When a company launches new shares on the stock market through an Initial Public Offering, it can be a frustrating experience for both investors and the company selling stock. Wall Street has a monopoly over the IPO process which creates all kinds of problems. However, new technological advances are challenging the investment banks' control of the IPO market and could create new channels for investors to pick up shares through early financing.
IPO Problem 1 - Expensive and Inconvenient for Companies
An initial public offering (IPO) is when a private company decides to go public by selling shares of equity to outside investors. This gives companies a way to raise money without taking on more debt. Although IPOs can be an attractive way to gain funding and increase exposure, the IPO process is neither cheap nor easy.
When a company decides to go public, they can't just call up retail investors and offer to sell them some shares. The startup must go through several stages before their shares finally reach the public.
First, the company needs to find an investment bank willing to set up an IPO. If a company looks extremely promising, big-name banks like JP Morgan, Goldman Sachs, and Credit Suisse, will compete for the opportunity to issue shares. However, most companies will need to spend time promoting and marketing themselves before they'll track down an investment bank willing to issue an IPO.
(photocredit: Andrey Kozlov)
Once an investment bank decides to take on the company, the investment bank splits the value of the company into shares and decides on a price per share in a process known as underwriting. Next, the investment bank divides the shares among a group of banks or other institutional investors to spread around the funding and the risk. Once the institutional investors have gotten their shares, the company's stock will finally go public and retail investors will be able to buy in. The whole IPO process is expensive and time-consuming as this "wedding day" approach can take as much as six months to complete..
IPO Problem 2 - Unfair and Frustrating for Investors
IPOs are not only daunting for startups but also can be extremely unfair for retail investors. Since the investment banks allocate shares to other banks and large institutional investors before releasing them to the public, regular investors don't have equal investment opportunities. IPOs regularly run out of shares at the initial price and retail investors can only buy in later at a higher market price.
This distorts the market and creates unfair trading opportunities for banks. Henry Davis, an investor at Index Ventures, points out that "whoever gets shares in an offering is typically carefully selected by the syndicate banks - and who they choose to give shares to can have a meaningful impact on the share price after trading begins." This also creates a conflict of interest for the banks because the way they decide on an allocation on shares might be more based on their trading profits rather than the best interest of the company going public.
Fidelity Challenges the IPO System
A recent example of this problem happened when Twitter announced it was going public. Fidelity, a brokerage firm with a massive investor base, wanted 23 million shares of Twitter but instead was only allotted 250,000 from the investment banks. Fidelity, an active member in the debate against the IPO monopoly, expressed their frustration after receiving a remarkably small amount of Twitter's shares compared with the large demand from their customer-base of retail investors.
(photocredit: Andrey Kozlov)
Once Twitter's shares went on to be traded on public exchanges Fidelity investors eventually owned 22 million shares, but never got a chance to buy in at the price they wanted during the IPO. When major players in the industry are upset, changes have to be on the horizon. Head of equity origination at Fidelity Capital Markets, Hank Erbe, critiques that although technology within finance has flourished over the past decade, "nowhere has technology touched the IPO market. And that is the final frontier."
Fidelity "fired warning shots at Wall Street" this June by pitching to venture capitalists and other investors about finding alternative methods to the traditional IPO. The IPO method can be old-fashioned because "Wall Street still has a lock on the way stock offerings work." William Hambrecht of WR Hambrecht was invited for his firms offering of "open IPOs,'' which provide open access to stocks that are going live to the public. Another way that both the individual investor and the entrepreneur can get greater transparency and lower costs is to raise capital through crowdfunding.
Crowdfunding - A Valuable Alternative to IPOs
Crowdfunding can be used to get a company off the ground in the early stages of its growth and is not exactly the equivalent of an IPO. IPOs typically come later in the company's evolution - often after early rounds of funding from family, friends, angels and/or venture capitalists. So, the comparison is not really apples to apples. In a crowdfunding equity offering, a new company reaches out to investors, usually online, to collect investments into the company. By using equity crowdfunding platforms, like those listed on Fund Wisdom, startups are able to quickly and inexpensively raise capital while small investors can buy into new companies while avoiding the hurdles of IPOs.
Crowdfunding is also a much fairer process as shares go out on a first-come, first-serve basis rather than the predetermined allocation of an IPO. The investors get to decide how many shares they want to buy; investment banks don't control the market.
Now, Crowdfunding is not an exact replacement of an IPO. Crowdfunding is seen as a way to get a company off the ground while IPOs are the official way to launch into the stock market. However, while the IPO process is undergoing scrutiny, the crowdfunding market is growing at an exponential rate and could soon be seen as a true challenge to IPOs.
So how do you succeed in this new world of investing? Fund Wisdom can provide you with all the tools and resources necessary to find investment opportunities that fit your needs before those opportunities slip away.
Using Fund Wisdom, investors can search through investment opportunities to find startups that hold potential. This service is a free and efficient way for investors to hold equity in a company that might one day be the next big thing, before it even launches its IPO.