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Initial public offerings have long held the interest of the American public. With the frenzy of IPO day -- and all the media coverage around hot offerings -- it can be hard to resist the excitement and the idea of getting in on the ground floor. But for a long time, the average investor had to settle for watching from the sidelines.
Historically, average investors have largely been locked out of the IPO market, waiting until shares begin trading to get in on the action if interested in buying the shares. That's because IPO underwriters -- investment banks tasked with selling the shares -- often issue the bulk of IPO shares to their biggest clients, such as institutional investors, including pension funds, mutual funds, and insurance companies.
In the rare cases when brokers did approach small clients about investing in an IPO, such offers might be met with suspicion, said Timothy Loughran, a finance professor at the University of Notre Dame.
"Historically if my broker called me up and tried to sell me on an IPO, I would say, 'This is not a good idea,' and take a pass," said Loughran. "The only time they were going to go down to someone like me is if the IPO is having trouble and they're having trouble placing the shares."
In recent years, however, new services are starting to change that. Last year, one online brokerage firm began allowing investors to put as little as $250 into certain IPOs, while another, founded in 2013, advertises IPO opportunities with $100 minimum investments.
"What these new platforms are doing is they're opening up access," Loughran said.
And some IPO-ready companies themselves are warming up to the benefits of including small investors in share allocations. Smaller investors are more likely to pursue a buy-and-hold strategy for stocks, meaning less volatility for the company's shares.
Car-financing company Santander Consumer USA, which worked with one of these new online brokers offering low-minimum IPO investing , found that 60% of investors held on to their stocks for at least six months, according to the broker that offered the IPO.
But it's important for any investor considering investing in an IPO to remember that what's good for a company isn't always good for investors. Investing in a newly public company at its IPO price can be a risky proposition.
A report by The Wall Street Journal earlier this year found that more than 70% of companies with U.S. IPOs in 2015 were trading below their IPO prices in February 2016.
Nonetheless, IPO opportunities can appear attractive, as new shares sometimes "pop" from their initial prices on their first day of trading. A few have even seen one-day gains exceed 100%. The thing is, a lot of investors only remember these huge success stories and forget that for every major success, there is another notable flop.
Critics charge that platforms advertising IPO investments may attract investors vulnerable to making uninformed decisions. Those who invest believing they're guaranteed a handsome profit may be sorely disappointed if the stock plummets on its first day of trading, as some do. Other smaller investors may assume that a stock's IPO price is a fair one, while a sophisticated institutional investor may conclude otherwise and walk away.
As Motley Fool contributor Jon Quast wrote, the "arrangement opens the door for many investors with unrealistic expectations, who don't really know the first thing about investing."
If you are considering an IPO investment, it's wise to approach it as you would any other investment -- with careful consideration and much research.
One way to start the latter is by scouring the company IPO registration forms filed with the Securities and Exchange Commission. The forms, which include information about the company's assets, financial condition, management, and risk factors, are available at the SEC's EDGAR database.
