institutional investors and potential shareholders.
- Board: The company forms a board of directors and creates processes for reporting auditable financial and accounting information every quarter.
- Listing & Trading: The company’s shares are listed on a stock exchange. On the IPO date, the company’s shares begin trading and investors can buy and sell shares of the stock.
- Post-IPO: Publicly traded companies must adhere to ongoing reporting requirements, including regular financial reporting, disclosures of material events, and compliance with securities regulations.
How do you purchase stocks in an IPO?
Oftentimes, there will be more demand than supply for a new IPO. For this reason, there is no guarantee that all investors interested in an IPO will be able to purchase shares. Those interested in participating in an IPO may be able to do so through their brokerage firm, although access to an IPO can sometimes be limited to a firm’s larger clients.
Regular retail investors are typically not able to get access to shares the instant the IPO stock starts trading. Oftentimes, by the time a retail investor gets to buy the stock the price is much higher than initially listed, so the investor misses the substantial early market gains. New platforms, such as Robinhood and SoFi, now enable retail investors to access certain IPO company shares at the IPO price.
Another option is to invest through a mutual fund or another investment vehicle that focuses on IPOs.
Should You Purchase Stocks in the IPO?
Even if you can get access to an IPO, you should be cautious about investing in it. A private company going public has less available information than an established publicly traded one required to submit filings to the SEC. You will be making an investment decision based on fewer facts than if you were investing in a known entity with an established financial record.
Unfortunately, most IPOs see negative returns. According to Statista.com, more than half of IPOs in 2022 generated negative first day returns. Between 1975 and 2011, over 60% of newly public companies saw negative returns after five years. And, Nasdaq calculated that “[t]hree years after their IPO, … almost two-thirds of IPOs were underperforming the market, with most (64%) more than 10% behind the markets returns.”
One case in point is Lyft (LYFT), which went public in March 2019. It opened at $87.33 and closed at $78.20 that same day. A year later, the stock was trading in the mid-$20 range. As of the date of this article, it is trading around $10. If you had purchased Lyft in the IPO and continued to hold onto it today, you would be out a lot of money.
How are IPOs Faring in 2023?
Over the past few years, SPACs (special purpose acquisition companies) have been all the rage. While these trendy vehicles crowded the public’s vision for a while – with 613 SPAC IPOs in 2021 and 86 in 2022 – they do not match pace with traditional IPOs. In 2021, 1035 companies went public through traditional IPOs and 2022 saw 181 companies conduct traditional IPOs. While IPOs are trending downward, with just 120 in the first nine months of 2023, September was a busy month – with 15 IPOs – with some saying the IPO drought is over.
Five of September’s IPOs collectively raised a combined $5.4B, led by Arm Holdings’ (ARM) blockbuster IPO, according to SA analyst Renaissance Capital IPO Research. Arm’s trading debut at $56.10 on September 14, was the biggest IPO of the year, injecting fresh optimism into the IPO market. Following this strong debut, Instacart (CART) priced its IPO at $28-$30 a share, as the grocery delivery firm aimed to raise as much as $660M, valuing it at $9.3B-$9.9B. On September 19, it opened at $42 per share, but then settled in closer to its $30 IPO price. Meanwhile, Klaviyo (KVYO), a marketing automation company, priced its IPO at $30 and opened trading on September 20, at $36.75, before finishing its first session at $32.76.
What Does the Future Hold?
The economy influences the pace at which companies conduct IPOs. Fears of recession play a role in investor’s decisions to bet on unproven investments. Investors were supportive of the 1035 IPOs in 2021 because they had a high tolerance for risk. Interest rates were near zero and investors felt comfortable taking a chance on companies that had not yet shown profitability. Now, however, investors are more interested in companies that are profitable or on track to becoming profitable. Fueling investor worry is high inflation, which poses a risk to the business prospects of any company going public.
Uncertainty about the government shutdown is also wreaking havoc on upcoming IPOs. A government shutdown will impact near-term IPO prospects because SEC staff will be unavailable to sign off on IPO documents. Companies in earlier stages may also be impacted because they require regulatory input before making their IPO plans public.
With so much uncertainty in the economy, it appears that our IPO numbers will remain south of the markets’ 2021 numbers.
Investing involves risks, and no investment strategy can guarantee success. The information provided here is for general purposes and should not be considered as legal, financial, or investment advice. If you are interested in investing in IPOs you should seek the advice of a certified financial advisor.
-Written by Lauren Levi
