A Space To Think About Demystifying The IPO - Unpacking the Financial Phenomenon

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Thank you to the 2,242 thinkers who are sharing this moment with me. Today we’re going to think about the IPO process and how it might impact you.

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Over the past two decades, global wealth has skyrocketed by a staggering $160 trillion . Today, the world's billionaires hold more wealth than 4.6 billion people , and a significant driver of this wealth accumulation is the IPO process.

Founders, employees, investors, and companies all stand to gain from IPOs. It's the moment where dreams turn into centi-millionaire or billionaire realities. Just ask Mark Zuckerberg, who transformed his 24% ownership in Facebook into a jaw-dropping $19 billion overnight when it went public in 2012 .

Employees also benefit from stock options when their company takes the IPO plunge, as exemplified by early Amazon and Google employees who saw substantial fortunes materialize over time.

Venture capitalists are constantly on the hunt for promising startups before they go public. Their early investments can yield returns that defy imagination, adding potential blockbuster IPOs to their portfolios.

Moreover, the influx of capital from an IPO can propel companies to expand exponentially, as evidenced by Google's transformation from 1,000 to 20,000 employees over five years , securing their industry dominance.

The Allure and Evolution of IPOs: A Historical Perspective

The history of initial public offerings (IPOs) spans several centuries, with roots tracing back to the early 1600s when the Dutch East India Company pioneered the first modern IPO. This groundbreaking event marked the beginning of a tradition where companies sought to raise capital by offering ownership shares to the general public. In 1792, the establishment of the New York Stock Exchange (NYSE) created a pivotal institution in the world of IPOs . Some of the earliest U.S. IPOs, including the Bank of New York and the First Bank of the United States , were listed on the NYSE.

In the 2000s, IPOs have played a prominent role in shaping the business landscape, with several notable success stories. When the Chinese e-commerce company Alibaba Group went public in 2014, it raised $21.7 billion, making it the largest U.S. IPO in the past decade. Alibaba later sold additional shares, bringing the total IPO value to $25 billion, which was the largest IPO ever at the time . Alibaba's IPO helped accelerate the growth of e-commerce and online retail worldwide from $12.6 billion in sales in 2014 to $128 billion in 2023, a 915.9% increase.

In 2012, Facebook raised $16 billion , making it the largest tech IPO and third-largest overall U.S. IPO to date. Facebook's offering further fueled the growth of social media, with global users increasing from 1 billion in 2012 to 2.9 billion in 2022, a 190% increase .

With an IPO value of $29.4 billion in December 2019, Saudi Aramco broke records for the largest IPO in history . Saudi Aramco's public listing helped drive further growth for the oil and gas industry from $5 trillion global market in 2019, projected to grow to $8.6 trillion by 2027 .

When General Motors went public in November 2010, it raised $20.1 billion, making it the biggest U.S. IPO ever at the time . This supported General Motors' revival after its 2009 bankruptcy . The offering contributed to an increase in global auto sales from 70 million units in 2010 to 88 million units in 2019, an 25.7% increase.

In September 2020, the tech company Snowflake raised $3.4 billion with its IPO , ranking among the largest U.S. tech public listings. Snowflake's IPO has contributed to the expansion of cloud computing and big data. The worldwide public cloud services market is forecast to grow from $233.4 billion in 2019 to over $600 billion in 2023 .

These examples underscore how IPOs have played an enduring role in raising capital and driving innovation across various industries, from e-commerce and social media to oil, automotive, and technology sectors. By offering ownership shares to the public, companies can tap into new funding sources to grow their operations and develop groundbreaking products and services that shape the business landscape.

Evaluating Recent IPO Performance

The US IPO market has experienced ups and downs in activity and proceeds raised over the past 5 years. In 2019, there was strong IPO activity with 168 offerings raising $50.7 billion. Despite the challenges of the COVID-19 pandemic, 2020 witnessed 224 IPOs that raised $86.2 billion. In 2021, the US IPO market hit a new record with 416 IPOs raising $155.8 billion. However, in 2022 IPO activity declined to 90 offerings raising $8.6 billion, likely impacted by market volatility .

The first half of 2023 indicates a potential rebound with 63 IPOs raising $10.1 billion, representing significant 115% and 24% increases over the comparable 2022 period.

Recent high-profile IPOs point to a mixed appetite among public investors for new companies. Instacart went public on September 19th, falling to a low of $29.96, below their $30 IPO price. ARM went public September 14th, hitting a low of $51.52, coming close to its $51 IPO price. Klaviyo also went public September 19th, hitting a low for the day of $30.26, just above its $30 IPO price.

Understanding the dynamics shaping IPO success is crucial in today's market. With recent IPOs exhibiting mixed performance , it’s important to reflect on the cautious stance of public investors towards new tech opportunities.

The valuation of a company plays a pivotal role in its post-IPO performance. Overly ambitious valuations can lead to challenges in the stock market.

Market volatility also impacts IPO success. When markets face uncertainty, many companies postpone IPO plans until conditions stabilize, as volatile markets increase risk for new public companies. Investor sentiment is another essential factor, as enthusiasm or lack of interest in an offering can sway performance regardless of company fundamentals.

Furthermore, a company's industry impacts expected performance. IPOs in fast-growing sectors like tech and biotech historically outperform other sectors. This indicates investors tend to favor IPOs in popular sectors.

Given these dynamics, companies aiming for a successful IPO need to realistically assess their valuation, market factors, and investor demand when planning to go public. Careful navigation of these variables can help position a company for optimum performance post-IPO even in challenging markets.

Navigating the Meticulous IPO Process

The process involves several critical steps that companies must take to transition from a private to public entity. Most companies hire an investment bank to serve as the underwriter and guide them through the complex IPO process. The underwriter conducts thorough due diligence, examining financial statements, operations, business plans, and legal compliance. This level of scrutiny reduces risks and builds confidence ahead of the IPO.

After securing an underwriter, the company files a registration statement known as an S-1 with the SEC. This document discloses vital information about the business, risks, and the planned use of capital raised. The underwriter also plays a key role in setting the IPO offer price based on valuation models and investor demand data.

In the weeks leading up to the IPO, the company presents to institutional investors in a series of meetings known as a roadshow . Companies hold numerous meetings with potential investors during the roadshow. This process generates investor interest right before shares begin trading publicly. On the first day of trading, the underwriter facilitates trading on stock exchanges.

The IPO process takes several months from initial planning to completion. Thorough preparation and regulatory compliance are essential for transitioning to a public company through a successful IPO.

The Power Players: Understanding the Key Roles in an IPO

The issuing company looking to offer shares to the public for the first time takes the lead role. The issuing company works closely with investment banks that act as underwriters to determine important details like share price, number of shares to offer, and structuring the overall offering. Investment banks also market the shares to potential investors, either through a firm commitment to sell all shares or on a best efforts basis.

Throughout the IPO process, regulatory bodies like the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) ensure the issuing company complies with necessary regulations and provides relevant information to investors.

Venture capitalists who previously invested in the issuing company during earlier growth stages may see an IPO as a chance to realize returns on those early investments.

The issuing company must also meet listing requirements to have its shares traded on stock exchanges like the New York Stock Exchange (NYSE) or Nasdaq after the IPO.

In addition to these key players, the issuing company relies on its own management team along with legal counsel and auditors to advise on the transition from a private to public company through a successful IPO. With coordination between these various experts, a company can effectively tap into public markets for raising capital and increasing visibility.

Alternatives Emerge to Streamline Public Listings

Direct listings and SPACs (Special Purpose Acquisition Companies) have emerged as alternatives to the traditional IPO process for companies seeking to go public. Direct listings allow companies to be listed on a public exchange without the costs associated with investment banks that underwrite IPOs, and allow companies to go public without diluting existing shareholders' stakes, since new shares are not created like in an IPO. Additionally, the share price in a direct listing is set by market supply and demand rather than by underwriters. This eliminates the underwriting and roadshow process required for IPOs. Spotify , Slack , and Coinbase did direct listings.

SPACs are publicly traded shells created solely to merge with a private company and take it public. This streamlined process provides private companies with access to public capital without the time and expense of an IPO. SPACs also allow more flexibility in valuation and pricing compared to IPOs. The certainty and transparency of the SPAC process has attracted companies like Lucid Motors , Grab , and Ginkg . However, SPACs have declined in popularity recently, with some SPAC-tracking funds down 40% in the past year. The SEC has also opened two dozen investigations into SPACs since January 2020 .

Overall, both direct listings and SPACs offer alternatives to IPOs that provide potential cost savings, flexibility, and access to public capital.

The Math Behind the Magic: Quantifying IPO Outcomes with Data

The offer price, set by the underwriter, is the price at which securities issued in an IPO can be acquired before trading on stock exchanges begins. Unlike the fixed IPO price, the opening price on the first day of trading fluctuates based on market supply and demand.

The difference between the offer price and the first-day opening price is known as the "pop." During the dot-com bubble in 2000, IPOs averaged a substantial 6% pop on the first trading day . However, first-day pops vary over time and do not necessarily predict long-term performance. In fact, research shows IPOs' long-term stock performance differs significantly. Some companies greatly outperform the broader market in the months and years after their IPO, while others underperform. Factors like sales growth, market penetration, and overall growth prospects influence long-term performance.

When evaluating an IPO, investors should consider metrics like the offer price, first-day pop, and post-IPO stock performance along with the company's financials, growth potential, and prevailing market conditions. Together, these factors provide a more complete picture of an IPO's success and prospects.

The Outlook: Sobering Times Ahead for IPOs

The IPO market is at a critical juncture amidst several converging headwinds. Bleak post-IPO performance of recent de-SPACs, with over 80% trading below listing price, has sapped investor appetite . This sentiment shift coincides with declining valuations, especially for high-growth technology companies that accounted for many recent IPOs. Some former unicorns have seen valuations slashed 70% or more . Ongoing crypto market volatility and global banking turmoil have further dampened IPO investor sentiment.

Tougher funding conditions now prevail, as investors emphasize profitability and sustainability over growth projections. The IPO process itself has also become more complex than ever, with navigating legal requirements and assessing risks being hugely difficult. Fierce competition for investor attention also marks today's crowded IPO landscape.

In essence, the IPO landscape faces a perfect storm of weak post-IPO performance, declining valuations, arduous funding conditions, greater complexity, and intense competition. Companies seeking to go public need convincing profitability potential and realistic valuations to overcome today's substantial IPO headwinds. Strong financials and sustainability will likely dictate the near-term future outlook for IPOs rather than previously alluring growth narratives.

Demystifying IPOs sheds light on a complex yet pivotal aspect of the financial world.

Thank yourself for taking the time to show up and creating space to think. Remember real knowledge is intrinsic, and it’s built from the ground up.

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Stay prosperous,

Brylan Donaldson