Reuters / Brendan McDermid
- Uber’s shares opened below the IPO price and Main Street investors were lucky they couldn’t get in ahead of the IPO.
- Despite Uber’s early trading, IPOs often represent an opportunity for investors to book significant gains quickly.
- Markets Insider walks through the challenges that retail investors face getting in highly sought pre-initial public offering shares.
- Read more stories at MarketsInsider.com
Uber went public on Friday as the most highly anticipated initial public offering in a year loaded with them. The typical retail investor, however, struggled to get in at the IPO price, missing out on any early price action as shares hit the market.
That proved to be a blessing as Uber’s stock opened below its initial offer price, and stayed lower in early trading.
However, IPOs often represent opportunities for easy gains, and it’s difficult for mom-and-pop investors to get involved. In 2019 alone, IPOs Tradeweb, PagerDuty, Pinterest, and Zoom all rose more than 25% during their trading debuts. Zoom topped the list with an 81% gain in its first day of trading.
That said, there are also risks to jumping on the IPO bandwagon. Besides Uber, rival ride-sharing app Lyft is down more than 20% from its IPO price.
Despite recent market volatility, demand for IPO shares remains strong. For example, Uber’s shares were oversubscribed just two days into its investor roadshow, according to a Bloomberg report, which cited anonymous sources close to the matter.
But with early-stage investors and institutional players having already gobbled up most available shares, many small investors will find it difficult ot get a piece. Investing in IPOs is far more complicated than placing a trade to buy stock, according to research conducted by Fidelity.
A big part of that is because IPOs are typically run by investment banks such as Goldman Sachs, Morgan Stanley, and Bank of America. A bank usually allocates 90% of the available shares to institutional investors, such as pension funds and hedge funds. Retail investors who who have brokerage accounts with the firm are allotted the remaining 10%.
Further, all retail investors seeking to get in before an IPO must meet brokerage requirements of minimum investable assets as well as answer Financial Industry Regulatory Authority (FINRA) questions about investment style and risk tolerance.
Once those requirements are met, those investors must review the company’s prospectus — which lays out the risks of the investment — before indicating the maximum number of shares they wish to purchase. The day before an IPO begins trading, investors are given confirmation of their share allocations as well as pricing of the issue.
IPOs with strong demand are over-subscribed and retail investors usually only receive a part of their maximum indication — sometimes as low as 10-20% — with the brokerage firm deciding the exact amount each investor receives.
"Typically, customers with significant, long-term relationships with their brokerage firm will receive higher priority than those with smaller or new relationships," according to Fidelity’s website. In other words, the rich get richer while smaller investors may receive no shares at all despite their request.
To the extent that brokerage firms do allocate IPO shares to smaller investors, this is usually a sign that there is limited demand for the IPO which may result in weak trading.
"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," Timothy Loughran, a finance professor at the University of Notre Dame told US News & World Report in June 2018. "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."
Despite these challenges, some companies have made an effort to broaden the allocation to mom-and-pop investors. Most notably, Facebook added E*Trade as one of the 33 underwriters to its IPO. E*Trade then offered shares to its nearly 3 million retail accounts.
With demand outstripping supply, however, E-trade noted that shares would be allocated in a process where "asset levels" and trading history would be taken into account. Similar to the bulge-bracket brokerage houses, larger clients received a preference.
In a twist to Uber’s IPO, the ride-sharing app has set aside 3% of its shares, $2.4 billion at the IPO price, to be sold directly to its drivers. To qualify for this "directed share program," drivers must have completed a minimum of 2,500 trips.
In addition, Uber drivers are set to receive up to $40,000 as a "driver appreciation reward" ahead of the ride-hailing giant’s IPO.
The company announced in a SEC filing that it expected to pay about $300 million in bonuses to more than 1.1 million drivers worldwide on or around Saturday.
"To acknowledge drivers who have participated in our success, we are paying a one-time cash driver appreciation reward to qualifying drivers in jurisdictions where we operate through owned operations," Uber detailed in the filing.
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