IPOs: Not just for high rollers

There sure have been a lot of big-name initial public offerings (IPOs) so far this year, and a lot more in the pipeline.

Already we’ve seen Zoom, Slack, Beyond Meat, Chewy, Fiverr, Pinterest, Uber, and Lyft. Still on deck are AirBNB, Postmates, Robinhood, and WeWork parent The We Company.

Traditionally, retail investors have been unable to participate in IPOs. The big winners were investors affiliated with the underwriting banks that sell the initial shares.

Recent innovations in both regulations and how the financial services industry responded now make IPO investment possible for the retail investor.

Think twice

Just because you can do something, though, doesn’t mean you should. Many investment advisors, when presented with a client interested in new IPOs, suggest waiting a few months to avoid the initial volatility. This might limit the upside, but it gives the investor a chance to actually get a peek at company earnings.

Still, we can’t avoid the subject. There are a lot of IPOs being floated now. There were 70 in the first half of this year, so we’re on a pace to exceed the 134 that debuted in 2018, which eclipsed the 107 the year before.

What this suggests is an appetite – presumably among both issuers and investors – for more of these. The underwriters are nowhere near capacity. So far this millennium, barely 2,000 IPOs hit Wall Street. From 1990 through 2000 – a period that’s only about half as long – there’s more than double that number.

In 1996 alone, there were 677 IPOs including Yahoo, which Business Insider once called one of “the 11 greatest IPOs of all time”. It also saw the debut of Cymer, a semiconductor equipment maker that is still publicly traded and returned ample value to its Day 1 investors. Ingram Micro was also part of the Class of ’96 and thrived for 20 years before agreeing to be acquired.

But it also included Remec, a onetime wireless communications equipment maker that was eventually liquidated; a court-appointed receiver now runs its website. Then there was PointCast, a dot-com that declined to take News Corp’s half-billion-dollar offer for a screen saver and ended up going nowhere. Lest we forget, 1996 also brought us InVision Technologies, a security screening device maker that ran afoul of the Foreign Corrupt Practices Act.

So give the following menu of ideas a read, but please think about it – and talk about it – before you act.

Public options

Let’s start with the caveat that IPO investing can be risky – it is day-trading in its undiluted form: taking shares that had no market value when you woke up this morning and flipping them before your kid’s soccer game at a price greater than the issuer might ever reach again. So absolutely talk to a financial professional before dipping your toe into this particular pond.

That said, here are a few potential paths to buying into new companies.

  • Non-traditional underwriters. For its IPO, Intercontinental Exchange, the parent company of the New York Stock Exchange, picked Etrade as an underwriter. That’s the same Etrade that helped bring Facebook public. Other small-scale underwriters include Keefe Bruyette Woods, Allen & Company, Canaccord Genuity and Northland Securities. If you’re what the Securities Act of 1933 defines as a “qualified investor” – and if you make more than $200,000 per year from all sources – opening accounts with non-traditional underwriters might be the best pathway for you.
  • IPO funds. Many exchange-traded funds are owned by institutions that underwrite IPOs or are otherwise toward the front of the line when it comes to participating in them. Some of these specialize in using their parent firm’s clout to give retail investors a chance to get in.
  • Direct listing. In a direct listing, a company lists on a stock exchange but doesn’t actually sell shares. Instead, current equity holders – that is, the executives, vested employees, and early-round venture capitalists – can then sell their shares on the exchange. This is how Spotify and Slack launched.
  • Regulation A. Regulation A of the Jumpstart Our Business Startups Act of 2012 allows for startups to do a light version of an IPO, providing that they’re seeking to raise less than $50 million. This path gained the market’s respect in August 2017 when Chicken Soup for the Soul Entertainment turned a $30 million Reg A raise into a stock trading on Nasdaq as CSSE.
  • Equity crowdfunding. Equity in issuing companies – usually going the Reg A route – can be purchased away from the exchanges through such online platforms as AngelList, CircleUp, and Fundable. This is the next generation of IPO-focused exchange-traded funds. If you find ETFs more comforting, they are still an available option.
  • Investing in companies with IPO stakes. Every innovation-heavy enterprise has a “Ventures” subsidiary that finds and nurtures startups that they hope will transform the business. SoftBank, the exemplar of this dynamic, started out as an electronics parts retailer in Japan, then invested in Vodafone and Sprint, which caused it to morph into a telecom. Then it bought into Alibaba, Uber, and WeWork and essentially became a merchant bank. It now backs DoorDash, Wag, and Flipkart among others. But Salesforce, Google, Tesla, and other brainpower nodes are all playing the same game. If you want to invest in the tech these companies are excited about, you could do so indirectly by buying their stock. Of course, that means you’re primarily investing in their core businesses, so you will want to be sure you are comfortable with that.
  • Directed shares. IPO issuers sometimes allocate shares to “friends” of the company. The trick here is to be intimately involved with the issuer while it’s still pre-IPO. So you would need to be of some perceived value to the founding team. This isn’t an option for passive financial investors, but we’re just throwing it out there.

Weigh the risks

The two decades since the dot-com boom and bust have seen the advent of many policy initiatives that have changed the IPO landscape. The main reason the JOBS Act was considered necessary is that, in 2002, the Sarbanes-Oxley Act (SOX) overreached and quashed small firms’ prospects of going public. In an effort to rein in the excesses of the 1990s equity markets, SOX placed an excessive financial burden on publicly traded companies and, despite the JOBS Act, IPO volume for small firms remains far below historical norms.

The passage of time has also seen changes in the business climate. Established companies with strategic interests in innovative young firms are offering startups enough cash that many are skipping the IPO roadshows entirely. In 1991, around 90% of venture capital exits went to the IPO market and the remainder were purchased through mergers-and-acquisitions deals. By 2001, these proportions were reversed, and to this day M&A has maintained that position.

This would tend to depress supply of IPO issuances while demand remains strong, which in turn suggests that today’s Day One investors might be paying a premium for the privilege of being first in line.

Also, consider the age of the present expansion. Nobody wants to be the last one to leave the party. It’s telling that there were 380 IPOs in 2000, but only 79 the following year. There were 159 in 2007, and only 21 the year after that. Depending on how much room for growth you believe is left in this economic cycle, an IPO might not be a suitable investment.

So, while there are lots of ways to get in the ground floor of new stock issuances, maybe you ought to speak with a financial professional first.

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