How to invest in an IPO: 4 things to know

While Aucklanders spent six years in lockdown during 2021, it turns out IPOs were popping off. The great IPO bonanza of 2021 set an all-time record year for IPOs taking companies to list on the US share markets. But before we delve into the big picture of IPOs, let’s zoom in.

What is an IPO?

An initial public offering, or IPO as it’s commonly known, is a company’s first time offering its shares for sale to the public. Also known as ‘going public’, when a company goes through an IPO, new shares are created and sold to raise money. Money raised is typically used to grow the business, to grow revenue and profit, and occurs after a series of capital raising efforts in the private sector have run their course. 

During an IPO only a select group of investors are given the opportunity to invest - think big banks, and big private investors like Warren Buffet. It’s only after an IPO that the remaining shares become available to everyday retail investors after listing on a stock exchange, like the Nasdaq or NYSE.

A whopping 1,035 IPOs landed on the share markets in 2021, which was more than double the amount in 2020. Among the companies making their public debuts were Bumble (BMBL), Coupang (CPNG), Palantir (PLTR), Roblox (RBLX) - and of course, Aotearoa’s own Allbirds (BIRD). Due to volatile global market challenges, like the ongoing impacts of Covid, inflation hikes, supply chain issues, shipping bottlenecks, however, many newly listed companies struggled with achieving their planned growth targets (squeezing out any return for early investors). 

The increase in IPO listings was in part due to more special purpose acquisition companies (SPACs) listing on the share markets. SPACs are shell companies created solely to merge with a private company to take it public. By going public through a SPAC, the listing company has fewer regulations to navigate, and can therefore list more quickly without the higher level of scrutiny of a typical IPO. But having fewer eyeballs on the process is not necessarily a good thing. 

2022 shaped up to be a slower IPO market. This is likely due to global supply chain challenges, the Russia-Ukraine war. and the impacts of climbing inflation and interest rates. But there still are high profile companies seeking to IPO in 2022, including Stripe, Reddit and Databricks.

Thinking about investing in IPOs?‍

It’s easy to get caught up in all the excitement and possibility of buying into one of your favourite companies. That’s just human (and it can also make investing feel exciting, because you’re buying a slice of a company you like). But before you go putting all of your hard-earned money into the ‘latest and greatest’ IPO, it may help your decision-making by embracing these four steps:

1. You can learn a lot from a company prospectus

An IPO prospectus is a legal document produced by the publicly-listing company that details the IPO, business operations, debts, revenue and how the company plans to spend the money they raise. To find it, go to a browser like Google, and type: ‘investor relations + company name’ and it should pop up. Remember too, while most companies disclose as much information as possible in their prospectus, it's written by the company wanting to sound like one worth investing in, and not by an unbiased third party. Reading the prospectus can be a starting point for research, but it may be wise to supplement this info with other research. Which takes us to number 2….

2. Do the research (and then some!)

Getting information on companies that are about to go public can be a challenge. Unlike most publicly traded companies, private companies don’t typically have analysts pouring over their every move. You can still use the internet to search for information on the company and their competitors, how they’ve raised money so far, any new products they’re planning, along with growth strategies and overall industry information.

Read news sites too, to find out more about the company’s leadership, governing board and consumer sentiment. Look for things like investigations, inconsistencies with what they’re saying and consumer and competitor sentiment, issues with the board or governance, their environmental practices, and whether they’re a progressive or mature industry. Information available online may be limited or hard to find, but learning as much as you can about the company will help you decide whether you want to own a piece of them.

3. Look into lock-up periods

IPOs come with contractual lock-up periods. The lock-up period is typically around 90 to 180 days. During this time, insiders like founders, directors and employees aren’t allowed to sell their shares. Why? The main reason for an IPO lock-up period is to stop large investors from flooding the market with shares (and devaluing the share price and company as a result).

Many seasoned investment professionals recommend that investors wait for the lock-up period to expire before investing in newly minted companies. Even when share prices are going up during a market boom, this same market isn’t always favourable to new listings. New stocks can fall in price when insiders unload their shares at the end of the lock-up period, which happened to Facebook. This is when some investors swoop in and buy shares of the relatively new company for a bargain. Waiting for lock-up to finish also gives you time to track a stock’s performance.

4. Consider and avoid hype

Even for the most optimistic investors, scepticism can be a positive strategy when you’re considering investing in a newly listed company. There can be quite a bit of uncertainty surrounding IPOs, and as a result, share price volatility. It can be wise to approach investing armed with information, so you’re better placed to avoid a potential flop. 

Buy more than multiple companies at once

If you don’t have the time to invest in individual IPOs and do your research to see if they’re really worth your money, you may consider an Exchange Traded Fund (ETF). An IPO ETF tracks the performance of companies that have recently gone public. By buying shares of an IPO ETF, you’re able to invest in a large number of IPOs with a single fund and not rely on being a company picking expert.