How to Invest in IPOs

Sign reading Initial Public Offering

So you say you want to invest in IPOs? Maybe make a fortune on the next Facebook ? Well, good luck.

The fact is, most IPO stocks underperform the market for several years after going public. That's not surprising. After all, when a company sells stock to the public in an "initial public offering," its goal isn't to give you a quick profit. Its goals are more often to:

  • help its early, private shareholders cash out (a strange move if they expect the stock to go up);
  • help the company's founders monetize their stock;
  • raise cash to pay down debts the company had to run up pre-IPO; and
  • raise cash to fund ongoing losses -- the ones that got the business in debt in the first place.

These are just a few reasons why Warren Buffett tells investors that they're better off staying away from IPOs than investing in them, calling IPOs in general " a stupid game ." That being said, if you're determined to invest in IPOs, here's how to do it.

3 steps to investing in an IPO

Most of the big discount brokers -- Ameritrade, Fidelity, and Schwab for example -- offer access to at least some IPOs. Each imposes different requirements to participate, but in every case, you must have an account with the respective broker in order to invest in an IPO via said broker. Here's how the process works:

Prove eligibility. TD Ameritrade will permit you to invest in an IPO if you have at least $250,000 in assets with the firm or have traded stock with Ameritrade at least 30 times in the last 12 months. In this way, Ameritrade is limiting IPO access to what it considers its better customers. Fidelity's requirements are similar. Customers having $100,000 with the broker are eligible to participate in IPOs led by underwriter Kohlberg Kravis Roberts & Co. (KKR). Eligibility for other IPOs might be restricted to customers having as much as $500,000 with Fidelity -- or placing 36 trades in the past year would qualify a customer to participate. Schwab's requirements are even easier to meet: $100,000 in your account, or 36 trades in your history.

In addition, the Financial Industry Regulatory Authority (FINRA) has its own requirements, which basically boil down to trying to keep brokerage employees and persons employed by IPO underwriters from participating in IPOs on their own behalf.

Request shares. Assuming you meet the requirements for participating in an IPO, your next step will be to request a certain number of shares in the IPO. You may not be allocated all the shares that you offer to buy. You may or may not be allocated a "pro rata" portion of the number of shares you offer to buy. Just think of your request as the maximum number of shares you'd like to buy assuming they are available.

Place your order. On the evening the IPO "prices," your broker will notify you that the offering is going forward. You will be given a deadline to place your order. Only after you place the order will you find out for certain if you were able to buy any shares -- but in any case, you should not end up buying any more shares than you have asked to buy, nor at prices higher than the price you have offered to pay.

Then, make sure to check in the following morning when the stock finally begins trading to find out if your IPO shares have skyrocketed -- or collapsed.

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