Testing the Waters: What It Means in an IPO

Testing the Waters: What It Means in an IPO

Testing the waters in the initial public offering (IPO) process allows companies and related parties that are looking at going public to gauge how successful their prospective IPO would be — without going through the actual process of going public.

The Securities and Exchange Commission (SEC) voted in 2019 to adopt a new rule to allow companies interested in going public to test the waters (TTW). Specifically, the SEC formally rolled out Rule 163B under the Securities Act on December 3, 2019.

The IPO process can be long, costly, and risky for some companies, and thus some companies can be reluctant to try going public. But the ability to test the waters by communicating with potential investors, gauging their interest, and examining how an IPO would be received, is valuable before having to go all-in on a public offering.

Key Points

•   Testing the Waters (TTW) is an SEC rule that allows companies to gauge the success of a prospective IPO without going through the actual process.

•   The JOBS Act of 2012 allowed small businesses to communicate with Qualified Institutional Buyers (QIBs) and Institutional Accredited Investors (IAIs).

•   Testing the Waters allows companies to assess investor interest, explain the direction of the company, and strengthen areas of weakness.

•   The expanded rule for all issuers allows for greater transparency and communication between IPO-hopeful and the markets, as well as investors.

•   Investors have access to additional information about a company’s expected IPO and more time to decide whether to invest.

Testing the Waters During the IPO Process

Starting in 2012, testing the waters was available only for emerging growth companies, also known as EGCs. In 2019, testing the waters was extended to all issuers to increase the chance of a company successfully completing an initial public offering (IPO), and to encourage issuers to enter the public equity markets.

So, what does testing the waters mean, and how does it work? In effect, testing the waters is a way for issuers to dip their toes in the water, so to speak, and gauge the temperature before fully jumping into the IPO process.

When the new SEC rule was proposed and adopted in September 2019, Chairman Jay Clayton said, “Investors and companies alike will benefit from test-the-waters communications, including increasing the likelihood of successful public securities offerings.”

Details of the TTW rule

The TTW rule allows issuers to assess market interest in a possible IPO (or other registered securities offering) by being able to discuss the IPO with certain institutional investors before, or after, the filing of a registration statement.

Generally, issuers set up TWW meetings with investors after the issuer has filed with the SEC. They could potentially speak with specific issuers before filing with the SEC, but issuers typically want to align on the first round of SEC comments and then have a clear direction when speaking with potential investors.

Example of Testing the Waters

In late spring of 2022, a tech company that created a platform for grocery delivery, decided to test the waters for a potential IPO.

There were good reasons for the company to be cautious. The market had seen a steep drop since the beginning of the year, and investors had largely cooled on tech stocks, with IPOs taking a noticeable hit year-over-year.

Thanks to taking this step, the company was projected to IPO by the end of 2022, using the interim period to adjust their valuation and their path forward, given the competition in the space.

To sum it up, testing the waters allows companies to see what investors say, answer questions, and potentially identify areas of weakness that could be strengthened.

💡 Quick Tip: Access to IPO shares before they trade on public exchanges has usually been available only to large institutional investors. That’s changing now, and some brokerages offer pre-listing IPO investing to qualified investors.

Purpose of Testing the Waters

Testing the waters has two chief aims: The first is communicating with potential investors to explain the direction of the company and gathering their feedback. The second is to evaluate the market before having to invest large sums in an actual IPO.


💡Quick Tip: How do you decide if a certain trading platform or app is right for you? Ideally, the investment platform you choose offers the features that you need for your investment goals or strategy, e.g., an easy-to-use interface, data analysis, educational tools.

Communication with Potential Investors

In addition to giving issuers a chance to see whether their offering will be successful, TWW allows companies to communicate highly specific information.

Some industries call for greater detail of information from investors, which makes testing the waters ever more critical.

For example, in the life sciences industry, testing the waters is popular because issuers tend to have a shorter operating history and also need to communicate detailed scientific information to their potential investors. For these types of industries and issuers, testing the waters is highly beneficial.

Cost-Effective Market Evaluation

Testing the waters allows issuers to determine whether it makes sense for them to devote the time and resources to filing an IPO. Before the TWW rule, many companies avoided the IPO process because of the cost and not having clarity around investor demand.

Testing the waters takes away some of those risks and provides more information as a company enters the IPO. In a sense, it allows for a company to evaluate the market, and for the market, in turn, to evaluate the company exploring an IPO.

What the JOBS Act Meant for Testing the Waters

In 2012, Congress under President Obama passed the Jumpstart Our Business Startups Act (also known as the JOBS Act) to revitalize the small business sector. The JOBS Act, which created Section 5(d) of the Securities Act, made it easier for small businesses, also known as emerging growth companies or EGCs, to gain access to funding. It removed certain barriers to capital and reduced regulation.

The enactment of the JOBS Act also allowed small businesses to communicate with potential investors — qualified institutional buyers (also known as QIBs) and institutional accredited investors (or IAIs). By communicating with potential investors before or after filing a registration statement, EGCs were given the ability to get a sense for interest in a potential offering.

With the expansion of that rule in 2019 to include all issuers, not just EGCs, more opportunity opened up for a range of businesses.

What Does This Mean for Investors?

While it makes good business sense to expand regulations and allow all businesses considering an IPO to test the waters, just what does this all mean for the average retail investor?

First, the expanded test-the-waters rule for all issuers allows companies more flexibility when determining whether to move forward with an IPO. So for investors, the expanded rule means that they have access to communication from issuers regarding upcoming IPOs. They also have more time to determine whether it’s the right investment for them.

This can be valuable for retail investors, who may benefit from having additional information about a company’s expected IPO. Investing in IPO stock can be highly risky, as IPO shares are typically quite volatile.

In short: Testing the waters gives more flexibility to both issuers and investors.

Investing in IPO Stocks

IPOs have been popular among investors and certain IPOs can generate excitement in the investor community. Prices on the day of an IPO and immediately afterward tend to produce volatile price movements, which can produce large gains or losses. Luckily, the 2019 SEC rule that allows any company to test the waters before committing to the IPO process is a boon to businesses as well as investors.

TTW, as the rule is known, allows for greater transparency and communication between the IPO-hopeful and the markets, as well as investors, prior to the full-blown IPO process. This enables companies to adjust their strategy for the IPO, and it allows investors to assess whether they want to invest.

Whether you’re curious about exploring IPOs, or interested in traditional stocks and exchange-traded funds (ETFs), you can get started by opening an account on the SoFi Invest® brokerage platform. On SoFi Invest, eligible SoFi members have the opportunity to trade IPO shares, and there are no account minimums for those with an Active Investing account. As with any investment, it's wise to consider your overall portfolio goals in order to assess whether IPO investing is right for you, given the risks of volatility and loss.


Invest with as little as $5 with a SoFi Active Investing account.

FAQ

Is testing the waters an offer?

No, testing the waters is not an offer. Testing the waters in the IPO process allows issuers, which are corporations, investment trusts, etc., to gauge interest and investor demand for a potential IPO without actually having to go public.

What is the post-IPO quiet period?

The quiet period is a set amount of time when the company cannot share promotional publicity, forecasting, or expressing opinions about the value of the company. In an IPO, the quiet period begins when a company files registration with U.S. regulators for 25 days after the stock starts trading — and sometimes longer.

What is an analyst day in an IPO?

When planning to go public, the issuer or company meets with syndicate analysts who do not work for the issuer or the company going public. This type of meeting, also called an “analyst day,” is important because analysts create their own opinion about the issuer. They then help educate the market about the company once the transaction has launched.


Photo credit: iStock/LumiNola

SoFi Invest®
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

Investing in an Initial Public Offering (IPO) involves substantial risk, including the risk of loss. Further, there are a variety of risk factors to consider when investing in an IPO, including but not limited to, unproven management, significant debt, and lack of operating history. For a comprehensive discussion of these risks please refer to SoFi Securities’ IPO Risk Disclosure Statement. IPOs offered through SoFi Securities are not a recommendation and investors should carefully read the offering prospectus to determine whether an offering is consistent with their investment objectives, risk tolerance, and financial situation.

New offerings generally have high demand and there are a limited number of shares available for distribution to participants. Many customers may not be allocated shares and share allocations may be significantly smaller than the shares requested in the customer’s initial offer (Indication of Interest). For SoFi’s allocation procedures please refer to IPO Allocation Procedures.


Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

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Going Public vs. Being Acquired

IPO vs Acquisition: Advantages and Disadvantages

An IPO is an initial public offering, when a company makes its shares available for public trading, and it’s quite different from an acquisition. IPOs are synonymous with entering the public market, while an acquisition is typically when a larger company takes over a smaller target company.

What does IPO mean vs. an acquisition for investors? When a company applies for an IPO, it enters into the traditional process to be listed on a public exchange and get funding. In an acquisition, or takeover, the target company may not survive — or it may thrive, but only as part of the newly combined organization.

Investors contemplating companies at these two different stages would do well to think through the benefits and risks.

Key Points

•   IPOs, or Initial Public Offerings, allow private companies to offer shares to the public to raise capital and enhance visibility.

•   An acquisition occurs when one company buys a significant part, or all, of another company, taking control over its assets and operations.

•   IPOs involve going public to raise funds and gain publicity, while acquisitions entail one company taking over another, potentially merging their resources and strategies.

•   IPOs can provide substantial funds and publicity but involve high costs, stringent regulations, and expose companies to market volatility.

•   Acquisitions can foster growth and innovation but may lead to conflicting priorities, strained partnerships, and brand reputation risks.

How IPOs Work

When companies go public, that’s when a private company decides to sell its shares to investors, to raise capital to fund growth opportunities for the company; create more awareness about the company; or to acquire other businesses, among many other possible reasons.

The IPO is the process of selling securities to the public. The company decides how many shares it wants to offer. The price of the company shares are determined by the company’s valuation and the number of shares at listing, and the funds raised by the IPO are considered IPO proceeds.

Once the IPO is approved, the company is then listed on a public stock exchange where qualified investors can buy shares of the IPO stock. Because IPO stock is highly volatile, it can be risky for retail investors to plunge into IPO investing, so doing the usual due diligence for investing in any type of security is wise.

💡 Quick Tip: IPO stocks can get a lot of media hype. But savvy investors know that where there’s buzz there can also be higher-than-warranted valuations. IPO shares might spike or plunge (or both), so investing in IPOs may not be suitable for investors with short time horizons.

Advantages of Going Public

What are the advantages of going public? There can be many, which is why companies aspire to go through what can be an arduous, time-consuming, and expensive process.

Capital for Investment

The biggest advantage associated with an IPO is fundraising. Once investors start buying IPO stocks, the proceeds from an IPO can be substantial. The company then takes this capital and typically uses it toward internal investments and expansion.

The company can use the funds it raises for research and development, to hire more staff, or expand its operations in other states or countries. There are a variety of ways this new capital can be deployed to benefit the company.

Publicity

In some cases, IPOs generate publicity. This, in turn, can drive more attention to the company and make investors interested in purchasing shares of its stock. IPOs are frequently covered in business news, which adds to the IPO buzz.

However, if there is too much hype, that can contribute to high expectations for the stock, which can also create volatility after the IPO.

Valuation

Some companies that go public can end up having higher valuations. Certainly, that is a hoped-for result of the IPO process. Because the public company has access to more capital and steadily grows its business, the shares of the company can increase in price over time, but they can also lose value — a common occurrence.

Disadvantages of Going Public

What are the disadvantages of going public? There are a series of steps and regulations companies must adhere to in order to have a successful IPO — and the process can be time consuming and difficult.

High Cost

The first factor a company must consider is cost. The company needs to work with an investment bank, which will charge underwriting fees — one of the largest costs associated with an IPO.

Underwriting is mandatory to review the company’s business, management, and overall operations. Legal counsel is also required to help guide the company through the IPO. There are also costs associated with account and financial reporting. Companies will also accrue fees for applying to be listed on the exchange.

Not Enough Information for Investors

From an investor’s perspective, investing in an IPO can also be a challenge. In many cases, individual investors don’t have enough information or historical data on the company’s performance to make a determination on whether an IPO is a sound investment.


💡 Quick Tip: The best stock trading app? That’s a personal preference, of course. Generally speaking, though, a great app is one with an intuitive interface and powerful features to help make trades quickly and easily.

Stock Market Stress

Once a company goes public, it is now part of the public market. This means it is subject to scrutiny, market volatility, and investor sentiment. Every move and decision the company makes, such as a corporate restructuring, merger and acquisition, change in leadership, or release of earnings reports, will be reviewed closely by industry analysts and investors, who will provide their own opinions on whether the company is operating well or not.

While the company’s leadership may not have had to worry about these aspects when it was private, a public company needs to keep these market pressures top of mind.

What Is an Acquisition?

What does it mean for a company to be acquired? Similar to a merger, an acquisition is when one company buys a portion or the whole of another company and all its assets. An acquisition is the process of the acquiring company taking full control of the target company.

If the acquiring company takes more than 50% of the target firm’s shares, this gives the acquiring company control over decision making regarding the target company’s assets. While acquisitions of well-known and larger companies occur and are covered by the news, companies of any size can be the acquiring company or target company.

Advantages of Being Acquired

Being acquired doesn’t have to signal the end of a company — sometimes it can be a lifeline.

Growth

An acquisition can be a strategy for a company to grow into new markets and quickly become a leader in its industry. If the company is working in a competitive landscape, an acquisition helps increase its value and can add to a company gaining more market strength.

Innovation

When one company acquires another, this allows resources and experiences to come together. This may enable the new company to innovate new ideas and strategies that may eventually help grow the company’s earnings. This new partnership can bring together a new team of specialists and experts that can allow the company to develop and reach its goals.

More Capital

When an acquisition occurs, this will increase the cash holdings and assets of the acquiring company and usually allows for more investment in the newly formed company.

Disadvantages of Being Acquired

It’s hard to avoid the negative implications of an acquisition, and investors need to consider these as well.

Conflicting Priorities

In some acquisition scenarios, there may be competing priorities between the two companies that come together. The acquiring company and target company prior to the acquisition were used to working as individual entities. Now, as a newly formed company, both sides must work together to be successful, which is easier said than done. If there isn’t alignment on the goals of the organization as a whole, then there is a possibility that the acquisition may fail, or the transition could be rocky and prolonged.

Pressure on Existing Partnerships

When an acquisition occurs, the newly formed company becomes bigger and it is likely that their goals will grow as well. In the case where the company wants to develop more products to expand into new markets, this could require their suppliers to figure out how they are going to ramp up production to meet the demand.

For example, this could mean the supplier would need more capital to hire staff or purchase additional equipment and supplies to prevent production issues.

Brand Risk

Depending on which companies come together, if one has a poor reputation in their industry, the acquisition could put the other company’s brand at risk. In this case, both of the companies’ identities could be evaluated to decide whether they come together under one brand or are marketed as separate brands.

The Takeaway

Initial public offerings (IPOs) and acquisitions often get a lot of media and investor attention because they can offer opportunities for investors. That said, these two events are quite different.

An IPO is when a private company decides to go public and sell its shares to investors, whereas an acquisition is when a company buys out another, target company. In this case the acquiring company may gain certain market advantages, and the target company will typically lose its decision-making privileges since it is no longer an individual company.

There are a number of pros and cons to IPOs, just as there are advantages and disadvantages to a company being acquired. IPOs can provide a newly minted public company with a lot of growth opportunities — but the IPO process is expensive and time consuming, and being beholden to regulators and investor sentiment is never a picnic.

Acquisitions can be a lifeline to a company that’s struggling in a competitive market. While the takeover can effectively eliminate the target company as an independent entity, its products or brand may continue to exist.

Whether you’re curious about exploring IPOs, or interested in traditional stocks and exchange-traded funds (ETFs), you can get started by opening an account on the SoFi Invest® brokerage platform. On SoFi Invest, eligible SoFi members have the opportunity to trade IPO shares, and there are no account minimums for those with an Active Investing account. As with any investment, it's wise to consider your overall portfolio goals in order to assess whether IPO investing is right for you, given the risks of volatility and loss.

Invest with as little as $5 with a SoFi Active Investing account.

FAQ

Is an acquisition an IPO?

An acquisition is not an IPO. An acquisition is when an acquiring company purchases part of or all of a target company to form one new company.

What is the difference between an IPO and a takeover?

An IPO is when a private company decides to go public and sell its shares to individual investors, whereas a takeover is when a company buys out another company.

Is a takeover the same as an acquisition?

An acquisition can be a takeover. This is when two companies decide to come together and become one entity. All the assets of both companies are now part of a newly formed combined company.


Photo credit: iStock/Yuri_Arcurs

SoFi Invest®
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

Investing in an Initial Public Offering (IPO) involves substantial risk, including the risk of loss. Further, there are a variety of risk factors to consider when investing in an IPO, including but not limited to, unproven management, significant debt, and lack of operating history. For a comprehensive discussion of these risks please refer to SoFi Securities’ IPO Risk Disclosure Statement. IPOs offered through SoFi Securities are not a recommendation and investors should carefully read the offering prospectus to determine whether an offering is consistent with their investment objectives, risk tolerance, and financial situation.

New offerings generally have high demand and there are a limited number of shares available for distribution to participants. Many customers may not be allocated shares and share allocations may be significantly smaller than the shares requested in the customer’s initial offer (Indication of Interest). For SoFi’s allocation procedures please refer to IPO Allocation Procedures.


Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

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Shorting an IPO: When Can You Do It?

Shorting an IPO: When Can You Do It?

IPO stocks can be sold short once they are trading on public markets, known as the secondary market.

While traders can sell short IPO shares, investors allocated IPO shares may have to wait for a lock-up period to expire before they can sell.

Selling short an IPO on the listing day also has extra challenges you should know about. This article will cover how it works, when to do it, and any possible complications you might encounter in the process.

Key Points

•   It’s possible to short an IPO once it starts trading on the public market, with some limitations.

•   IPO stocks are heavily regulated and it can be difficult to borrow the shares needed to do a short sale.

•   Investors should do their due diligence before investing in any kind of stock, as there are no guarantees.

Can You Short an IPO?

IPO stocks can be sold short once they are trading on public markets, known as the secondary market. Shorting IPO shares on the listing day can be done, though there are some challenges.

Shorting a Stock

Shorting a stock is a strategy traders use to profit from a decline in the price of a stock. Any stock available for trading can be shorted. It is risky considering that the stock price can only go to zero — in which case a profit of 100% is realized (not including taxes and commissions). The risk is that the stock price increases. There is no theoretical limit to how high a share price can go.

A short sale happens when you borrow a stock and repay it in the future. The goal is to see the stock drop in value. When you sell short, you buy the shares, immediately sell them, then buy them back later. You want to buy the shares back at a price less than at which you lent them.

There is a fee for borrowing when selling shares short. That cost can be as low as 0.3% (on an annualized basis) for stocks with very little short interest, but it can soar to 30% for hot stocks with extremely high short interest. You might also be required to post collateral to sell short.

For example, let’s say you want to sell short shares of XYZ stock that currently trade at $100 per share. You enter an order to sell short the shares and you receive $100 per share. A month later, the stock price has dropped to $80, and you decide to close your short position by repurchasing the shares in the market. You buy back the shares for $80. Your profit on those stocks is $100 – $80 = $20.


💡 Quick Tip: Investment fees are assessed in different ways, including trading costs, account management fees, and possibly broker commissions. When you set up an investment account, be sure to get the exact breakdown of your “all-in costs” so you know what you’re paying.

Challenges of Shorting an IPO

While shorting an IPO on listing day is allowed, there are practical limitations that could make it difficult.

A critical facet to shorting IPO shares is being able to borrow the shares from a brokerage firm. A broker needs an inventory of stock from which to lend and a company often only takes a small part of the company public, which can limit shorting opportunities. On IPO day, the two primary entities holding an inventory of shares are the underwriting banks and investors (both institutional and retail).

The IPO underwriters cannot lend shares for short sale for 30 days, per U.S. SEC rules. Investors can lend out their shares to investors seeking to short the IPO stock. That said, some shareholders might be unwilling to lend their shares.

IPO stocks are considered high-risk investments, and while some companies may present an opportunity for growth, there are no guarantees. Like investing in any other type of stock, it’s essential for investors to do their due diligence.

The Takeaway

You can short an IPO once it starts trading on the public market. But it’s worth remembering that shorting carries risk and there might be a high cost to borrow shares. In addition, IPO stocks are heavily regulated, which can make it difficult to borrow the shares needed to do a short sale.

Whether you’re curious about exploring IPOs, or interested in traditional stocks and exchange-traded funds (ETFs), you can get started by opening an account on the SoFi Invest® brokerage platform. On SoFi Invest, eligible SoFi members have the opportunity to trade IPO shares, and there are no account minimums for those with an Active Investing account. As with any investment, it's wise to consider your overall portfolio goals in order to assess whether IPO investing is right for you, given the risks of volatility and loss.

Invest with as little as $5 with a SoFi Active Investing account.

FAQ

How soon can you short an IPO?

You can short an IPO once it begins trading on the public stock market. The IPO lock-up period typically lasts from 90 to 180 days. It is intended to prevent too many shares from flooding the market in the early days of the IPO. A high supply of shares could drive down the price of the IPO stock.

Can you sell an IPO immediately?

An investor who purchases shares on the secondary market can sell shares immediately. Investors who were allocated IPO shares have a lock-up period before they can sell. Learn more about selling an IPO.

How long until you can sell an IPO?

A company founder, a longtime employee holding company stock, or an investor allocated IPO shares must wait for the lock-up period to elapse before selling their shares. The IPO lock-up period might last anywhere from 90 to 180 days after the IPO. There might be multiple lock-up periods that end on different dates, too.


Photo credit: iStock/MarsBars

SoFi Invest®
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

Investing in an Initial Public Offering (IPO) involves substantial risk, including the risk of loss. Further, there are a variety of risk factors to consider when investing in an IPO, including but not limited to, unproven management, significant debt, and lack of operating history. For a comprehensive discussion of these risks please refer to SoFi Securities’ IPO Risk Disclosure Statement. IPOs offered through SoFi Securities are not a recommendation and investors should carefully read the offering prospectus to determine whether an offering is consistent with their investment objectives, risk tolerance, and financial situation.

New offerings generally have high demand and there are a limited number of shares available for distribution to participants. Many customers may not be allocated shares and share allocations may be significantly smaller than the shares requested in the customer’s initial offer (Indication of Interest). For SoFi’s allocation procedures please refer to IPO Allocation Procedures.


Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

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IPO Pop & IPO Trends

What Is an IPO Pop?

An IPO pop occurs after a company goes public, when its stock price jumps higher on the first day of trading.

No matter how much preparation they’ve done, company executives and shareholders never really know how a stock will perform once it hits the market through its initial public offering (IPO).

While they of course hope to see some increase in price, a big spike — or IPO pop — could indicate that the underwriters underpriced the IPO.

Key Points

•   An IPO pop occurs when a company’s stock spikes on its first day of trading and may indicate that underwriters didn’t properly price retail investor demand into the IPO price.

•   In 2021, IPOs saw increases of 40% on average on the first trading day, but in the second quarter, companies were pricing below their expected ranges.

•   Direct listings are an alternative to IPOs that may help avoid an IPO pop, but they aren’t as efficient at raising capital.

•   Buying IPO stocks can be profitable, but it’s important to research the company before investing and to consider broad market trends.

•   IPO pops are relatively common, and larger companies tend to have larger pops since they are in high demand.

IPO Pop Defined

An IPO pop occurs when a company’s stock spikes on its first day of trading. An IPO pop may be a sign that underwriters did not properly price retail investor demand into the IPO price.

For instance, if a company prices its shares at $47 in its IPO and the price goes to $48 or $50, that would be considered a normal and positive IPO increase. But if the stock jumped to $60, both the company and its early investors might believe an error occurred in the IPO pricing.

This is one of the reasons that IPO shares are considered highly risky. In many cases, historically, that initial price jump hasn’t lasted, and investors who bought on the way up have taken a hit on the way down.

Recommended: What Is an IPO?

Problems Indicated by an IPO Pop

Many different factors go into pricing an IPO, including revenue, private investment amounts, public and institutional interest in investing. IPO underwriters try to find a share price that institutional investors will buy.

If the public thinks a company’s shares are more valuable than what early investors, underwriters, and executives thought, that means the company could have raised more money, increasing their own profit. Or they could have raised the same amount of money but with less dilution.

Also, when bankers price an IPO too low, that means their customers benefit — while company founders and VCs miss out on more profits.

If the share price soars on the first day, some investors will be happy, but it means the company could have raised more money if they had priced the stock higher from the start. It also means that existing investors could have given up a smaller percentage of their ownership for the same price.


💡 Quick Tip: Before opening an investment account, know your investment objectives, time horizon, and risk tolerance. These fundamentals will help keep your strategy on track and with the aim of meeting your goals.

IPO Trends

In the past, some companies have seen significant IPO pops occur on their first trading day. But in many cases the market cooled down after the first quarter, with some high-profile companies seeing declines on their first day.

Take 2021 as an example; in that year there were a record number of IPOs in the market.

In the first quarter of 2021 many companies were pricing their IPOs at the top of their expected range, due to increased demand, an improving economy, and a strong stock market. Even after that, IPOs still saw increases of 40% on average on the first trading day.

But in the second quarter, companies were pricing below their expected ranges and some weren’t even reaching those prices on the first trading day. This made the public less eager to buy into IPOs. This type of volatility is common to IPOs, and another reason why investors should be cautious when investing in them.

There was also a boom in special-purpose acquisition corporations (SPACs), IPOs of shell companies that go public with the sole purpose of acquiring other companies.


💡 Quick Tip: Access to IPO shares before they trade on public exchanges has usually been available only to large institutional investors. That’s changing now, and some brokerages offer pre-listing IPO investing to qualified investors.

Direct Listings

Some companies have turned to direct listings as a way to try to avoid an IPO pop. In a direct listing, the company doesn’t have an IPO, they just list their stock and it starts trading in the market. There is a reference price set by a market maker for the stock in a direct listing, but it isn’t nearly as important as the price of a stock in an IPO. Although this can help avoid an IPO pop, it is not as efficient as an IPO as a means of raising capital.

Setting a price for an IPO is a key part of that fundraising strategy. A newer strategy companies are trying is raising a large amount of private capital just before going public, and then doing a direct listing instead of an IPO. The process gives a valuation to the stock price but in a different way from pricing shares for an IPO.

A third strategy is to direct list, and then do a fundraising round some time after the listing, giving the public a chance to establish the market price for the stock.

Do IPOs Usually Go Up or Down?

Although stocks increase an average of 18.4% on their first day of trading, 31% of IPOs decrease when they start to trade. Calculations of IPO profits show that almost 50% of IPOs decrease from their day-one trading price on their second day of trading. While IPO investing may seem like a great investment opportunity, IPOs remain a risky and unpredictable asset class.

Average IPO First Day Return

IPO pops are relatively common. Sometimes average first day returns increase significantly, such as during the dot-com bubble when the average pop was 60%. Larger companies generally have larger pops, since they are in high demand.

Determining the Right IPOs to Invest In

Buying IPO stocks can be profitable, but it also has risks. Just because a company is well known or there is a lot of publicity around its IPO doesn’t mean the IPO will be profitable. As with any investment, it’s important to research the market and each company before deciding to invest.

It’s also important to be patient and flexible, as individual investors don’t always have the ability to trade IPO shares. Or investors may have access at some point after the actual IPO. In addition, IPO shares can be limited.

If you’re interested in upcoming IPOs, it’s important to keep in mind that IPOs increase in price on the first day but quickly decrease again, and almost a third of IPOs decrease on their first listing day. Popular IPOs are more likely to increase, but they are also crowded with investors, so investors might not see their orders fulfilled.

When investing in IPOs through your brokerage account, it’s important to look at broad market trends in addition to individual company fundamentals. When the market is strong, IPOs tend to perform better. Also, when high-profile companies have unsuccessful IPOs, investors may become more wary about investing in upcoming IPOs.

Each sector has different trends and averages. Generally tech companies have higher first day returns than other types of companies, even though they’re also often unprofitable. Investors still want in on these IPOs because they may have strong future earnings potential.

Historically, some of the most successful tech stocks started out with negative earnings, so low earnings are not a strong indicator of future success or failure.

The Takeaway

As exciting as an IPO pop can be, it’s another example of how hard it is for individual investors to time the market. First, there’s no way to predict if a newly minted stock will have a spike after the IPO. Sometimes there is a pop and then the price plunges. This is one reason why IPOs are considered high-risk events.

Investors who find IPOs compelling may want to assess company fundamentals and other market conditions before investing in IPO stock.

Whether you’re curious about exploring IPOs, or interested in traditional stocks and exchange-traded funds (ETFs), you can get started by opening an account on the SoFi Invest® brokerage platform. On SoFi Invest, eligible SoFi members have the opportunity to trade IPO shares, and there are no account minimums for those with an Active Investing account. As with any investment, it's wise to consider your overall portfolio goals in order to assess whether IPO investing is right for you, given the risks of volatility and loss.

Invest with as little as $5 with a SoFi Active Investing account.


Photo credit: iStock/Olemedia

SoFi Invest®
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

Investing in an Initial Public Offering (IPO) involves substantial risk, including the risk of loss. Further, there are a variety of risk factors to consider when investing in an IPO, including but not limited to, unproven management, significant debt, and lack of operating history. For a comprehensive discussion of these risks please refer to SoFi Securities’ IPO Risk Disclosure Statement. IPOs offered through SoFi Securities are not a recommendation and investors should carefully read the offering prospectus to determine whether an offering is consistent with their investment objectives, risk tolerance, and financial situation.

New offerings generally have high demand and there are a limited number of shares available for distribution to participants. Many customers may not be allocated shares and share allocations may be significantly smaller than the shares requested in the customer’s initial offer (Indication of Interest). For SoFi’s allocation procedures please refer to IPO Allocation Procedures.


Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

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What Is Yield to Call? Formula & Examples

What Is Yield to Call? Formula & Examples

An investor calculating yield to call is getting an idea of how much their overall bond returns will be. Specifically, yield to call refers to the total returns garnered by holding onto a bond until its call date. That doesn’t apply to all bonds, naturally, but can be very important for many investors to understand.

For investors who utilize bonds — callable bonds, in particular — as a part of their investment strategy, having a deep understanding of yield to call can be critical.

What Is Yield to Call?

As mentioned, yield to call (often abbreviated as “YTC”) refers to the overall return earned by an investor who buys an investment bond and holds it until its call date. Yield to call only concerns what are called callable bonds, which are a type of bond option.

With callable bonds, issuers have the option of repaying investors the value of the bond before it matures, potentially allowing them to save on interest payments. Callable bonds come with a call date and a call price, and the call date always comes before the bond itself matures.

A little more background: in a YTC scenario, ”yield” refers to the total amount of income earned over a period of time. In this case, the yield is the total interest a bond purchaser has accrued since purchasing the bond.

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*Customer must fund their Active Invest account with at least $10 within 30 days of opening the account. Probability of customer receiving $1,000 is 0.028%. See full terms and conditions.

How Yield to Call Works

If an investor buys a callable bond, they’ll see interest payments from the bond issuer up until the bond reaches maturity. The callable bond also has a call date, and the investor can choose to hold onto the bond until that date. If the investor does so, then YTC amounts to the total return the investor has received up until that date.

Yield to call is similar to yield to maturity, which is the overall interest accrued by an investor who holds a bond until it matures. But there are some differences, especially when it comes to how YTC is calculated.

💡 Quick Tip: When you’re actively investing in stocks, it’s important to ask what types of fees you might have to pay. For example, brokers may charge a flat fee for trading stocks, or require some commission for every trade. Taking the time to manage investment costs can be beneficial over the long term.

Yield to Call Formula

The raw yield to call calculation formula looks like this:

Yield to Call Formula:

Yield to call = (coupon interest payment + ( The call price – current market value ) ÷ time in years until call date ) ÷ (( call price + market value ) ÷ 2)

An investor should have all of the variables on-hand to do the calculation. Before we run through an example, though, here’s a breakdown of those variables:

•   Yield to call: The variable we are trying to solve for!

•   Coupon interest payment: How much the bondholder receives in interest payments annually.

•   Call price: The predetermined call price of the callable bond in question.

•   Current market value: The bond’s current value.

•   Time until call date: The number of years until the bond’s first call date arrives

The yield-to-call calculation will tell an investor the returns they’ll receive up until their bond’s call date. A bond’s value is roughly equal to the present value of its future earnings or cash flows — or, the return, at the present moment, that the bond should provide in the future.

How to Calculate Yield to Call

It can be helpful to see how yield to call looks in a hypothetical example to further understand it.

Yield to Call Example

For this example, we’ll say that the current face value of the bond is $950, it has an annual coupon interest payment of $50, and it can be called at $1,000 in four years.

Here’s how the raw formula transforms when we input those variables:

Yield to call = ($50 + ( $1,000 – $950 ) ÷ 4 ) ÷ (( $1,000 + $950 ) ÷ 2)

YTC = $25 ÷ $975

YTC = 0.0256 = 2.56%

Interpreting Yield to Call Results

Once we know that our hypothetical, callable bond has a yield to call of 2.56%, what does that mean, exactly? Well, if you remember back to the beginning, yield to call measures the yield of a bond if the investor holds it until its call date.

The percentage, 2.56%, is the effective return an investor can expect on their bond, assuming it is called before it matures. It’s important to remember, too, that callable bonds can be called by the issuer at any time after the call date. So, just because there is an expected return, that doesn’t necessarily mean that’s what they’ll see.

Yield to call calculations make a couple of big assumptions. First, it’s assumed that the investor will not sell the bond before the call date. And second, the calculation assumes that the bond will actually be called on the call date. Because of these assumptions, calculations can produce a number that may not always be 100% accurate.

Yield to Call Comparisons

Two calculations that are similar to YTC are “yield to maturity,” and “yield to worst.” All three calculations are related and offer different methods for measuring the value that a bond will deliver to an investor.

A different type of yield calculation would be needed if you wanted to try and measure the overall interest you’d earn if you held a bond to maturity. That’s different from measuring the overall interest you’d earn by simply holding the bond until its call date.

Yield to Call vs Yield to Maturity

YTC calculates expected returns to a bond’s call date; yield to maturity calculates expected returns to the bond’s maturity date. Yield to maturity gives investors a look at the total rate of return a bond will earn over its entire life, not merely until its call date (if it has one).

Yield to Call vs Yield to Worst

Yield to worst, or “YTW,” measures the absolute lowest possible yield that a bond can deliver to an investor. Assuming that a bond has multiple call dates, the yield to worst is the lowest expected return for each of those call dates versus the yield to maturity. Essentially, it gives a “worst case” return expectation for bondholders who hold a bond to either its call date or for its entire life.

If a bond has no call date, then the YTW is equal to the yield to maturity — because there are no other possible alternatives.

💡 Quick Tip: Look for an online brokerage with low trading commissions as well as no account minimum. Higher fees can cut into investment returns over time.

The Takeaway

Learning what yield to call is and how to calculate it, can be yet another valuable addition to your investing tool chest. For bond investors, YTC can be helpful in trying to figure out what types of returns you can expect, especially if you’re investing or trading callable bonds.

It may be that you never actually do these calculations, but having a cursory background in what the term yield to call means, and what it tells you, is still helpful information to keep in your back pocket.

Ready to invest in your goals? It’s easy to get started when you open an investment account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).

For a limited time, opening and funding an Active Invest account gives you the opportunity to get up to $1,000 in the stock of your choice.

FAQ

What is the advantage of yield to call?

Yield to call helps investors get a better idea of what they can expect in terms of returns from their bond holdings. That can help inform their overall investment strategy.

How do you calculate yield to call in Excel?

Calculating yield to call can be done the old fashioned way, with a pen and paper, or in a spreadsheet software, of which there are several. An internet search should yield results as to how to calculate YTC within any one of those programs.

Is yield to call always lower than yield to maturity?

Generally, an investor would see higher returns if they hold a bond to its full maturity, rather than sell it earlier. For that reason, yield to call is generally lower than yield to maturity.


Photo credit: iStock/MicroStockHub

SoFi Invest®
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Claw Promotion: Customer must fund their Active Invest account with at least $10 within 30 days of opening the account. Probability of customer receiving $1,000 is 0.028%. See full terms and conditions.

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