“What’s all the hype?” is a question you might ask when you see an announcement for a company that’s going public. IPOs, or initial public offerings, tend to drum up excitement for investors. But it’s important to understand what the process involves and whether the investment is right for your portfolio.
Key Insights
- IPOs let private companies sell shares to the public, but the process involves preparation, SEC review, pricing, allocation, and public trading.
- IPO access is limited, and individual investors may not receive requested shares even when they’re eligible to participate.
- First-day prices can move quickly, so market demand may push shares above or below the IPO price.
- IPOs may not fit every portfolio, especially for investors who are uncomfortable with volatility or have uncertainty about what the company is worth.
- Investors can also consider alternatives, such as using IPO-focused funds, choosing diversified funds, or waiting until shares trade in the secondary market. Keep in mind that prices can continue to fluctuate after trading begins.
What is an IPO?
An IPO is when a private company first sells shares to the public and becomes publicly traded. IPOs happen in the primary market, where companies sell new securities directly through a broker dealer and receive capital in exchange for an ownership stake. After an IPO, shares trade on an exchange such as the NYSE or Nasdaq, where investors buy and sell them in the secondary market.
Note: Vanguard Brokerage Services® doesn’t underwrite IPOs or provide access to IPO allocation platforms, so you can’t request IPO shares through your Vanguard Brokerage Account before they begin trading. Vanguard portfolios can hold the stock from day 1, even if Vanguard Brokerage clients can’t participate directly. Once the security is available for secondary-market trading, you can place an online order through your Vanguard Brokerage Account
Why does a company decide to offer an IPO?
There are many reasons a company might make a move to the public sector: to acquire more growth, to raise capital, to let early investors cash out their investments, or to garner publicity and excitement. The IPO process can be costly and time-consuming, so companies who decide to go public are hoping that the benefits far outweigh the costs.
Understanding the IPO process
Going public is a complex, multistage process that requires extensive preparation, disclosure, and marketing before shares can be sold to investors.
IPO process step-by-step
- Prepare the company and assemble the IPO team. Before filing, the company works with legal counsel, auditors, and investment banks to evaluate whether it’s ready for public-company requirements.
- Select underwriters. The company chooses one or more investment banks to manage the offering. These underwriters help structure the deal, estimate investor demand, prepare marketing materials, and coordinate the sale of shares.
- File the registration statement and complete SEC review. The company files a registration statement (typically Form S-1) with the SEC, including a prospectus with key business, financial, risk, and offering details. The SEC may request revisions before the offering can move forward.
- Market the offering. Company leaders and underwriters present the investment opportunity to potential investors to explain the company’s strategy and gauge demand for the shares.
- Collect indications of interest. Investors may submit nonbinding indications of interest to show how many shares they might want and at what price. Underwriters use this demand information to help recommend the final offer price and share allocation.
- Set the IPO price and allocate shares. The company and underwriters set the final IPO price, usually the evening before trading begins. Shares are then allocated to participating broker-dealers or selling group members—not directly to end-user individual investors—based on each firm’s relationship to the offering and available allocation.
- Begin public trading. Once the IPO is approved and priced, the company and its underwriters determine the trade date, though that date can change.
Who can buy IPO shares?
Access to IPO shares at the offering price is significantly limited for individual investors, with the vast majority of shares allocated to institutional investors and preferred clients of underwriting firms.
- Eligibility depends on the brokerage and the offering. To request IPO shares at the offering price, you generally need an account with a brokerage that has access to that IPO and may need to meet firm or regulatory requirements.
- Not everyone who requests shares will receive them. IPO shares are limited, and submitting a request doesn’t guarantee an allocation, especially if demand exceeds supply.
- Institutional investors usually receive the largest allocations. Underwriters often prioritize large buyers, such as mutual funds, pension funds, and hedge funds, because they can place larger orders and may have established relationships.
- Individual investors may have access, but it’s often limited. Individual investors can sometimes participate through brokerages that receive IPO shares, but availability varies by brokerage, account type, and eligibility.
How to buy IPO stock
- Confirm whether you can participate at the IPO price. Check whether your brokerage offers access to the IPO before trading begins, and if not, consider buying once the stock trades in the secondary market.
- Research the company and read the prospectus. Review the company’s financials, strategy, risks, offering terms, and planned use of proceeds.
- Decide how much you’re willing to invest. Consider whether the IPO fits your goals, risk tolerance, time horizon, and overall portfolio.
- Place a limit order before trading begins, if available. A limit order can help set the maximum price you’re willing to pay before the stock opens on the secondary market.
- Monitor when the stock begins trading. IPOs don’t always open at the market bell, so watch for trading to begin before adjusting or placing a new order.
- Adjust your open order after trading begins, if needed. Once the stock is trading, you may be able to change the order type, share quantity, limit price, or duration.
- Review your order status and confirm the trade. Check whether the order executed and make sure the position still aligns with your investment plan.
As newly public companies mature and meet specific criteria, they may be added to major market indexes. When that happens, investors in index funds that track those benchmarks may gain exposure to the companies as part of a diversified portfolio. This approach can offer access to newly public companies over time while helping reduce the impact that any single stock’s poor performance may have on the overall portfolio.
