IPO stands for initial public offering and occurs when a company first sells its shares to the public.
The IPOs of all but the smallest of companies are usually offered to the public through an "underwriting syndicate," a group of underwriters who agree to purchase the shares from the issuer and
then sell the shares to investors. Only a limited number of broker-dealers are invited into the syndicate as underwriters and some of them may not have individual investors as clients.
Moreover, syndicate members themselves do not receive equal allocations of securities for sale to their clients.
The underwriters in consultation with the company decide on the basic terms and structure of the offering well before trading starts, including the percentage of shares going to institutions
and to individual investors. Most underwriters target institutional or wealthy investors in IPO distributions. Underwriters believe that institutional and wealthy investors are better able to
buy large blocks of IPO shares, assume the financial risk, and hold the investment for the long term.
Eligibility Requirements Of A IPO
By their nature, investing in an IPO is a risky and speculative investment. Brokerage firms must consider if the IPO is appropriate for individual investors in light of their income and net
worth, investment objectives, other securities holdings, risk tolerance, and other factors. A firm may not sell IPO shares to an individual investor unless it has determined the investment is
suitable for that particular investor.
Even if the firm decides that an IPO is an appropriate investment for an individual investor, the brokerage firm may sell the IPO only to selected clients. For example, before you can purchase
an IPO, some firms require that you have a minimum cash balance in your account, are an active trader with the firm, or subscribe to one of their more expensive or "premium" services. In
addition, some firms impose restrictions on investors who "flip" or sell their IPO shares soon after the first day of trading to make a quick profit. If you flip your IPO shares, your firm may
refuse to sell you other IPOs altogether or prevent you from buying an IPO for several months. You can often find these restrictions on the firm's website.
Pricing Differences Of A IPO
You may have found that there can be a large difference between the price of an initial public offering (IPO) and the price when the IPO shares start trading in the secondary market.
The pricing disparities occur most often when an IPO is "hot" or appeals to many investors. When an IPO is hot, the demand for the securities far exceeds the supply of shares. The excess demand
can only be satisfied once trading in the IPO shares begins. This imbalance between supply and demand generally causes the price of each share to rise dramatically in the first hours or days of
trading. Many times the price falls after this initial flurry of trading subsides.
Lockup Agreements On A IPO
Lockup agreements prohibit company insiders, including employees, their friends and family, and venture capitalists from selling their shares for a set period of time. In other words, the
shares are "locked up." Before a company goes public, the company and its underwriter typically enter into a lockup agreement to ensure that shares owned by these insiders don't enter the
public market too soon after the offering.
The terms of lockup agreements may vary, but most prevent insiders from selling their shares for a period of 180 days. Lockups may also limit the number of shares that can be sold over a
designated period of time. The federal securities laws do not govern the actual terms of lockup agreements, but they require a company employing a lockup to disclose the terms in its
registration documents, including its prospectus. At the same time, some states require lockup agreements under their "blue-sky" laws.
If you are considering investing in a company that has recently conducted an initial public offering, you should determine whether the company has a lockup and when it expires. This is
important information because a company's stock price may drop in anticipation that the lockup shares will be sold into the market when the lockup ends.