What Is an IPO?

Every few years, a company goes public with so much hype that it feels like a once-in-a-lifetime opportunity. Facebook. Uber. Airbnb. Coinbase. The media frenzy around an IPO makes it seem like getting in on Day 1 is a golden ticket. But the reality of IPO investing is far less glamorous than the headlines suggest — and for most individual investors, IPOs are a losing game.

How It Works

An Initial Public Offering (IPO) is when a private company sells shares to the public for the first time, listing them on a stock exchange. Before the IPO, the company was owned by founders, employees, and private investors (venture capitalists, private equity firms). After the IPO, anyone with a brokerage account can buy shares.

The process typically works like this:

Step 1: The company hires investment banks (Goldman Sachs, Morgan Stanley, etc.) to underwrite the offering. These banks help determine the initial share price, market the deal to large institutional investors, and handle the logistics.

Step 2: The "roadshow." Company executives travel to meet with large institutional investors — pension funds, mutual funds, hedge funds — to pitch the company and gauge demand.

Step 3: Pricing. Based on demand, the underwriters set the IPO price. This price is where shares are sold to institutional investors before the first day of public trading.

Step 4: First day of trading. The stock opens on the exchange and the public can buy shares. The opening price is often significantly higher than the IPO price — this gap is called the "IPO pop." When Facebook priced at $38 in 2012, shares briefly traded above $42 before falling below the IPO price within days.

The key thing to understand: you, as a retail investor, almost never get shares at the IPO price. That allocation goes to big institutional clients of the underwriting banks. By the time you can buy, the stock has already popped — meaning you're buying at an inflated price.

Why It Matters for Investors

The data on IPO investing for retail investors is sobering:

According to a study by Jay Ritter, professor of finance at the University of Florida (often called "Mr. IPO"), the average IPO underperforms comparable stocks by about 18% over the first three years after going public. The median IPO does even worse — half of all IPOs lose money within three years.

Why? Several reasons:

Information asymmetry. The company and its insiders know far more about the business than you do. They chose to sell when conditions were favorable — for them, not for you.

Valuation optimism. IPOs are priced during periods of peak excitement. Investment banks have an incentive to price high (their fee is a percentage of the deal). The roadshow is designed to create maximum hype.

Lock-up expiration. Company insiders typically can't sell their shares for 90-180 days after the IPO. When the lock-up expires, a flood of insider selling often depresses the stock price.

No track record. Public companies must disclose detailed financials quarterly. But at the time of the IPO, you have limited historical data as a public company and no track record of quarterly earnings beats or misses.

Warren Buffett has never bought an IPO in his life. He once said: "An IPO is like a negotiated transaction — the seller chooses when to come public, and it's unlikely to be a time that's advantageous to you."

Real Example

Let's look at the class of 2021 — peak IPO mania:

• Rivian (RIVN): IPO'd at $78, briefly hit $179. By mid-2024: ~$11. Investors lost 86% from the Day 1 close.
• Coinbase (COIN): Opened at $381 on Day 1. Dropped to $36 by end of 2022. Recovered to ~$200 by 2024, but still well below the opening price.
• Robinhood (HOOD): IPO'd at $38, briefly hit $85. By mid-2024: ~$17. A 55% loss from IPO price.
• Affirm (AFRM): Opened at $90.90 on Day 1. Dropped to $9 by end of 2022. Recovered partially but still well below the initial price.

For every Google (IPO in 2004 at $85, now $175+ adjusted for splits) or Amazon (IPO in 1997 at $18, now $185+), there are dozens of IPOs that destroyed wealth. The winners are memorable. The losers are forgotten — which is exactly what makes IPO investing so deceptive.

The smart approach: let the IPO happen, wait 6-12 months for the hype to fade and the lock-up period to expire, then evaluate the company on its actual public-company financial results. The best IPOs are still great companies years later — and you can buy them at much more rational prices.