Initial public offerings (IPOs)

What an IPO is

An IPO, or initial public offering, means that a private company sells its shares to the public for the first time and lists on a stock exchange. The company raises capital for growth, or the existing owners cash in their stakes. As an investor, you can subscribe for shares in the offering before trading begins.

A company has two main motives for listing, and it's good to tell them apart. In a share issue, the company issues new shares and raises capital for itself for growth, paying off debt or investments. In a sale offering, on the other hand, the existing owners (founders, employees or private equity investors) sell their own shares and cash in their investment. Many listings combine both, and the ratio between them says a lot: if most of it is existing owners selling out, it's worth asking why they want out right now.

For an investor, an IPO offers access to a company that was previously within reach of professional investors only. That's its appeal: the chance to “get in from the start”. But it's important to understand that a listing isn't the beginning but often already a mature stage. The company has typically grown for years as a private company, and the biggest rise in value may already have happened before the public gets in. The private equity investors who owned the company cheaply are now selling, and on the other side is the public, buying at a higher price.

Why pricing is difficult

In an offering, the share has no trading history, so it's hard to assess the right price. The seller has an information advantage over the buyer, and the timing of the listing is often chosen to suit the seller (good market sentiment). You aren't buying at the bottom but at a price the seller has set.

The difficulty of pricing stems from a deep information asymmetry. The company's management, the private equity investors selling it and the investment banks arranging the listing know the company inside out; the public only sees the prospectus and the marketing material. This means there's always a better-informed party on the other side of the table, with a motive to get the best possible price. So you aren't buying from a neutral market but from a seller who knows more than you do.

In addition, the timing of the listing is chosen to benefit the seller, not the buyer. Companies typically list when market sentiment is high and investors are willing to pay a lot: the “window” opens in a rising market and closes in a falling one. This systematic timing means that IPO shares are often sold exactly when they are at their most expensive. Investment banks also deliberately price the offering slightly low to ensure a “successful” first-day rise (the pop), but this initial jump mainly benefits those who get shares in the offering, not those who buy on the exchange on the first day.

The risks of an offering

Typical risks: overpricing (hype), volatility in the first days, and lock-up periods, at the end of which existing owners can sell and push the price down. Many listings marketed as hot have turned out to be disappointments.

The risks pile up especially around the end of the lock-up period. In a listing, existing owners usually commit not to sell their shares for a certain time, typically 3–6 months. When this period ends, a large number of shares for sale can suddenly hit the market, which weighs on the price, often just when private investors have had time to get excited. The lock-up expiry date is therefore an important date that many new investors miss.

The research evidence on the long-term returns of IPOs is lackluster: on average, IPOs have performed worse than the market in their first years, even though individual success stories get the most attention. This is due both to systematic overpricing and to the fact that listings are timed for peaks of hype. Be especially careful with companies that don't yet make a profit but list on the strength of a compelling story: their valuation rests on promises that don't always come true. Heat generated by the media and marketing is a poor basis for an investment decision.

How to approach IPOs

You don't have to take part. If the company is good, a broad index fund will buy it later as part of the market, without the single-company risk of the offering. If you do take part, do it with a small share and after doing your homework, not by chasing hype.

For a long-term investor, the most decisive insight is that a broad index makes the IPO decision for you, without the single-company risk. When a listed company grows large enough and becomes established, it automatically ends up in a market-cap-weighted index, and then you own it as part of a diversified whole, without having had to guess the offering price or carry the volatility of the first months. So you don't miss out on anything essential by skipping the offering; you get the good companies later, when their situation is clearer.

If you do take part in a listing, do it well informed and with a small share, not carried away by the story or FOMO. Read the prospectus and understand how the company makes money, who is selling and why, and at what valuation the offering is priced relative to comparable companies. Treat it as picking an individual stock that belongs, at most, in a small satellite part of your portfolio, not as a core strategy. Above all, remember that a sense of urgency is not your friend: the offering is designed to create the feeling that you have to act now, and that is exactly the feeling to recognize and resist.

The IPO process step by step

A listing is a process that lasts months, and understanding its stages helps you see what's happening behind the scenes. The company chooses investment banks as arrangers, prepares a detailed listing prospectus, and goes on tour to present itself to large investors (the roadshow). Based on these meetings, demand is gathered and a price range is formed, within which the final subscription price is set.

It's essential to notice that large investors and institutions get into the process before the public and often get better terms. The public offering is typically only part of the whole, and a private investor sees only the end result of the process: an offering that has already been priced. This structure highlights the information asymmetry: by the time the offering opens to the public, the price has already been shaped by the demand of the players with the most information. Knowing the process helps you understand why the public is the last link in the chain, not the first.

The prospectus: what to read in it

The listing prospectus is a legally required document, often hundreds of pages long, that contains everything essential about the company. Few people read it in full, but a few sections are worth going through before you subscribe:

• Risk factors: the risks the company lists itself; often the most revealing section.
• Use of proceeds: does the money go to growth or to existing owners selling out?
• Financial figures: revenue, profitability and debt over several years.
• Owners and lock-up periods: who is selling, who stays, and when the lock-up ends.

The tone of the prospectus is salesy, but the risk factors section has to be written carefully, because the issuer is legally liable for the prospectus. That's where you'll often find the concerns the marketing doesn't highlight.

Pricing and the subscription price

Pricing an IPO is a balancing act. The company and the sellers want the highest possible price to maximize the capital raised, while the investment banks want a price that ensures the offering is fully subscribed and has a “successful” first day. This creates a systematic tendency to price the offering slightly low (underpricing), so that the share rises on its debut day and the offering looks like a success.

This initial jump (the IPO pop) is, however, a misleading signal for a private investor. The discount benefits those who got shares at the subscription price in the offering, often institutions. A private investor who buys the share on the exchange on the first trading day pays the price after it has already risen and gets no discount at all. So the first-day rise doesn't tell you that the share is a good investment. It only tells you that the offering was priced low. The long-term return is a completely different question.

Lock-ups and insider selling

The lock-up period is one of the most important but least understood mechanisms of an IPO. It prevents the company's founders, employees and early investors from selling their shares for a certain time after the listing, typically 90–180 days. The purpose is to stop insiders from “running for the exit” right away and to give the share price time to settle. But the end of the period is a critical moment.

When the lock-up ends, shares for sale can suddenly flood the market as early owners take their profits. This increase in supply often weighs on the price, and the weak phase of many IPO shares falls right around the lock-up expiry. As a private investor, it pays to know the lock-up expiry date in advance and to understand that existing owners' eagerness to sell right after the lock-up is a signal: if the company's own people want out at the first opportunity, it says something about their view of the company's value. Following insider behavior is often more revealing than marketing talk.

Other routes to listing: SPACs and direct listings

Alongside the traditional IPO, alternative routes to the stock exchange have emerged. A SPAC (blank-check company) is a shell company that is already listed on the exchange, raises money and then looks for a target to acquire, which in this way gets onto the exchange faster than through an ordinary IPO. A direct listing, on the other hand, brings a company onto the exchange without issuing new shares and without pricing underwritten by investment banks: the existing shares simply start trading.

Of these, the SPAC boom of 2020–2021 in particular turned out to be a disappointment for investors: many SPAC targets were overpriced and low quality, and the vast majority produced significant losses once the frenzy died down. In a SPAC structure, the incentives are often skewed in favor of the party that finds the target, and the private investor carries the risk. A direct listing can be more transparent but offers less protection against wild pricing. For an ordinary investor, these special routes don't change the basic rule: a new, hyped listing through any mechanism is a high-risk single bet, not a long-term investor's core strategy.

Underpricing and the first-day pop

Studies consistently show that IPOs are on average underpriced: on the first trading day, the share rises on average significantly above the subscription price. That sounds good, but the benefit goes to those who got shares in the offering at the subscription price. In practice, private investors often get only a small share of popular offerings, and most of the discount flows to institutions.

Even more importantly, the first-day pop doesn't predict the long-term return. On the contrary, the hottest listings with the biggest pops have often performed worst in the following years. The debut-day rise tempts private investors to buy on the exchange at an inflated price, which is typically a poor starting point. So the underpricing phenomenon is real, but it isn't the private investor's friend: it's a mechanism that rewards the offering's insiders and tempts the public to buy a share that has already risen. Understanding this helps you avoid reading the debut-day rise as a buy signal.

How to assess a company that is listing

If you're considering taking part, a listing company is assessed on the same principles as any stock, but with less information. Focus on the questions the prospectus answers: is the company profitable or does it rely on a promise of growth alone, how durable is its competitive advantage, and how is the offering priced relative to comparable listed companies. If the valuation is clearly higher than that of established competitors, you are paying full price for promises about the future.

Pay special attention to who is selling and where the money goes. If the main emphasis of the offering is raising new capital for growth, the motive is constructive; if it's mostly existing owners selling out, it's worth asking why they want out at exactly this price. Private equity investors are professionals who know the company, and their wish to sell is a signal. A realistic assessment therefore requires both analysis of the company and reading the motives, and in both, a private investor is the underdog in terms of information.

IPOs as part of a portfolio

Even though listings are tempting, their role in a sensible portfolio is small and considered, not central. A single IPO is a high-uncertainty bet: a limited history, possible overpricing and big early volatility make it closer to stock picking than to core investing. That's why it belongs, at most, in the satellite part of a portfolio: the small share you use to act on your own view in a controlled way.

The core strategy stays the same: a broad, diversified index takes care of your market exposure, and IPOs end up in it automatically in due course. If you want to take part in a single offering, size the stake so small that its failure won't hurt the whole. Treat it like any other individual stock pick. This way you get the chance to take part in an interesting listing without losing the security of your portfolio's basic structure. Listings are exciting, but excitement isn't an investment strategy.

Finnish and international listings

The IPO market moves in cycles: in a rising market offerings come thick and fast, and in a falling market the “window” practically closes. Finland has seen both successful listings and disappointments, and the market is small, so the quality of individual offerings varies. Internationally, especially in the United States, listings are bigger and more visible, and the mega-listings of tech companies get enormous media attention.

For a private investor, size and country don't change the basic setup: the more media frenzy, the more reason for caution. The hottest listings that dominate the headlines are often exactly the ones that are priced most aggressively and turn out to be disappointments. Quieter listings with less glamour can sometimes be better investments precisely because they don't come with the same hype. Whatever the geography, the best protection is the same: doing your homework, restraint, and remembering that an index investor misses out on nothing by skipping the offering.

Common mistakes with IPOs

Mistakes with IPOs are often emotional. Buying on hype is the most common: media frenzy and FOMO push people to subscribe without understanding the company or its valuation. Chasing the first-day pop leads you to buy on the exchange at an inflated price after the discount is already gone. Ignoring the lock-up period catches you off guard when insider selling pushes the price down. And too large a stake in a single offering exposes your portfolio to one company's risk.

The deepest mistake, however, is treating a listing as a long-term investment, even though it's a speculative single bet. IPO marketing is designed to create a sense of urgency and opportunity, and that very feeling leads to rash decisions. A long-term investor's best protection is to remember that taking part isn't compulsory: good companies will enter the index in due course, and skipping the offering costs nothing. Most of the time, the best decision is not to take part, and that is deliberate discipline, not something lost.

How to approach IPOs: a checklist

Your approach to IPOs comes down to a few principles that protect you from hype and information asymmetry:

• No obligation to take part: a broad index buys the good companies in due course, without the risk of the offering.
• Read the prospectus: especially the risk factors, the use of proceeds and who is selling.
• Check the lock-up period: when insiders can start selling and push the price down.
• Don't chase the pop: the first-day rise doesn't predict the long-term return.
• Assess the valuation: relative to peer companies; are you paying full price for promises?
• A small stake: at most a satellite, not the core; size it so that a loss doesn't hurt the whole.

Listings are a visible and exciting part of the market, but research and history call for caution. A long-term investor's strongest advantage is not having to take part. A sense of urgency is the offering's tool, not the investor's friend. Understand how an offering works, and you'll be able to say “no” without feeling that you're missing out.