Companies often start as private organizations, but they may go public in an event known as an initial public offering (IPO). Investors could buy and sell shares of a company on stock exchanges once it’s public.
IPOs may generate a lot of buzz from media and market forecasters, resulting in widespread interest among investors. However, this hype may also lead to intense price movements and high volatility.
So would buying IPO stocks benefit your investment portfolio? And if so, how would you buy them? Let’s look closely at IPO stocks and explore their benefits and drawbacks.
What is an IPO?
Watching a company go public could be thrilling, but it's the end of a long process called initial public offering or IPO. During an IPO, the company's public shares are usually sold to institutional investors and wealthy individuals.
People who get to invest in an IPO might be getting in on the ground level of the next hot company, with the potential for a significant return as the company grows.
However, this gain is far from guaranteed. IPOs often experience high risk levels, and their stock prices may move in a volatile manner. Investing in an IPO stock may require a lot of research and readiness for loss because some companies may fail after going public.
Did you knowIn 2021, 951 companies became publicly traded on stock exchanges. This was more than double the number in 2020 and an all-time high.
How does an IPO work?
Company founders often use IPOs to create an influx of capital to help them pay off debt, fund new growth, or create excitement for the company with the general public.
The IPO process requires three main steps to be successfully carried out:
- Regulatory filing and underwriting: When a company begins the IPO process, it chooses a lead underwriter, usually an investment banking firm or broker-dealer, to help it register with the Securities and Exchange Commission (SEC).
- Valuation: The company needs to be valued to determine how much it’s worth. The underwriter then puts a price on the public shares.
- Stock sales: The company may sell its shares to groups of investment banks and broker-dealers before the IPO is official. These groups, known as syndicates, then offer the shares to brokerages, financial institutions, and individual investors. Once the IPO is completed, the company’s shares become publicly available.
Who can buy IPO stocks?
Getting IPO access may prove difficult for many investors. If the company going public is popular or has a lot of hype around it, its IPO shares may all be reserved for investors even before the company goes public.
Some of the investors who may get early access are:
- Syndicates: Syndicates often acquire and sell large quantities of IPO stocks to brokerages and financial institutions. These brokerages and institutions may then offer those shares to high-net-worth clients who want early access to certain companies.
- The IPO company’s employees and friends: The company’s employees, managers, and even friends, family, initial venture capitalists, and other private investors might also be able to buy the IPO shares before its official opening as a thank you for their early support.
- Wealthy individuals: Brokerages may limit who can participate in an IPO offering because there is often a limited supply of IPO stocks. A brokerage may require that customers have a significant amount of assets held with the brokerage, meet specific trading frequency requirements, or have a long-term relationship with the IPO company itself.
If any shares are still available after the SEC certifies the IPO, they would then go on the public market.
That’s why it might be challenging for beginners and new investors to gain access to IPO stocks. You may be able to place a pending order with your broker for any available shares left, but there would be no guarantee you’d get them.
How to buy an IPO stock
If you’re a high-net-worth individual and a company you’re interested in is going public, it would be best to speak to your broker about how you may gain access to its initial public offering. However, if you aren’t a wealthy individual, you might still be able to buy public shares, if any are available, by placing an order through your online brokerage account.
TipCheck out our list of the best brokerage accounts to find the one that best fits your needs as you research and buy the IPO stock you want.
Do your research
Start by researching upcoming IPOs on a stock exchange such as the Nasdaq or the New York Stock Exchange (NYSE). The IPO process may take several months before it’s finalized, so check back regularly for updated information.
If you’re interested in an upcoming IPO, review the documents the underwriter has filed with the SEC. One example is Form S-1, which would contain:
- Background information about the company and its management team
- The company’s financial health and business plan and projections
- Available financial statements
- Risk factors
- The offering price of the shares and dividend policy
- Any required disclosures and information
This form and other documents are reviewed by the SEC. Once approved, the company would be public and begin trading on the stock market. Keep in mind that some Information may change until the SEC officially approves the filing, so there might be several versions of each document.
Researching the IPO company you may invest in is essential since one of the reasons IPOs may have a high level of risk is the lack of available public information. Private companies are not required to make the same disclosures public companies make, which reduces the amount of information about the company’s history and future potential.
Be sure to avoid getting caught up in a company’s IPO hype. Just because a company is going public does not mean it’s financially stable. Many companies have gone public with much fanfare, but share prices drop dramatically a few months later. Some have even gone out of business within a few years.
Find a broker that offers IPOs
Once you’ve researched the company you’re interested in, search for a broker that sells its IPO stock. You’ll need a broker that is included in the initial syndicate offer.
You’d also need a broker that has enough stocks for their clients. If you find a broker selling the IPO stock, make sure that buying it is available to you based on your relationship with the broker.
Because IPO stocks are often limited in number, financial institutions and brokers tend to restrict who can buy them. In many cases, you may need to meet eligibility requirements to be able to participate in an IPO.
For example, Linqto would allow you to invest in some IPOs starting from $10,000, but you would need to be an accredited investor with a $1 million net worth or a $200,000 annual income.
Learn more in our Linqto review.
Many brokers restrict IPO access to investors with a high net worth and experienced traders with a high-risk tolerance. Review the brokerage’s eligibility requirements to see whether you qualify.
Request the IPO stock
If your brokerage is selling the IPO stock and you meet its requirements, your next move would be to request shares in the IPO using your brokerage account. You would normally enter the details of your request, select the account you want to use to complete the purchase, and submit your request. This process is known as an indication of interest (IOI).
Remember that you aren’t ordering the IPO shares yet. You’re simply indicating to your brokerage that you meet its requirements and are interested in an IPO stock it offers. Submitting an IOI doesn’t guarantee that you would be able to buy the stock.
Place the IPO order
After you’ve expressed interest in purchasing the IPO stock, you may be allowed to make a conditional offer. The offer is usually made before the IPO is public and is not a guarantee you’ll be able to buy the IPO shares.
Once you place your order, you might be able to change or cancel it until the SEC declares the company’s IPO filing approved. Your offer would go into effect at this point, and you would see the IPO shares appear in your brokerage account.
Risks of buying IPO stocks
People who invest in stocks online might consider IPOs a great way to get rich quickly or get large returns on their investments. However, all investments come with risks, and IPOs might come with more risk than an average mutual fund or an exchange-traded fund (ETF).
Some risks you may face during or after an IPO stock purchase:
- There is no guarantee of getting access to the IPO shares as an individual investor.
- There is a high barrier to entry, so you might be excluded from participating if you don’t meet eligibility requirements.
- IPOs could be unpredictable. There are no guarantees that the IPO price will stay above its starting price or that the company will be profitable over the long term.
- You may have limited access to information and documents that help make an informed evaluation,as the SEC disclosure requirements differ between public and private companies.
Remember that each company’s IPO is unique and should be evaluated independently on its own strengths and weaknesses. Individual investors may not have the time or skills to assess every available new IPO option, or might misinterpret crucial information.
Alternative options to IPO stocks
If you had your heart set on IPO investing but feel like it might be too complicated, other investment options may help you learn how to invest money in a less risky, more accessible way.
Invest after the IPO
If you favor a company that’s going public but can’t get access to its IPO shares, consider investing after the IPO phase is complete. Allowing the dust to settle on a company’s public launch may save you from the roller coaster effect of fluctuating prices and allow you to make a better-informed decision.
Waiting may also give you more data when deciding whether you want to invest because there may be more financial information when the stock becomes available again.
Invest in IPO mutual funds
Some mutual funds and ETFs may offer access to IPOs. Although investing in them still comes with increased risk compared to a standard mutual fund or ETF. Because mutual funds tend to be conservative investment vehicles, looking for low-risk options to add to their portfolio, you may have to search for a fund with IPOs.
For example, Renaissance Capital established an IPO ETF in October 2013 that still exists today. The fund invests its main allocation in companies that recently completed an IPO and are listed on U.S. stock exchanges.
Invest in stocks and ETFs
If you don’t find any IPO options that appeal to you, or don’t have the stomach for the high risk level, consider investing in standard stocks, mutual funds, index funds, or ETFs. Although you might receive a lower return, you may also have smaller losses.
Remember that all investment options carry risk, and there’s no guarantee you’ll see a return on your investment in standard or IPO stocks. Be sure to do your homework and talk with your financial advisor to help you weigh the risk against the potential reward.
FAQs about IPO stocks
Are IPOs high risk?
IPO shares may be particularly volatile and risky during the first days and months after the IPO is completed. Little company information might be available, which can make it tough to determine its prospects. IPO share prices also tend to fluctuate dramatically when they first become available as investors weigh the company's true value.
What is IPO lock-up?
An IPO lock-up is a term that might be included in an IPO purchase contract that prevents people who bought IPO shares from selling them for a set time. The waiting period varies case by case but might typically be 180 days long. A lock-up agreement might also limit the number of shares an investor could sell at one time.
Lock-up periods are critical when investing in an IPO company because share prices may drop dramatically in anticipation of a rush to sell once the lock-up period expires.
Can you buy IPO stocks on Robinhood?
Robinhood may allow investors to place orders for a small selection of IPO stocks. It does not guarantee that your order will go through, and you wouldn’t be participating in the IPO itself. Robinhood simply lets you put your order in the queue the morning the IPO becomes available, but it wouldn’t execute your order until the stock begins trading publicly.
Read our Robinhood review to learn how the platform works and which services it provides.
IPOs often offer exciting times for new companies but can be potential roller coasters for investors. Although there might be a lot of media coverage that creates significant hype around IPOs, don’t let that coverage lure you into making hasty decisions.
Remember that IPOs come with several risks, and you may not qualify to invest in them if you don’t meet your brokerage firm's eligibility requirements. If you’re interested in investing but you don’t feel ready to take on the challenge of IPOs, you could explore investment opportunities through the best robo-advisors and learn some investing advice from Bill Gates.
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