Testing the Waters: What It Means in an IPO

By Samuel Becker · September 11, 2023 · 7 minute read

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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.

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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.

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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.


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

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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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