Initial Public Offerings can be among the most exciting opportunities available to investors, especially in the age of tech startups with red-hot growth, and they also come with increased risk. But what exactly are they, and how can retail investors participate?
Private companies that need capital can raise it by selling shares in the company to investors in what is known as an initial public offering or IPO. An IPO is one method companies may use to raise capital and is a direct path to trading on a U.S. stock exchange, where stocks can be traded publicly. In exchange for selling a piece of the company to the public, it can boost its profile and get cash to grow.
For investors, IPOs can provide an opportunity to purchase shares before a company begins trading publicly. Some investors participate in IPOs in hopes the company’s value will grow over time, but IPO investments also involve significant risks, including price volatility and uncertain performance after the stock begins trading. As with any investment, it’s important to carefully consider both the potential opportunities and risks before investing in an IPO.
The IPO process requires a company to file a prospectus with the U.S. Securities and Exchange Commission. The filing lays out key information about the business, including its financial history, current revenue and debts, potential risk factors and plans for the newly raised capital. It also lists the details of the offering. A company typically hires an investment bank to act as underwriters or buyers of the shares before selling them to the public. The underwriter helps determine the offering price, number of shares to be sold and timing of the listing. The company also selects whether to list on the New York Stock Exchange or the Nasdaq Stock Exchange.
Traditionally, underwriters offer IPO shares to institutional investors and company insiders. It’s often a complicated and selective process because underwriters want to sell IPO shares to individuals who will remain long-term investors. If it is a popular company, an IPO can become oversubscribed, meaning there are more investors than shares. An IPO is typically priced the day before it starts trading, and it may go up or down depending on investor demand. Some IPOs will have a lock-up period during which IPO investors are not allowed to sell shares, ranging from 90 to 180 days. It’s not uncommon for the stock to fall when a lock-up period expires as some investors seek to cash out.
Not everyone can purchase shares in IPOs, although it’s a lot easier now thanks to digital platforms like SoFi (NASDAQ: SOFI), which allow everyday investors to request IPO shares with no account minimums. Before companies like SoFi came on the scene, IPO shares were relegated to institutions and high-net worth investors. SoFi may participate in certain IPO offerings through relationships with underwriters, acting as part of the underwriting syndicate to distribute shares to retail investors. SoFi Securities provides eligible members access to IPOs by allowing users to browse upcoming offerings, review the prospectus and submit an Indication of Interest.
When it comes to investing in IPOs, there are pros and cons. Pros include early access to a potentially growing company, possibility of significant price movements, liquidity, portfolio diversification, and transparency from SEC filings. Cons include volatility, risk of falling below IPO price, limited company history, downward pressure when lock-up expires, and potentially unsustainable valuations.
Before investing, it's important to do due diligence by reading the entire prospectus, understanding the company’s business model, revenue streams and competition. Pay special attention to risk factors and how the company plans to use proceeds. IPO investing is now more accessible to retail investors through platforms like SoFi Securities. For more information, visit SoFi's IPO page.
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE. Brokerage and Active investing products offered through SoFi Securities LLC, member FINRA/SIPC. Investing in an IPO involves substantial risk, including loss of principal. For a comprehensive discussion of risks, refer to SoFi Securities' IPO Risk Disclosure Statement. This is not a recommendation and does not constitute an offer of any securities.
