IPOs: Initial Public Offerings

IPOs are when private companies first sell shares to the public. While IPOs can be exciting, understanding how they work helps you avoid costly mistakes. [DEFINITION] IPO (Initial Public Offering): The process through which a private company offers shares to the public for the first time, transitioning from private to publicly traded status. ### The IPO Process 1. **Preparation:** Company hires investment banks as underwriters 2. **Due diligence:** Lawyers and accountants verify financials 3. **SEC filing:** Company files S-1 registration statement 4. **Roadshow:** Management pitches to institutional investors 5. **Pricing:** Underwriters set the offering price 6. **Trading begins:** Shares open for public trading [EXAMPLE] A company goes public at $20 per share (IPO price). On the first trading day, it opens at $35 (a "pop"). Institutional investors who got shares at $20 have an immediate 75% gain. Retail investors buying at $35 may be overpaying. ### IPO Terminology - **Underwriter:** Investment bank managing the IPO - **Offering price:** Price institutions pay for shares - **Opening price:** First public trade price - **IPO pop:** Percentage gain from offer to open - **Lock-up period:** Time insiders can't sell (usually 90-180 days) [KEY] Most retail investors don't get IPO shares at the offering price. They buy at the opening price, which is often significantly higher due to IPO pops. ### IPO Statistics That Matter Research shows: - IPOs underperform the market over 3-5 years on average - The first-day pop benefits insiders and institutions - Post-lock-up expiration often brings selling pressure - 60-70% of IPOs trade below their IPO price within 3 years [TIP] If you want IPO exposure, consider waiting 6 months after the IPO. By then, the lock-up has expired, early hype has faded, and you can evaluate actual public company performance. ### Red Flags in IPOs - **No profits:** Many IPOs are unprofitable companies - **Extreme valuations:** Price-to-sales ratios above 20 - **Insider selling:** Heavy selling at IPO - **Dual-class shares:** Founders control voting despite minority ownership - **Complex business model:** If you can't explain what they do, be cautious [WARNING] The dotcom bubble of 2000 saw unprofitable companies IPO at billions in valuation, only to go bankrupt within years. Excitement is not due diligence. ### How to Research an IPO 1. **Read the S-1:** Focus on risk factors and financials 2. **Understand the business:** Can you explain how they make money? 3. **Check valuation:** Compare to established competitors 4. **Watch the first 6 months:** See how management handles public scrutiny [EXERCISE] A hot tech company IPOs at $30, opens at $60, and you buy at $65. Six months later, it trades at $35. What lessons can you learn? |ANSWER| 1) Don't chase IPO hype—the opening price often reflects excessive enthusiasm. 2) Wait for the lock-up expiration—insiders selling drove the price down. 3) Valuation matters—the stock fell 50% from where you bought because the $65 price was unjustified. [SCENARIO] You're excited about a company going public. They're growing revenue 100% annually but losing money. The IPO values them at 30x sales. What questions should you ask before investing? Key questions: 1) When will they be profitable? 2) How much cash do they have (runway)? 3) What's the path to profitability? 4) Why is this valuation justified versus profitable competitors at 5x sales? 5) Can I wait 6 months and reassess at a potentially lower price?