Every public company was once private. The moment it transitioned – when its shares became available for anyone to buy on an exchange – was its initial public offering. Understanding how that process works explains why IPO-day excitement often produces disappointing outcomes for retail investors.
What an IPO Is
An IPO is the first sale of a company's shares to the public. Before it, ownership is restricted to founders, employees with equity grants, venture capital firms, and private equity investors. After it, anyone with a brokerage account can buy a stake.
Companies go public for several reasons: to raise capital for expansion, to give early investors a path to sell their holdings (liquidity), and to use stock as currency for acquisitions or employee compensation. The IPO itself generates proceeds that go either to the company (if new shares are issued) or to selling shareholders (if existing shares are sold), or both.
The Six-Step Path to Public
1. Hiring underwriters
The company selects one or more investment banks to manage the offering. Goldman Sachs, Morgan Stanley, JPMorgan, and similar firms underwrite most significant IPOs. Underwriters advise on timing, structure the deal, and distribute shares to institutional investors.
2. Filing the S-1
The company submits a registration statement – called an S-1 – to the Securities and Exchange Commission. The S-1 is a public document containing audited financial statements, a business description, risk factors, competitive analysis, and information about how the company intends to use the proceeds. Reading the Risk Factors section of any S-1 is one of the most informative 30 minutes an investor can spend before deciding whether to participate.
3. The roadshow
Before setting a final price, the company's management team and underwriters conduct a roadshow – a series of presentations to large institutional investors (pension funds, mutual funds, hedge funds). These presentations generate interest and, importantly, gather indications of demand: how many shares institutions want and at what price.
4. Pricing
Based on roadshow demand, underwriters and the company agree on an IPO price. If demand is strong, the final price often lands above the initial range. Airbnb's December 2020 IPO originally suggested $44 to $50 per share. After overwhelming institutional interest, it priced at $68 per share, raising $3.5 billion.
The IPO price is what institutional investors pay. Retail investors rarely receive access at this price.
5. First-day trading
On IPO day, the stock lists on NYSE or NASDAQ. The opening price – the first trade of the public market – is determined by supply and demand at the open, not by the IPO price. When Airbnb listed on December 10, 2020, the IPO price was $68. The first public trade printed at $146 – more than double. By the end of the day, it closed at $144.
Retail investors who wanted to buy on IPO day paid approximately $146, not $68. The "first-day pop" had already occurred.
6. Post-IPO trading
After listing, the stock trades like any other public security. Prices reflect ongoing supply and demand based on the company's actual performance versus market expectations.
One important constraint: the lockup period. Insiders – founders, employees with equity, early investors – typically cannot sell their shares for 90 to 180 days after the IPO. When the lockup expires, a significant volume of shares can hit the market simultaneously. This additional supply frequently pushes prices lower. Airbnb's share price, after reaching a peak of approximately $220 in February 2021, declined to around $120 within a year – partly reflecting the fundamental valuation adjustment as lockup periods ended and insiders sold.
The Retail Investor's Position
The mechanics create a structural disadvantage for retail investors in IPOs. Institutional investors receive IPO allocations at the IPO price as a function of their relationship with the underwriting banks. Retail investors access the stock at the post-pop opening price, often 15 to 40% above the IPO price.
If the company performs well and the stock continues rising, the higher entry price may not matter over a multi-year holding period. If the stock declines after the first-day spike – a common pattern across IPO research – the investor who bought at the inflated opening price faces both the decline and a higher cost basis than institutional participants.
Historical IPO Performance
Research consistently shows that IPOs, as a group, underperform the S&P 500 over 3 to 5 year periods. First-day pops are memorable. The subsequent multi-year performance is not. There are exceptions – Amazon, Salesforce, and Snowflake delivered strong multi-year returns from their IPO prices. But the base rate for IPOs beating the index over five years is well below 50%.
A More Measured Approach
Waiting six to twelve months after an IPO to evaluate the company allows for several useful data points: actual public earnings reports (not just the roadshow narrative), lockup expiration and the subsequent price reaction, and a clearer picture of how the business performs under public market scrutiny. Many companies that IPO at premium valuations trade at lower prices six months later – providing a better entry point for investors willing to wait for evidence.
This content is for educational purposes only and does not constitute investment, legal, or tax advice. Investing in securities involves risk, including possible loss of principal. Always conduct your own research and consult a licensed financial professional before making investment decisions.
The IPO is the first moment a company enters public markets. What happens next - secondary offerings, potential splits, and ongoing shareholder dilution - follows from the foundation set at listing.
→ Share Events and Structural Changes → The full sequence from IPO through secondary offerings and splits - www.breakoutbulletin.com/article/corporate-share-events-ipos-secondary-offerings-stock-splits
→ Secondary Offerings Explained → When companies return to equity markets after the IPO and what it signals - www.breakoutbulletin.com/article/secondary-offerings-explained-for-teen-investors
→ How Companies Make Money from Stocks → Why the IPO is the company's payday and everything after is investor-to-investor - www.breakoutbulletin.com/article/how-companies-make-money-from-stocks