How do IPO’s work and how can you buy shares before the market opens? In other words, how do you get the initial IPO price which is often much better than you can get after the bell sounds on the first day of trading?
That is what is on a lot of investor’s minds with the possible upcoming IPO offerings of Snapchat, Pinterest, Uber, Lyft, Spotify, Magic Leap and many others. Initial public offerings are always a hot topic and investors are excited about making money and getting in on the ground floor.
What Is An IPO?
An initial public offering is when a private company decides to raise money by selling shares to investors on a listed exchange (usually the NASDAQ or NYSE). It is a long and complicated process involving investment bankers, lawyers, the SEC, and many other groups of people. Usually only companies that are successful and growing will have an IPO because they need to have people interested in buying shares or they won’t make the amount of money they need.
Here is a bare bones summary of how an IPO works:
1) A company decides to go public and hires and underwriter which is a fancy word for an investment bank. That bank analyzes all of the companies records and financials in an attempt to decide what the company is worth and whether they want to take on the job because they will incur a lot of the risk. Bigger IPOs may involve multiple underwriters to spread that risk.
2) The underwriter(s) inform the company through a letter of intent of all their findings and include information on what the stock price might be, how many shares will be offered, how much money will be raised, and what the fees will be. Once the company agrees to the letter of intent, the underwriter files an S-1 disclosure statement with the SEC. This is a comprehensive breakdown of everything related to the intended IPO and it might be the most complicated document that you have ever seen. You can see an example of one here for the Alibaba IPO.
3) The underwriter then has another big job to do: figure out what the market thinks of the company so that it can accurately price the companies stock shares in order to keep interest high when it opens on day one. It is desirable to have a stock that goes up right from the start and picking the right IPO price is a VERY important part of how the offering will be received.
4) IMPORTANT: It will also be the responsibility of the underwriter to find clients who want to purchase the stock at the initial IPO price. The underwriter/investment bank guarantees the company that the shares will be bought and so the banker must find buyers for those shares before the IPO. This is the share price you would like to get if you can because if the IPO is popular, the stock will be bid up at the opening bell on day 1.
5) After months of back and forth negotiating, finalizing, clarifying, and any other business verb you can think of between everyone involved (and that can be A LOT of people), it is finally time to have the IPO. Everything that has led up to the IPO is largely invisible to the common investor who now can at last buy the stock for their own portfolio. Day one of any IPO involves a lot of celebrating and hoopla along with media coverage if the company is well known and popular.
How To Get The IPO Price Before The Market Opens
Unfortunately, it is very difficult for the average investor to get the insider price you hear about on TV. This is because the investment bank responsible for the IPO will first offer shares to people working for the IPO company, big clients, and anyone it wants to curry favor with. From there, other major players in the investment world may be offered the opportunity to buy shares but even some of the biggest hedge fund managers are often left out.
An online broker that does give small investors the possibility of getting in early on an IPO is Motif. Invest in IPOs with Motif Investing> $0 Commission Trades> Pre-Market Access> Flexible Dollar-Amount Investing. Signing up with Motif (its free) will give you a chance of investing in IPO’s where J.P. Morgan is an underwriter due to a partnership between the two companies.
Buying IPO Stocks
The bottom line is that if you are reading this, you will most likely have few opportunities to buy any IPO stock before it goes public. The system is stacked against the average investor to get in before everyone else.
But if you can’t get in on the low pre IPO price, that doesn’t mean that you can’t still make money on IPO’s by buying them when the go public the first day. You can make money, especially if you pick the right ones and don’t get greedy. Remember, a lot of companies go public that you never hear about and not all of them are successful. It is vitally important to pick companies that you understand what they do and you fully believe they have a good business models that will proper into the future. Buy IPO stocks because you believe in their business, not because you want to make quick money.