Tech IPOs involve a technology company going public, and making its stock available for purchase on the open market by any interested investor. Given the tech sector’s incredible growth over the past couple of decades, tech IPOs tend to garner a lot of attention from investors, who may feel that they’re investing in the next big thing.
But the IPO process isn’t simple or easy for firms to navigate, and for investors, buying shares of newly public companies can carry significant risk. As such, there are many things to consider and know about tech IPOs before stocking up on shares.
What Are Tech IPOs?
A technology initial public offering or IPO marks the debut of a company’s shares on the stock market. Issuing an initial public offering is a multi-step process that involves venture capitalists, investment bankers, regulators and stock exchanges.
Tech IPOs tend to garner excitement from investors of all stripes, but while newly public tech stocks are often believed to offer rapid growth potential, not all live up to expectations.
For that reason, investors may benefit from revisiting some best practices or tips for investing in tech companies before putting their money on the line.
The Appeal of Tech IPOs
Large tech companies have largely dominated gains in the U.S. stock market for several years. Investors have flocked to shares of the so-called FAANG stocks — Facebook, Apple, Amazon.com, Netflix and Google — as soaring prices of those companies left many investors looking for the next big thing out of Silicon Valley, Seattle, Austin, and other tech-dominated cities.
IPOs had traditionally been an important step for burgeoning tech companies and signaled a level of corporate maturation to the market. Going public means companies will be exposed to a broader array of investors, greater regulatory requirements, and increased trading of its company shares.
But in recent years, some tech companies have shunned the traditional IPO model, either by staying private for longer periods of time, or seeking alternative routes to going public, like direct listings, or by merging with special purpose acquisition vehicles (SPACs).
How Tech IPOs Work
A company may pursue an IPO in order to raise funds or obtain more liquidity for its shares. IPOs can also be an exit strategy for early stakeholders like corporate insiders, angel investors, and venture capitalists. And lastly, a small startup may think listing its shares will potentially increase its brand recognition and prestige. Public companies tend to have more shareholders than private ones.
When a tech company is ready to go public, it typically starts the IPO process by hiring investment bankers. The process by which investment bankers handle an IPO is called underwriting.
The investment bank will buy the shares from the company before trying to transfer them to the public market. One bank typically leads the IPO process, but a handful of banks are typically involved, typically as means of diluting risk.
Underwriters then typically hold roadshows — events in which they pitch institutional investors on the IPO. The idea is to build up hype and demand for the new stock, increasing its value.
Institutional investors include hedge funds, mutual funds, and pensions. If these investors want to buy the IPO shares, underwriters can allocate them a proportion of the shares that will be listed. This all occurs before the stock debuts on the public markets, where retail investors can purchase shares.
IPO Regulatory Requirements
Going public also means that companies become subject to regulations by the U.S. Securities and Exchange Commission (SEC) . Under those regulations, companies will be required to make quarterly and annual filings and disclose material events to the public, among other things.
If a company gets SEC approval to go public, the underwriter files an S-1 and puts together a prospectus. The prospectus includes financial data and describes what the proceeds will be used for, as well as potential risks to investors.
Listing Tech IPOs
Tech companies also need to choose their listing exchange. This isn’t the only market where investors can trade the company’s shares but a significant proportion of volume will be done on the listing venue. The two biggest markets for IPOs in recent years have been the New York Stock Exchange (NYSE) or Nasdaq, though there are many types of exchanges.
Nasdaq has attracted many large tech companies in its history, such as Apple, Amazon.com, Facebook, Google and Microsoft. But the NYSE has likewise drawn some big tech IPOs. The listing fees that companies pay for NYSE are more expensive than for Nasdaq, but only stocks listed on the Nasdaq qualify to enter the Nasdaq 100 Index, which is the basis for the popular Invesco QQQ exchange-traded fund.
The day of the IPO, the shares are listed on the exchange and trading commences. At Nasdaq, the process of price discovery is all done electronically, while at NYSE, floor traders also play a role. Underwriters typically underprice shares in order for them to have a strong performance, or “pop” on the first day. This basically means that they hope shares will gain significant value on the first day they’re listed for trading.
Recommended: What Determines a Stock’s IPO Valuation?
Many stocks, after an IPO, are subject to lock-up periods. This is a period of time after the public offering in which early investors aren’t allowed to sell their shares. Lock-up periods are designed to keep share prices stable post-IPO.
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Staying Private
In recent years, many tech companies have stayed private for relatively longer periods of time before going public, finding more avenues for funding as the venture capital world has expanded.
One reason: Going public is an expensive, often onerous process. Investment bank fees can take up 4% to 7% of an IPO’s proceeds alone. As such, many firms are incubating longer before IPOing. Between 1980 and 2021, the median age of tech companies going public was eight years. But for three of the last four years, the median age was 12.
This has led to the proliferation in Silicon Valley of so-called unicorn companies — privately held companies valued at greater than $1 billion.
New IPO Routes for Tech Companies
The IPO market experienced something of a resurgence in 2020 as the stock market reached new peaks. The tides turned in 2022, however, as the number of IPOs fell considerably, largely due to rising interest rates, inflation, and shaky economic sentiment.
For tech companies that have decided to go public in recent years, though, many have taken to experimenting with alternatives to the traditional IPO.
SPACs, or special purpose acquisition vehicles (or special purpose acquisition companies), have proven to be one effective method for some companies. Also known as blank-check companies, SPACs use the IPO process to raise money and then look for companies to merge with. They often have a two-year time horizon to find an acquisition.
For many startup companies, merging with a SPAC can offer a faster way to go public versus the drawn-out process of an IPO.
Some companies also opt for direct listings. In a direct listing, companies forgo the step of hiring an investment bank as an underwriter. In such listings, banks may still play a smaller advisory role, but companies instead rely on the auction by the stock exchange to set their IPO price.
No additional capital is raised in direct listings, meaning they’re typically done by cash-rich companies that are already widely recognized by the market and public.
Pros of Tech IPOs
All things considered, tech IPOs do offer investors a number of potential advantages.
Initial Momentum
If you’re able to invest early in a hot tech IPO, you may be able to ride an initial wave of enthusiasm to some serious gains. Those gains may be short-lived, however, and there’s always the risk that enthusiasm among investors never materializes in any significant way.
A Growing Sector
Long-term prospects for the tech sector are mostly positive. Tech has been a growth industry for many years, but there are many other areas in which tech companies are expanding: machine learning, artificial intelligence (AI), bio- and pharmatechnology, and many more, for example. This could prove to be a boon for long-term investors.
Further Income
It’ll depend on the specific stock, but investors may be able to take advantage of extra income opportunities from their holdings, such as dividend payments. Usually, more mature stocks tend to pay dividends, but if you hold on long enough, IPO shares could become revenue-generating holdings.
Cons of Tech IPOs
Tech companies have their downsides; they face stiff competition from other innovators and disruptors. So investing in a tech IPO includes certain risks.
Sector Risk
Tech is still growing, but it’s a volatile space. In fact, many tech companies may be described as high-risk stocks, as they may be relatively new to the fold compared to more established companies. As such, initial valuations may not fully price in how risky these companies are.
Too Much Hype
Some stocks may not live up to the initial build-up that comes with any IPO. Consider this: During 2021, roughly a quarter of IPO stocks experienced a loss in value during their first day on the market. So, it’s possible to get caught up in the hype, and overlook some glaring issues with some IPO stocks.
Regulatory Risks
Regulation and government oversight of tech companies could also be changing. Many tech companies have found themselves in the crosshairs of regulators for antitrust issues, among other things, and such cases could have widespread ramifications for tech companies when it comes to their regulatory landscape and competitive practices.
|
Tech IPOs: Pros and Cons |
|
|---|---|
| Pros | Cons |
| Initial momentum | Sector risk |
| Growing sector | Too much hype |
| Further income opportunities | Regulatory risks |
The Takeaway
Tech IPOs are when tech companies list their shares for purchase on a public stock exchange. Though the method through which many tech firms are going public has changed (through SPACs, etc.), many tech companies are still using the traditional IPO process.
Buying IPO stocks of tech firms can offer investors an opportunity to invest in high-growth stocks with the potential for sizable gains. However, risks include high valuations for unseasoned companies, as well as disappointed share price performance after the listing.
Interesting in IPO investing? Using SoFi’s Invest tools, investors can set up automated or active investing in a diverse array of stocks and ETFs. With pre-IPO trading, eligible SoFi members can even buy into companies before they begin trading — giving you a jump start on the market.
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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.
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