How to Disrupt the IPO Pop

The way initial public offering pricing works is that investors want to buy stock in a new company at a low price, and the company wants to sell it at a high price, and an investment bank listens to both sides’ arguments and then tells the company what price it can sell the stock at, and the company generally does what the bank tells it to do. And then it sells the stock and it usually goes up like 10% or 20% or even more the next day. This is called the “IPO pop,” and it happens in most IPOs, though of course not all of them: IPOs are inherently risky investments, and sometimes they go down, and several very high-profile recent IPOs have “cracked” immediately and stayed below their IPO prices. But if there is a pop, and there usually is, it suggests that the investors might have been willing to pay a bit more than they let on, and that the bankers were maybe a bit conservative in their advice to the company. Over and over again.

I happen to think that there are good reasons for this system, and that it mostly works well for companies and their pre-IPO investors. (Which is why it’s been the almost universal way that companies have gone public for many decades.) Companies want good relationships with their shareholders over the long run, so it is nice for them to introduce themselves to the market in a way that makes the market happy. Early investors tend to hold onto their shares for some time after the IPO, so they want the stock to trade well. And, as I argued the other day, the systematic underpricing of IPOs is what convinces big investors to pay attention to smallish risky new companies; the fact that most IPOs go up is the reason that Fidelity is coming to your $2 billion company’s roadshow. Venture capitalists are giving up first-day gains on most of their stocks, but that buys them a system in which they can easily take lots of companies public at attractive valuations.