IPO Public Markets

The Market Minute: How IPOs Are Priced

Hello, and welcome to the first edition of The Market Minute, a new column at Crunchbase News focused on public markets.

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I’m Sophia and, along with my other beats, I’ve been covering the late-stage venture scene and IPO markets at Crunchbase News for the past year or so. I’ve written about how much it actually costs to take a company public through an IPO, how the 2021 IPO pipeline was shaping up, and how newly public companies have initially performed.

I missed the boat to write about the GameStopRedditRobinhood madness last week, so this week I thought I’d write about something else that often seems to rile people up: IPO pricings.

If you follow the initial public offering market, you’ve surely seen the first-day surges of IPOs in recent months. Perhaps most memorable was Snowflake’s blockbuster IPO, when its stock closed nearly 112 percent above its IPO price on its first day of trading. And if you’re on tech/VC Twitter (my condolences if you are), you’ve surely seen the outcry and incredulousness that comes with every large jump in a stock price.

Typically, there’s a lot of blaming of underwriters and questions about how a company’s stock could jump so much. I don’t have an easy answer for that, but I can shed some light on the somewhat opaque process of how IPOs are priced in the first place.

The IPO process

The mechanics of an IPO work something like this: When a company wants to list on the public equity markets via a traditional initial public offering, it first files an S-1 registration document with the U.S. Securities and Exchange Commission, baring its soul (read: its financials), any associated risks that come with investing in the company, and so on. 

The company hires an investment bank and goes on a roadshow (or, in the time of COVID, sits through long days full of Zoom meetings) where execs solicit interest, primarily from institutional investors. The underwriters set a price range for the company’s stock, often increasing it as the first day of trading nears. 

Finally, the night before trading is set to start, a block of shares is sold to investors at a set price, allowing a company to raise capital in the process.

Why the outcry when a newly public company’s stock surges on its first day of trading? The idea is that when that happens, money was essentially left on the table — if the stock had been priced higher, the company could have raised more money by selling the block of shares — while underwriters had the chance to buy at a below-market price.

Determining price

The two primary factors in an IPO’s price are the company’s financials and demand from investors.

“Depending on the level of demand among institutional investors, that’s how pricing is supposed to be set,” said Patrick Healey, founder and president of Caliber Financial Partners. “They’ll put a range out there initially, and if there’s oversubscribed demand that pricing will go up.”

For investment bankers, the main influence for pricing is the demand for shares, Healey said, adding that he’s noticed investment bankers tend to be more conservative with pricing to improve stability of trading activity for the stock’s first day. Pricing too high could cause “huge swings in volatility,” he added.

“If you ask the investment bank, they would rather have a stable trading environment and leave some meat on the bone,” Healey said. “And if you ask the company, they would rather capture as much money as they can and fuel growth.”

Another factor in understanding demand for a stock is peer groups, according to Louis Cordone, senior vice president of data strategy at AST. Underwriters will typically look at a comparable publicly traded company and “build a basket of those peer groups to try to understand demand,” he said. 

For example, a private rideshare company looking to go public might look at Uber and Lyft, publicly traded rideshare companies, to understand demand. And besides the financials and stock performance of a peer company, underwriters will look at what kind of investors are purchasing a company’s shares. 

As for the first-day surges that newly public companies like Airbnb have experienced, Cordone said that could be attributed to more retail investors investing in equities.

“I do think that the amount of cash that’s in the market today is certainly driving demand for IPOs, and the participation of retail investors is really driving the price of these things,” he said.

The participation of retail investors in the market was clear last week with GameStop’s stock surge, something Cordone said likely contributed to several of last week’s IPOs not seeing the giant pops we’ve become accustomed to. 

“If you look at the back half of January, the most recent IPOs didn’t do that well,” Cordone said. “I think it’s market participation, and if you look at the overall equity markets throughout COVID, it’s been pushed by retail investors moving into equities, taking on more yield.”

Up next: Bumble IPO buzz

January was a busy month for companies going public, and there are a lot more in the pipeline gearing up to debut on the public markets, either via traditional IPOs, SPACs or direct listings. The next IPO I’ll be watching closely is dating and networking app Bumble, which recently indicated it aims to raise up to $1 billion via an IPO and set its share price range between $28 and $30.

Send me your thoughts

I’d love to hear from readers about what public market topic I should cover next. My email is sophiak@crunchbase.com and you can also connect with me on Twitter @SophiaKunthara. If you have a question about the public markets, chances are someone else is probably wondering the same thing. Just let me know, I’m happy to dig around and find some answers.

Illustration: Dom Guzman

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