Are IPOs Interesting for Small Investors?
Initial Public Offering is the first sale of stock by a privately owned company to the public. Companies negotiate a sale of their stock to an investment banker or several bankers that act as an underwriter for the offering.
IPOs and Small Investors
Being a small investor here is a bit of a downside - small investors are not the target market. They do not have the money, therefore, they are of no interest for the underwriters.
For small investors chances of getting early shares in an IPO are very poor unless they are insiders in the company. If you still get a chance to buy such shares, it may be wise to have a good thought about it. The shares may be available just because nobody wants them.
The only way to get shares in an IPO is to have a frequently traded account with one of the investment banks in the underwriting syndicate.
Analyzing the Company
It's hard enough to analyze the stock of an established company. An IPO company is even harder to analyze because there's not much historical information.
You are left with the prospectus as the main source of your data. But remember that road shows and prospectuses are marketing events meant to get as much attention and create as much hype as possible. - Don't fall for it.
It is typically bigger investment banks that are involved in successful IPOs as they have the ability to promote a new issue well. Beware of smaller brokerages because they may be willing to underwrite all sorts of companies.
The number of unknowns here can make these investments very risky for small investors.
During the IPO, the underwriters conclude a lock-up agreement with the company management and employees. Lock-up agreements are prohibiting them from selling any portion of the stock for a specific period of time. Under the SEC Rule 144, the minimum period is 90 days, however, it can be anything up to two years. When the period is over, all the insiders in the company are allowed to sell their stock. The end of the lock-up period is often connected with strong downward pressure on a stock, which is something to be aware of too.