An #IPO Doesn’t Guarantee Strong Market Support

Many a company founder and even investor have bought into the delusion that performing an IPO can guarantee immediate market support for the company’s stock. This is fantasy. Before we get into the reasons why, let’s first discuss the difference in process. It will help to paint a picture as to why traditional IPOs may not be all their hyped up to be.

In a traditional IPO scenario an investment bank will serve as the lead underwriter of the stock. They’ll work with company management and shareholders to draft a company prospectus for the SEC registration statement which, after numerous rounds of comments from the SEC and NASD and various and sundry state organizations, is the underlying securities registered with the SEC. Once the lead underwriter has approval from the SEC, other broker-dealers are enlisted to find initial buyers for the company stock. Other brokerage firms will typically purchase blocks of shares (at a discount from the offering price), reselling them to their clients–both institutional and otherwise. Their commission is gleaned from the spread between the offer and their discount. In public offerings, the investment bank will typically purchase stock directly from the company, putting them in a position of risk if they’re unable to gain market support. Remember, private deals include a PPM with an agent acting as a go-between broker. In this scenario, the brokerage house actually gets in bed with the IPO candidate by owning and reselling securities in the offering.

IPOs are No Guarantee 

Brokerage firms who offer securities in an IPO are often under contract to continue their participation once the shares have begun trading in the general public. This is done by design as a “prop-up” tool for the earliest investors. The initial groups of buyers in any IPO deal want to get out early by selling their shares and making a quick profit. The brokerage firm acts as an initial active buyer of the shares in the open market to ensure the the stock is not initially “dumped.” It’s the age-old pump-and-dump scheme of the past with a little twist, someone is behind the curtain propping things up to ensure things just don’t get “too” bad.

Even with this type of false propped support from the underwriter in the deal, there are still many examples of stock tumbling at the time of an IPO. Facebook anyone?

Company filings after the market closed on Friday night however revealed the extent to which the banks who led Facebook’s initial public offering – in which $16bn of shares were sold to new investors – were forced to move in to the market and buy shares in order to keep the price above the $38 level. Morgan Stanley, Facebook’s lead financial adviser, ended the day with 162m shares, worth $6.16bn. Other banks including JP Morgan and Goldman Sachs also bought shares, ending the day with $3.2bn and $2.4bn holdings respectively.

In short, without the aftermarket support from the brokerage firms, the bare nature of the beast would include a natural fall in the stock price. An Initial Public Offering is, at least initially, made for investors who want their liquidity out of a potentially long-held investment. When they start selling, the stock will drop. Large underwriters can afford to take a hit to signal the market in general isn’t going to tank the stock. But, once the IPO is over, there is simply no guarantee that the general market itself won’t continue its sell-off in the months following an IPO.

Certainly, many reverse IPO opportunities can fare far worse than their over-hyped counterparts, but just because a company does an IPO, doesn’t guarantee traditional pump-and-dump schemes weren’t at play.

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Nate Nead
Nate Nead is a licensed investment banker and Principal at Deal Capital Partners, LLC which includes InvestmentBank.com and Crowdfund.co. Nate works works with middle-market corporate clients looking to acquire, sell, divest or raise growth capital from qualified buyers and institutional investors. He is the chief evangelist of the company's growing digital investment banking platform. Reliance Worldwide Investments, LLC a member of FINRA and SIPC and registered with the SEC and MSRB. Nate resides in Seattle, Washington.
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