Step Aside, Wall Street: IPOs Should Actually Be Open to the Public

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Every now and then, Wall Street loses its head over an initial public offering, or IPO. If you want an example, take a look at Twitter (NYSE:TWTR). After much pomp and circumstance, the social media company launched its IPO in November 2013, issuing 70 million shares priced at $26 a piece and raising $1.82 billion. On the first day of trading, shares closed up 73 percent at $44.90, making many Twitter employees paper-money millionaires and a few of them billionaires.

But company insiders with equity already on hand weren’t the only people to get rich. For example, the underwriters of the IPO — financial gatekeepers responsible for structuring and managing the IPO — earned 3.25 percent of the funds raised, about $59.2 million. The lion’s share of this prize pool went to lead underwriter Goldman Sachs, which placed about 39 percent of Twitter’s offer entitling it to about 39 percent of the fees, or $22.8 million. This is what we call “not bad” as far as IPO hauls go.

There’s a third group of ‘insiders’ that made an enormous amount of money on Twitter’s IPO, and those are the lucky investors that were granted shares at $26 a piece. Before any Main Street investor could get their hands on a share of Twitter stock, before the stock was officially listed on the New York Stock Exchange and opened up for public trading, it was all already sold to a relatively select group of institutional investors — again, at $26 per share, the same wholesale price that the underwriting investment banks pay. This means that due to little more than their fortuitous position in space and time (read: connections), these investors — mostly institutional or well-known mavericks with deep pockets — made up to 73 percent on their money over the span of just one trading day. This is what we call “pretty good” as far as intraday price jumps go.

For the record, this is not necessarily an evil or corrupt process. From the bank’s perspective, this is simply the privilege that comes with size and expertise. There is really no other way to orchestrate large IPOs without big banks, and this kind of pipeline — producer to wholesale to retail — is an effective way to conduct the whole thing. It saves the company actually issuing the shares a lot of pain, it makes the banks who do most of the work a ton of money, and it brings ownership of a previously privately held company to the public.

But it’s also not totally fair if you’re a retail investors who wants to get in on some of the action. To be clear, this is not necessarily advisable — an IPO is dense with risk — but it is reasonable for, say, long-time customers of a company to want to take an ownership stake, however small, in the business if it goes public. However, if you were an early adopter of Twitter and you believed in its long-term viability as a business, you either had to jump through a series of flaming hoops or have deep, deep pockets (or both) to get the stock at the IPO price.

If you’ve been around the block, you may know that there are such a things as “friends and family” shares or “directed” shares. As the name implies, these shares are offered to those close to the company — friends and family, sure, but also large or loyal customers, early private investors, key advisers, or whoever else is owed a goodwill gesture. Directed-shares programs exploded into popularity in the ’90s as tech companies began rapidly launching IPOs in a kind of frenetic, Internet-intoxicated haze, and (unsurprisingly) their popularity diminished in the post-tech bubble hangover. Currently, many professionals dismiss the programs as “not worth the headache,” as Tom Murphy, head of the securities and capital markets group at the law firm McDermott Will & Emery LLP, told The Wall Street Journal.

“You offer [shares] to employees, they feel like they should buy them, but aren’t happy if [the shares] don’t go up. Underwriters don’t like them, it’s less they can sell. There are more and more decisions about what to disclose. In most instances, they’re not worth the headache,” Murphy said.

Murphy was speaking in 2012, but Wall Street’s thinking hasn’t changed much. This is why it was so surprising when GoPro, self-proclaimed manufacturer of “the world’s most versatile cameras”, announced that it was taking its IPO social. At least, a little social.

About 1.5 percent of GoPro’s stock issue will be sold through a social IPO platform called Loyal3. As Loyal3 adverts, it’s a platform designed to allow you to “buy your favorite company’s stock at the same price and the same time as the big guys.”

Loyal3′s advert goes on to say that “an IPO can reward the people that help them succeed.” This is true — it’s the whole point, really — but it’s also a good excuse to repeat saying that IPOs are risky. Not only are companies launching IPOs are in a transitional phase they are surrounded by hype.

That said, Loyal3 makes the idea of social IPOs look good. It doesn’t factor out the investment bank but it’s not supposed to — financial experts are still needed to do research and value the company, and even with a healthy pool of retail investors willing to underwrite an IPO in aggregate, most IPOs will still require institutional underwriters simply because of their size.

Here’s The WSJ‘s Telis Demos talking about Loyal3 back in August 2013.

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