Small investors seem more influential than ever these days. So as the initial public offering market heats up, efforts to get those investors a bigger seat at the table is a hot idea. It’s also not a new one.
Upstart brokerages Robinhood Markets and SoFi Technologies recently said they would give their customers access to IPOs. They are among the latest firms to try to crack open one of Wall Street’s oldest clubs: those getting distribution of IPOs at the offering price, before shares begin trading.
That early access gives investors a shot at the vaunted IPO “pop.” Since 1980, standard U.S. exchange-listed IPOs have on average risen about 18% from their pre-trading offering price to the close of first-day trading, according to University of Florida finance professor
data. And some deals do much more than that, occasionally even doubling in first-day trading.
But the Wall Street investment banks that lead IPOs, as well as the listing companies themselves, have typically distributed the bulk of shares in the offerings to institutions. The portion that does go to so-called “retail” investors may go to large wealth-management customers, rather than small self-directed online accounts.
Now, as IPO pops get even bigger in this market—more than 40% on average last year, the best since 2000, according to Mr. Ritter—and as small investors begin to wield their increasing influence over the market, perhaps it seems natural that they might want a bigger slice of the pie.
During the first dot-com boom, some discount brokers sought to get into investment banking to increase their access to stock offerings, but those efforts mostly subsided after the bubble burst in the early 2000s. A couple more recent startups aiming to deliver big slices of hot IPOs to small investors also fizzled.
Established online brokers such as Charles Schwab offer some IPO access, typically via partnerships with investment banks. ClickIPO works with several online brokers to pool small investors and then helps underwriters and companies distribute shares to them. Occasionally, companies also set aside IPO shares for customers or users, as for example
did for hosts.
The boom-and-bust cycle of the IPO market itself has played a role in this halting progress. But there is also a more fundamental issue: scarcity. For any given hot IPO, demand typically far exceeds supply.
So bankers and companies get to be choosy. Many on Wall Street would argue that this process is best for capital formation, helping companies build sustainable bases of fundamental investors that will encourage long-term thinking. The prospect of a “pop” serves as an incentive for those investors to buy the initial offering.
SoFi and Robinhood aim to discourage IPO buyers from flipping their newly acquired shares by restricting those who sell within 30 days from participating in any more IPOs for two months or longer. This could boost the appeal of their clients to companies or underwriters.
Holding an IPO long-term, even with the first-day gains, carries the usual risks of investing in a single stock. From 1980 to 2019, the average gain on a U.S. IPO from its offering price over three years was just 2 percentage points better than the market, according to Mr. Ritter. But some listings have been far hotter of late: The average U.S. tech IPO listing in 2020 roughly doubled from its offering price within six months or by that year’s end.
Then there’s the question of how much stock a given buyer actually gets. Brokers with millions of customers might not have that many shares to distribute to each. SoFi, which can act as an underwriter on IPOs, says it will consider whether a client has bought previous IPOs when deciding how to allocate new shares. Robinhood, which is partnering with investment banks, randomly selects which of its customers get IPO shares from among those who put in requests to buy.
It is possible that more companies, seeing how much of a force online small-investor communities have become, will aim to make them a bigger part of their IPOs. But others might see reason to sidestep the whole complex process, believing an IPO pop represents “money left on the table,” or cash they could have gotten if they’d sold their stock at a higher price to a wider audience.
Alternative forms of public offerings like direct listings or auctions or mergers with SPACs, or special-purpose acquisition companies, which some big-name companies have used recently, in theory let individual investors play on the same field as institutions by filtering investors mainly by how much they are willing to pay.
Ultimately though, one of the aims of a more fully democratic IPO pricing process is to reduce the likelihood of a big pop once shares begin trading. To paraphrase Yogi Berra, nobody wants to go to a club that’s too crowded.
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