A company goes public. The stock opens, doubles on day one, gets breathless coverage on financial TV, and retail investors pile in. Three months later it's trading below the IPO price. This arc plays out constantly, and understanding why requires knowing what actually happens in an IPO — who benefits, who bears risk, and what the odds look like for someone who buys on day one.
What an IPO actually is
Initial Public Offering — the first time a private company sells shares to the general public on a stock exchange. Before an IPO, the company is owned by founders, employees, and private investors (venture capital funds, private equity). Going public lets them cash out some of that ownership and raises new capital for the business. In exchange, the company becomes subject to SEC reporting requirements, quarterly earnings disclosure, and public shareholder scrutiny.
How the IPO process works
The company hires investment banks (underwriters) — Goldman, Morgan Stanley, JPMorgan — to manage the process. The banks do a roadshow, pitching the company to institutional investors to gauge demand and set a price range. The final IPO price is set the night before trading begins. Institutional investors — large funds, hedge funds, asset managers — get the bulk of the allocation at that price. Retail investors generally buy on the open market when trading starts, which is usually above the IPO price.
That gap matters. If a stock is priced at $20 and opens trading at $35, the institutional investors who got in at $20 are already up 75%. The retail investor buying at $35 on open is starting significantly above where the "smart money" entered.
The lockup expiry — the cliff most retail buyers don't see
Company insiders — founders, employees, early investors — can't sell their shares immediately after the IPO. There's a lockup period, typically 90–180 days, during which they're restricted from selling. When the lockup expires, a wave of selling often follows as insiders finally liquidate some of their long-held positions. Many IPO stocks that held up well through the first few months experience their steepest drops right around lockup expiry. Check the lockup date before buying any recent IPO. It's disclosed in the S-1 filing.
Why so many IPOs underperform
Academic research on IPO long-term performance is pretty unkind. Studies consistently find that IPOs underperform comparable public companies over the 3–5 years following the offering. A few reasons: IPOs are timed when conditions are favorable for sellers (meaning valuations are often high), the company is presenting its most optimistic narrative during the roadshow, and the first-day pop pricing dynamic means retail buyers often pay well above fundamental value. The exceptions — Amazon, Google — are memorable precisely because they're exceptions.
None of this means all IPOs are bad investments. It means the base rate for "buy on day one" is worse than buying an established company with years of public earnings history.
How to evaluate an IPO if you're interested
The S-1 filing — filed with the SEC before the IPO — is the primary document. It contains the company's financial statements, risk factors, business description, and use of proceeds. Read the risk factors seriously, not just the business narrative. Check revenue growth and profit trajectory. Understand how the company makes money and whether its unit economics work. Look at the valuation implied by the IPO price relative to revenue or earnings — compare to public comps in the same industry.
Most importantly: give it time. Many great businesses became great investments not on IPO day but 12–24 months later, after the initial hype faded, the lockup expired, and the valuation reset to something more rational.
Direct listings and SPACs — alternatives to traditional IPOs
A direct listing bypasses the underwriting process — the company lists existing shares directly on an exchange without raising new capital. No roadshow, no IPO price set by banks, no institutional pre-allocation advantage. Spotify and Coinbase used this route. More transparent price discovery, theoretically better for retail investors who don't get disadvantaged by the pre-IPO allocation game.
A SPAC (Special Purpose Acquisition Company) is a blank-check shell company that IPOs first, then merges with a target private company. The 2020–21 SPAC boom has mostly ended — most SPAC-merged companies significantly underperformed traditional IPOs. Approach with extra skepticism.
Frequently asked questions
Should I buy a stock on its IPO day?
Statistically, the evidence argues against it. You're buying at or above the IPO price, often well above where institutional investors entered, with lockup expiry selling ahead. The businesses that make great long-term investments are usually better buys 12–18 months after the IPO, when the narrative hype has faded and the price has found a more rational level. Exceptions exist but are exactly that — exceptions.
How do I get access to IPO shares at the offering price?
Some brokerages — Fidelity, Schwab — allow eligible retail customers to participate in IPO allocations. Generally requires a significant account balance and active trading history. Availability is limited and prioritized toward institutional clients. Most retail investors who "buy an IPO" are actually buying on the secondary market after the stock starts trading publicly.
What is the S-1 filing?
The registration document a company files with the SEC before going public. Contains audited financial statements, risk factors, business description, management backgrounds, and planned use of IPO proceeds. Publicly available on SEC EDGAR. The most important document to read if you're seriously evaluating an IPO investment — more informative than any analyst coverage or media coverage.
What happened to SPACs?
The 2020–21 SPAC boom — driven by low interest rates, excess capital, and enthusiasm for pre-revenue growth companies — mostly collapsed. Most SPAC-merged companies traded significantly below their $10 NAV floor by 2022–23 as interest rates rose and speculative sentiment faded. The structure had inherent incentive problems: SPAC sponsors were compensated even when deals destroyed shareholder value.