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What is IPO and how can investors make money on it?

IPO is the initial public offering of a company’s shares on the stock exchange.

Why do companies go public?

First of all, to attract money for further development. The market value of the company increases, the liquidity of its shares increases and, in addition, its social image improves.

Preparing to go public includes a number of stages.

  • Preliminary stage

Approximately two years before the placement, the company begins to assess its business and asset structure to determine the approximate capitalization. The company also prepares financial statements on a quarterly basis, demonstrating the transparency of the business — after listing on the stock exchange, the company will be required to provide financial statements.

Based on the results of the preliminary stage, the board of directors decides whether it is profitable for the company to go public or not. If the answer is yes, the next step begins.

  • Team formation

The company selects a lead underwriter, who evaluates it and decides how many shares, when and at what price to go public. Underwriters are usually investment banks (such as Goldman Sachs, Morgan Stanley, etc.). Also, an exchange is selected for placement (for example, the New York Stock Exchange — NYSE), auditors and legal advisers.

Six to eight weeks before the official registration with SEC, a general meeting is held at which the IPO schedule is drawn up and the responsibilities of the team members are assigned. The IPO process officially begins with a general meeting.

  • Prospectus development

The prospectus is the main document of the IPO, which is needed for two purposes: to attract large investors and to obtain the approval of the financial regulator. Typically, a prospectus includes the company’s financial statements for the last five years, information about management and major shareholders, a description of the target market, competitors, development strategies, etc.

The first version of the prospectus is printed and submitted for verification to the Securities and Exchange Commission (SEC). If the regulator approves the document, an IPO date is set. The lead underwriter selects an investment syndicate that will help distribute the company’s shares to investors. The first version of the prospectus is sent to institutional investors.

  • Roadshow

The most important part of preparing to enter the market is a roadshow, an advertising campaign. Issuer and underwriter representatives meet with potential investors (funds, insurance companies, banks, individuals) and convince them to buy shares. Typically, a roadshow lasts three to four weeks, during which the underwriters form an investor order book. Large investors can buy shares prior to their official offering.

At the end of the roadshow, the company’s management meets with the investment bankers to agree on the final issue volume and share price (the “offer price”). Price and volume are selected based on the expected demand for the stock. When the final cost of the offer and the size of the issue have been agreed, the final version of the prospectus and the price amendment are printed. If approved, the shares are distributed to investors.

  • Trading starts

Two days after the prospectus final version release and after the share price has been agreed, the IPO takes off. A certain number of the company’s shares are distributed among the members of the investment syndicate, brokers and their clients. Shares on the exchange begin to trade the day after the IPO is announced — this stage is called listing. The lead underwriter is responsible for the organization of trading and the price stability of the company’s shares.

  • Completion of the transaction

Seven days after the company’s debut, the IPO is declared valid.

How can an investor make money from an IPO?

  • Buy shares of a company while it is still private (pre-IPO market)

Until the company goes public, it sells shares in closed investment rounds to large investors. Those, in turn, resell them in the secondary market.

Why Invest in Private Companies?

Private tech companies are growing 5 times faster than the S&P 500 index. At the same time, the value of their shares is much less dependent on market volatility.

Examples of current returns on companies from the Global Technologies Private Portfolio.

  • SpaceX. September 2019 — June 2021. Return + 129.3%
  • Klarna. December 2020 — June 2021. Return + 229%
  • Kraken. November 2020— June 2021. Return + 208.2%
  • Tradeshift. January 2021— June 2021. Return + 143.1%
  • Udemy. September 2020— June 2021. Return + 52.7%

Buy shares a few days before the company’s IPO from an underwriter

Since the underwriter issues shares, he has the right to buy them before the IPO at attractive prices and then resell them to private investors.

Why buy shares on the eve of a company’s IPO?

In order to sell them some time after the opening of trading and fix a profit — when a company’s IPO is successful, the value of its shares rises after the placement. There are several drawbacks to IPO investment.

Low allocation. Allocation is a distribution of shares granted to a participating underwriting firm during an initial public offering. Usually, an application for the purchase of shares during an IPO is not 100% satisfied: if the demand for shares is large, the underwriter closes the application for only 1%, 5% or 10%. The investor cannot influence this.

A possible lock-up period (from 90 to 270 days after the company’s public offering) when an investor cannot sell shares.

Buy shares immediately after the company’s listing on the stock exchange

Another way to invest in an IPO is to buy the company’s shares at the first public price. Another name for this strategy is IPO Market.

Why buy shares immediately after a company goes public?

This strategy has several advantages.

Trading is based on the risk calculated for each security and for the portfolio as a whole. Even with the deepest market falls, the portfolio will not suffer more than the amount of inherent risk.

There are no lock-up periods. This allows you to exclude unprofitable positions from the portfolio at any time according to risk management.

A wide range of hedging instruments, including hedging of the entire position in the portfolio with volatility derivatives, a reverse fund for the sector, and a number of others (depending on the composition of the portfolio).

The volume of the order is not limited due to access to market liquidity and margin trading.

The disadvantage of purchasing shares at the first public price is that these prices are usually higher than those of the underwriter.