Tomorrow, stock trading firm Robinhood (HOOD) is making its long-awaited public market debut. The mobile brokerage will raise an estimated $2.3 billion, offering 55 million shares priced between $38-$42, with an expected market valuation of up to $35 billion.
For retail investors, Robinhood’s IPO is yet another opportunity to participate in the company’s stated mission: the “democratization of finance.” In fact, Robinhood is setting aside a third of its shares for customers to buy directly through its app. This is unusual for IPOs, which typically reserves shares for institutional buyers.
But then again, Robinhood is no ordinary company. Here’s what you need to know about one of the most high-profile IPOs of 2021.
What is exactly is Robinhood?
Robinhood is a broker-dealer. In other words, Robinhood is like any financial firm that facilitates the buying and selling of securities. The company is regulated by FINRA, is a member of the Securities Investor Protection Corporation, and is registered with the U.S. Securities and Exchange Commission.
But Robinhood is no ordinary middleman. In fact, the firm has transformed the stock brokerage industry. For one, Robinhood -- which was born in Silicon Valley in 2013 -- pioneered the mobile-first experience in stock trading. The firm’s application is sleek and easy to use. Second, Robinhood has made it easier for retail investors to buy derivatives, allowing them to bet on the future price movements of stocks.
Third and most importantly, Robinhood introduced the zero-fee business model to the world of stock brokerages. Traditionally, broker-dealers levied a direct fee on customers (known as the commission). For buyers of securities, that meant paying brokers every time they wanted to acquire new stocks. Commissions disincentivized most ordinary people from putting spare cash into the stock markets: the fees were too costly, especially for those who wanted to actively trade in the markets.
When Robinhood tossed out the fee-per-trade structure, other brokerages soon followed. Now, retail investors can buy and sell securities to their heart's delight without having to pay any fees. But Robinhood’s innovation raises an important question:
How does Robinhood make money?
The answer is something called Payment For Order Flow (PFOF), a concept that sounds more complicated than it is. Market makers, or firms that hold inventory of securities and provide liquidity (like Citadel Securities), pay Robinhood to route users’ trades to their desks. Market makers earn money when the difference between the price they pay for a security and the price they sell it for is higher than the cost they pay to broker-dealers like Robinhood.
To compete, the entire brokerage industry has followed Robinhood’s lead, slashing trading commissions to zero in place of PFOF. The new zero-fee standard has encouraged a new generation of day traders, while also increasing brokers’ reliance on PFOF revenue. Eighty-one percent of Robinhood’s first quarter revenue was from PFOF, according to securities filings.
Why is Robinhood going public?
Like any company, Robinhood is offering shares to the public to raise money. The firm is aiming to haul in $2.3 billion dollars from its IPO. It will use this cash infusion to build new products, increase its marketing spend, and grow its business.
Going public allows Robinhood to raise a large amount of capital quickly. The stock trading app has raised $5.6 billion in 23 separate funding rounds over its eight year existence, according to Crunchbase. Robinhood is expected to raise over a third of that amount tomorrow.
An IPO is likely to benefit Robinhood’s shareholders. To date, only Robinhood’s employees, venture capital investors and accredited secondary market investors have been able to acquire -- and drive up the price -- of the company’s shares. Tomorrow, that opportunity opens up to millions of retail investors. And if their appetite for Robinhood shares is anything like their appetite for trading stocks on the Robinhood app, then a successful IPO awaits.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.