Introduction
An initial public offering, or IPO, is when a private company sells shares to the public for the first time. IPOs matter because they create new investment opportunities, they can reshape ownership and corporate governance, and they often drive high short-term volatility.
Should you try to buy the next high-flying listing at the offering price, or wait until after the initial excitement? In this article you'll learn how IPOs work, what to look for in the S-1 prospectus, typical trading patterns after listing, and practical ways for individual investors to participate without taking outsized risk.
Key Takeaways
- IPOs can deliver big short-term moves, but long-term performance is mixed; treat them as speculative unless fundamentals are clear.
- Read the S-1 to assess revenue quality, margins, cash flow, and insider ownership; focus on unit economics when profits are absent.
- Lock-up expiries, usually 90 to 180 days, create meaningful volatility risk as insiders gain the right to sell.
- Retail allocation is often limited; you can access IPOs via broker programs, direct allotments, or by buying on the open market after trading begins.
- Use position sizing, dollar-cost averaging, and valuation discipline to manage risk rather than chasing first-day pops.
How IPOs Work: The mechanics and players
An IPO transforms a private company into a publicly traded one by registering shares with regulators and listing on an exchange. The process usually begins with hiring investment banks to underwrite the deal, filing a registration statement like the S-1 in the US, and marketing the offering to institutional investors via a roadshow.
Key participants include underwriters, company insiders, early investors like venture capital firms, and public buyers. Underwriters set the offer price and manage allocations, so their incentives and the level of demand strongly influence whether retail investors get shares at the offering price.
Primary vs secondary shares
IPOs can include primary shares, which raise new capital for the company, and secondary shares, which let existing owners sell. A heavy secondary component means existing shareholders are cashing out, which can be a red flag if insiders are reducing their stake substantially.
Pricing and book-building
Book-building is how underwriters gauge demand and set the price range. Strong interest can compress the range or push the final offer price higher, while weak demand can lead to price reductions. Expect volatility on day one if demand is uneven.
Reading the S-1: What to focus on
The S-1 prospectus is the investor's primary source of information. It contains financial statements, risk factors, business description, use of proceeds, management discussion, and ownership schedules. You should be able to extract the story behind the numbers in 15 to 30 minutes.
Financial and growth signals
Look at revenue growth rates, gross margins, and cash flow trends. For unprofitable companies, focus on revenue growth and unit economics like customer acquisition cost (CAC) and lifetime value (LTV). Ask whether revenue is recurring or one-time, and whether margins are improving as scale grows.
Risk factors and corporate governance
Read the "Risk Factors" section for litigation, regulatory exposure, dependence on a few customers, or key person risk. Check insider ownership, dual-class share structures, and whether founders retain control through special voting rights. These governance features affect how responsive management will be to public-market investors.
Use of proceeds and balance sheet
Understand how the company plans to use IPO proceeds: growth initiatives, paying debt, or simply giving early investors a liquidity event. A strong balance sheet post-IPO reduces short-term financial risk and can support reinvestment in the business.
Typical IPO performance patterns and drivers
IPOs often follow a few common patterns. On listing day, many see an initial price surge as pent-up demand is executed. After the first few weeks, prices may cool as speculative participants exit and more supply hits the market.
Longer term, academic studies have found that, on average, newly public firms can underperform the broader market over three to five years. That doesn't mean every IPO fails, but it does mean you should separate hype from durable business quality before investing.
Drivers of post-IPO moves
- First-day pop: Driven by scarcity of supply to retail buyers and institutional demand; pricing can be intentionally conservative to ensure a successful trade.
- Lock-up expiries: When insiders can sell, downward pressure often appears as new shares become available.
- Quarterly results and guidance: Early public-company quarters reveal whether the private growth story holds up under public scrutiny.
- Market sentiment and macro conditions: Broad market risk appetite affects how investors value high-growth, unprofitable listings.
Lock-up period: why it matters
A lock-up is a contractual period after the IPO during which insiders cannot sell their shares. Typical lock-ups are 90 or 180 days, though they vary. Lock-up expiry dates are on the S-1 or in the prospectus supplement.
Why care? When lock-ups expire, a large volume of shares can be sold quickly, creating sudden supply that can depress the stock price. Even if insiders don't sell immediately, the mere prospect of possible selling can weigh on sentiment.
How to manage lock-up risk
- Check the expiry date in the prospectus and mark it on your calendar.
- Reduce position size ahead of the expiry if you want to avoid volatility risk.
- Watch insider ownership and intent, sometimes disclosed in subsequent filings or via accelerated filing schedules when insiders plan to sell.
How to evaluate valuation in IPOs
Valuation is particularly tricky for IPOs because many newly listed companies either have negative earnings or are in rapid investment mode. You can't rely solely on a P/E ratio. Instead, use a mix of comparable-company multiples, revenue multiples, and scenario-based discounted cash flow models.
Practical valuation checklist
- Compare revenue multiples to public peers, adjusting for growth rates and margin profiles.
- Estimate the path to profitability and test multiple scenarios for free cash flow timing.
- Assess TAM, realistic market share, and competition to judge whether growth assumptions are credible.
- Consider dilution from future equity issuance, option pools, and earn-outs, which lower your effective ownership.
For example, if a company expects $500 million in revenue in year three and trades at a 6x revenue multiple implied by its IPO price, the market is pricing $3 billion in enterprise value. Ask whether that multiple is reasonable compared with similar public companies and their growth trajectories.
Ways retail investors can access IPOs
There are three common routes: participating directly in a broker's IPO allocation, subscribing via a direct listing or special access program, or buying shares on the open market after the listing. Each route has trade-offs in access, price, and timing.
Broker allocations
Many brokers offer IPO programs that let eligible clients request an allocation. Allocations are limited and typically favor larger, long-term clients or those with strong brokerage relationships. Don't expect large allotments unless you qualify for higher tiers.
Buying after listing
Holding off and buying on the open market is the most democratic option. You can wait for the initial volatility to settle and for public filings and quarterly results to provide more data. This approach helps you avoid paying a first-day premium and gives time to evaluate fundamentals.
Real-World Examples and Scenarios
Example 1: Hypothetical IPO priced at $20 that opens at $30. If you were allocated shares at $20 and sold on day one at $30, you realize a 50% gain. However, if you bought after the pop at $30 and the stock later falls to $18 after lock-up expiry, you face a 40% loss.
Example 2: A real-world-themed scenario, not a recommendation. A fast-growing software company that lists with negative EBITDA might trade at 10x trailing revenue in the IPO. If you expect revenue to triple in three years, you might justify the multiple, but if growth slows to 30% annually, the multiple becomes hard to defend and the stock could decline sharply.
Example 3: Consider insider selling schedules. If founders hold 40% pre-IPO but plan to sell 25% of their holdings during the IPO and again after lock-up, your effective free float and potential selling pressure increase. That can materially affect price discovery and volatility.
Common Mistakes to Avoid
- Chasing the first-day pop: Many investors buy after a big open and get stuck when the price mean-reverts. Avoid buying solely because of momentum.
- Ignoring the lock-up: Not accounting for lock-up expiries can expose you to large, predictable drops. Check the expiry date and insider selling plans.
- Overweighting a single IPO: Allocating too much capital to one listing can blow up portfolio risk. Use position sizing rules and limits.
- Relying only on hype and marketing: Roadshows are sales processes. Base decisions on the S-1 fundamentals, not just investor presentations or media buzz.
FAQ
Q: How likely is it that I’ll get shares at the IPO price through my broker?
A: Retail allocations are limited. If you have a high-balance or active account, your broker may offer allocations, but many retail investors receive none and must buy after the listing on the open market.
Q: Should I buy shares on day one or wait?
A: That depends on your risk tolerance. Day-one trading is often volatile and can overpay for hype. Waiting lets you see early trading behavior, initial filings, and quarterly results, which reduces information asymmetry.
Q: Does a large first-day pop mean the company is a good long-term investment?
A: Not necessarily. First-day pops often reflect short-term demand and supply imbalances. Examine long-term revenue sustainability, margins, and competitive position before deciding on a long-term allocation.
Q: How do lock-ups affect my decision to buy an IPO?
A: Lock-ups create a predictable liquidity event. If you prefer lower volatility, avoid buying just before lock-up expiry or size your position small enough to tolerate potential price swings.
Bottom Line
IPOs create exciting opportunities, but they also come with distinct risks: limited information, concentrated ownership, and predictable volatility around lock-up expiries. If you're interested in IPOs, treat them as part of your speculative sleeve, size positions cautiously, and rely on fundamentals from the S-1 rather than hype.
Actionable next steps: read the S-1, mark lock-up expiry on your calendar, and decide whether you'll seek broker allocation or wait to buy on the open market. Use valuation checks, scenario analysis, and position sizing to protect your portfolio while you explore new listings. At the end of the day, being selective and disciplined will help you participate in IPOs without taking unnecessary risk.
