Technology initial public offerings (IPOs), the debut of a company in the stock market, tend to garner excitement from investors of all stripes. Tech IPOs are a multi-step process that involves venture capitalists, investment bankers, regulators and stock exchanges. And while newly public tech stocks are often believed to offer rapid growth potential, not all live up to expectations.
Large tech companies have dominated gains by the U.S. stock market for years. Investors have flocked to shares of the so-called FAANG stocks—Facebook, Apple, Amazon.com, Netflix and Google. The soaring prices of such names have left investors craving fresh shares of Silicon Valley companies.
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 shares.
But in recent years, some tech companies have shunned the traditional IPO model, either by staying private for longer or seeking alternative routes like direct listings or special purpose acquisition vehicles (SPACs).
How Tech IPOs Work
Why do private companies go public? 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, they typically start by hiring investment bankers. The process by which investment bankers handle an IPO is called underwriting.
The bank will buy the shares from the company before trying to transfer them to the public market. One bank typically leads the process but a handful of banks are typically involved, usually to share the risk of buying the shares.
Underwriters then typically hold roadshows–events in which they pitch institutional investors on the IPO.
Institutional investors include hedge funds, mutual funds and pensions. If such investors want to buy the IPO shares, underwriters can allocate them a proportion of the shares that will be listed.
IPO Regulatory Requirements
Going public would also mean that companies become subject to regulations by the U.S. Securities and Exchange Commission (SEC) . They’ll be required to make quarterly and annual filings and disclose material events to the public.
If the company gets SEC approval to go public, the underwriter files the S-1 and puts together the prospectus. The prospectus includes financial data and describes what the proceeds will be used for, as well as potential risks.
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Before They Trade on Exchanges
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.
Nasdaq has attracted many large tech companies in its history, such as Apple, Amazon.com, Facebook, Google and Microsoft. But the NYSE has 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 the shares in order for them to have a strong performance or “pop” on the first day.
Recommended: What Determines a Stock’s IPO Valuation?
Many stocks after an IPO are subject to lock-up periods. This a length of time after the public offering in which early investors aren’t allowed to sell their shares. They’re designed to keep share prices stable post-IPO.
In recent years, tech companies have been taking their time before debuting in the public stock market, finding more avenues for funding as the venture-capital world has expanded.
Going public is an expensive, often onerous process. Investment-bank fees alone can take up 4% to 7% of an IPO’s proceeds. Business publications have followed this trend, pointing to how the average age of a VC-backed U.S. company in 2013 going public was seven years. By 2018, it was 10 years. This has led to the proliferation in Silicon Valley of so-called unicorns—privately held companies valued at greater than $1 billion.
New IPO Routes in Tech
The IPO market has experienced somewhat of a resurgence in 2020 as the stock market reached new peaks. But when companies have been going public, they’re often experimenting with alternatives to the traditional IPO.
SPACs, or special purpose acquisition vehicles, have been one way. Also known as blank-check companies, SPACs raise money through an IPO then look for companies to merge with. They often have a two-year time horizon to find an acquisition.
For startups, merging with a SPAC can offer a speedy way to go public as opposed to the drawn-out process of an IPO. Media reporting in October noted that SPACs raised $51.3 billion in the U.S. in 2020, the highest ever and almost half the amount raised by IPOs as a whole.
Direct listings are another route tech companies have tried. 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 new money is raised in direct listings, meaning they’re typically done by cash-rich companies that are already widely recognized by the market and public. Data-mining company Palantir and corporate software maker Asana also chose to go public via direct listings, while news outlets have also reported that Airbnb had considered this route before deciding on a traditional IPO.
Pros of Tech IPOs
Inventor enthusiasm coupled with buoyant equity markets can propel shares of newly public stocks.
The Renaissance IPO Index has surged 88% in 2020 through Nov. 20. The gauge tracks companies that have gone public roughly in the last two years. The index’s rally vastly outpaced the benchmark S&P 500’s 12% gain over the same period. Tech stocks comprise a little over half of the IPO index.
Tech companies can also offer growth opportunities for investors. For instance, while the global COVID-19 pandemic has battered results for many industries, Silicon Valley names have been a bright spot when it comes to revenue, as consumers have been stuck at home, conducting their activities and making purchases virtually.
Cons of Tech IPOs
Tech IPOs also pose risks for investors. Because some of these companies haven’t been around for that long, they may not yet be profitable. This means that the IPO valuations could be too high.
Investors experienced the brunt of this firsthand when the dot-com bubble burst in the early 2000s, causing a slew of newly public tech stocks to shutter.
Much-hyped IPOs may also disappoint in terms of price performance. Data from Dealogic shows that since 2010, around a quarter of U.S. IPOs have seen losses after their first day.
Startups may also call themselves tech firms or be grouped into the industry, even when the actual technological features of their businesses are more limited.
Regulation and government oversight of tech companies could also be changing. In October, the U.S. Justice Department filed an antitrust lawsuit against Google, alleging that the search company uses anticompetitive practices. Such cases could have widespread ramifications for tech companies when it comes to their regulatory landscape and competitive practices.
Buying IPOs of tech firms can offer investors an opportunity to invest in high-growth stocks. However, potential pitfalls include high valuations for an unseasoned company as well as disappointed share price performance after the listing.
For investors, the IPO prospectus can be a valuable research tool if they’re looking to invest in a tech company with a listing coming up.
Of course, IPOs aren’t the only way investors can get access to Silicon Valley companies, even if they do seem to grab a lot of headlines. Investors can buy shares of tech names that have been public for years.
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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