I’ve been getting a lot of phone calls and emails about an upcoming IPO which shall not be named. The reason I won’t name it is because it doesn’t matter how amazing or how terrible the company making the Initial Public Offering. What matters is understanding the inherent challenges that an IPO creates for an investor.
Challenge #1 Track Record
Would you hire a financial planner who didn’t have a resume? Probably not. A resume shows a track record of success, sustainability. You want to know their education and how long they’ve been in the business. With an IPO, we don’t have a track record of publicly-available, independently-verified financials. Granted the S-1 is in-depth, but many of these companies have been unprofitable and growth is subsidized by cash infusions of funding rounds.
Challenge #2 Emotional Volatility
Using the same analogy, imagine this new hire is the son of the world’s richest, smartest person. Also this person is a bit of a celebrity and they say the sky’s the limit. Rumor has it that he’s going to take off like a rocket ship. And no, I’m not talking about myself. All of these rumors and glowing press can make us overly invested in not being left on the sidelines watching the stock go to Mars. The fear of missing out, the greed and the embarrassment when your golf buddies make fun of you for not getting in diminish your rational, deliberate decision-making process.
Challenge #3 Price Volatility
When an IPO is launched, the good press can create a price surge. Perhaps it’s warranted, perhaps not. However, behind the scenes early investors who were stock owners before the public stock offering are quietly biding their time. You see an IPO share lock-up is a legally binding contract that prevents company insiders, founders, and early investors from selling their pre-IPO shares for a specific timeframe after a company goes public. This means that in 3 to 6 months you may see a big drop in the prices simply because those people want to recoup their investment.
There are other concerns but those 3 are the big ones for retail investors. View IPOs with caution and participate while understanding the risks, both structural and behavioral.