Word on the street is that Robinhood is on a quest to democratize initial public offerings. When it comes to the distribution of IPOs and whether Robinhood can pull this off, we’ve got a few ideas on the matter.
There are two major events in the lifecycle of a company in which investors can really makes some bling. The first is in a private investment. An investment in a company is private before its shares are listed on a stock exchange for the PUBLIC to buy. There are different “rounds” or stages of a private investment including pre-seed, seed or angel rounds, Series A, B, and C rounds. When you hear the term pre-IPO investing, it usually refers to investing in a company in the last round before they officially file for an Initial Public Offering (IPO), in the Series C round. In a Series C round, a company has already proven their business model and been successful. The money they are raising is for things like developing new products or expanding into new markets. Companies also use Series C funding to boost their valuation in preparation for discussions of an IPO.
Institutional investors like hedge funds and private equity funds will invest in a Series C round. Also, accredited investors, including individuals having an annual income exceeding $200,000, or having a net worth that exceeds $1 million, will often have the opportunity to invest in pre-IPO shares of a company…if they know someone offering the shares. The pre-IPO price of shares is often a lower price than the anticipated IPO price. The reasoning is that the valuation of the company in the Series C round will be less than the valuation of the company when it goes to IPO. Pre-IPO shares are not as easy to find as public shares. Most financial institutions who serve retail investors do not offer private shares to their customers. So, you gotta know a guy.
The second opportunity for a retail investor to potentially make it rain, is by getting shares of an IPO. The idea here is that the IPO price, even though it may be higher than the pre-IPO price, will be cheaper than the market price of the shares once they start trading for the general PUBLIC to buy. One would hope. The reality is that the day a company starts trading shares in the public market, anything can happen.
A little company called Peloton went public in 2019. Here’s how it went:
- Peloton was formed in 2012
- IPO on Sept. 26, 2019, shares priced at $29/share
- Sold 40 million at $29/share to raise $1.16 billion in funding at a valuation of about $8 billion
- TCV was one of the venture companies that invested in Peloton in previous rounds including the IPO
- IPO was lead by Goldman Sachs and J.P. Morgan with 20 other smaller investment banks in the syndicate to sell shares
- After the first month of the IPO, the stock fell and traded in the low $20's
In a traditional IPO, investment banks form a syndicate that will be responsible for selling the shares to their customers. There are no rules around who they offer the shares to. They definitely play favorites. Typically, they will go to their largest or best clients or will use the shares as a way to entice a potential client to becoming a client of their firm. They also control how many shares each client receives. Clients of large investment banks like Goldman of J.P. are usually high net worth individuals or wealthy families or even institutions. These banks have asset minimums, so the typical retail investor would not meet the minimum to become a client of one of these firms.
We don’t see how Robinhood will be able to democratize the IPO distribution system. There are so many players in the cycle and rules around who can do what that it is very hard to imagine a world in which an individual, making an honest living, with an income of $40k/year and less than $10,000 in savings would have access to an initial public offering…but we do wish she could participate!
