IPO Investing Explained: How Companies Go Public and What Buyers Should Know
The first-day pop is the most famous part of an IPO — and the most misunderstood. It is a cost paid by the company, not a gift to you. Here is how the whole machine actually works.
By 360head Research Desk · Reviewed for accuracy · Informational only, not financial advice.
- An IPO is a fundraising and liquidity event for the company and its early backers — the process is designed around their interests, not yours.
- The first-day pop is deliberate underpricing: wealth transferred from selling shareholders to allocated institutional buyers. It is a cost, not a gift.
- Across decades of US data, average first-day returns are strongly positive while average 1-3 year aftermarket returns have historically lagged comparable stocks.
- Most retail investors cannot buy at the offer price and instead buy the pop — paying the price where the easy return has already been taken.
- The 180-day lock-up expiration is a predictable supply event; prices have historically softened around it on average.
- Waiting for a few quarters of public reporting — or for the lock-up to pass — costs little and removes much of the guesswork.
Executive Summary
IPO investing means buying shares of a company at or around the moment it first sells stock to the public. An initial public offering (IPO) is the process by which a private company registers shares with regulators, hires investment banks to underwrite the deal, markets itself to institutional investors, sets an offer price, and begins trading on a stock exchange. It is one of the most important mechanisms in capitalism — and, for individual buyers, one of the most misunderstood.
The central insight of this guide is counterintuitive: the famous first-day pop is a cost, not a gift. When a stock opens 40% above its offer price, that gap is wealth transferred from the company's selling shareholders to whoever received shares at the offer price — and that recipient is almost never a retail investor. Most individuals buy in the open market, after the pop, at the price where the easiest return has already been collected by someone else. This guide walks through the entire machine: how underwriters and roadshows set the price, why deals are deliberately priced low, what decades of evidence say about first-day versus multi-year returns, how the 180-day lock-up expiration creates a predictable pressure point, how direct listings and SPACs differ from a traditional IPO, which red flags to hunt for in an S-1 filing, and when waiting beats buying on day one.
What an IPO Actually Is
An initial public offering is the first sale of a company's shares to the general public on a stock exchange. Before the IPO, ownership is concentrated among founders, employees, and private investors such as venture capital and private equity funds. After it, anyone with a brokerage account can buy a piece of the business, and the original owners gain a market in which they can eventually sell.
Companies go public for a handful of recurring reasons, and it helps to know which one dominates any given deal:
- To raise capital. Selling newly issued shares brings cash into the business for expansion, debt repayment, or research. This is the healthiest primary motive.
- To create liquidity for insiders. Early investors and employees often hold most of their wealth in illiquid stock. An IPO creates a path — usually delayed by a lock-up — to convert it to cash. When a deal is mostly insiders selling, pay attention.
- To create acquisition currency. Liquid public shares can be used to buy other companies.
- For credibility and visibility. A listing imposes audited reporting and can help with customers, lenders, and hiring.
Notice what is absent from that list: giving retail investors a good entry point. The company wants the highest sustainable price for its shares; its bankers want a smooth, successful deal; its insiders want liquidity. The buyer at the open of trading is the counterparty to all of those goals. That does not make IPOs bad investments by definition — it means the process is not designed around your interests, so you have to look out for them yourself.
How the IPO Process Works
A traditional US IPO follows a well-worn sequence that typically takes four to six months from kickoff to first trade.
1. Hiring the underwriters
The company selects one or more investment banks as underwriters (also called bookrunners). The lead bank advises on structure and timing, performs due diligence, helps draft the registration statement, and — critically — builds the book of orders and sets the price. In a classic firm-commitment deal, the underwriters buy the shares from the company at the offer price (minus a fee, often around 5-7% of the proceeds for mid-sized deals) and resell them to investors, so the banks carry the risk of a failed sale.
2. The S-1 registration statement
The company files a registration statement — for most domestic issuers, form S-1 — with the Securities and Exchange Commission. It contains audited financials, a description of the business, the risk factors, how the proceeds will be used, who is selling, and the governance terms. It is amended several times in response to SEC comments. This document is the single most important research source available to you, and it is free on SEC EDGAR. We return to it in the red-flags section.
3. The roadshow and book-building
Management and the bankers present the company to institutional investors — pension funds, mutual funds, hedge funds — over one to two weeks of meetings called the roadshow. Meanwhile the banks run book-building: they collect non-binding indications of interest ("we would take 2 million shares at up to $24") and assemble an order book. This is where the real price discovery happens, and it happens among institutions. Retail investors are, with rare exceptions, spectators to this stage.
4. Pricing night
The evening before trading, the company and the underwriters agree on the final offer price and the share count. This number is a negotiated compromise: the company wants it high, the banks want it low enough that the deal trades well and their institutional clients profit, because those clients reward banks that feed them profitable allocations with future business.
5. The first day of trading
Shares begin trading on the exchange, often after an opening auction that can take hours while the designated market maker balances buy and sell interest. The opening print — the first price you, as a retail buyer, can realistically transact at — is set by public supply and demand, not by the company. The gap between the offer price and that opening price is the famous pop, and it is the subject of the next section. Underwriters typically also hold a greenshoe option, the right to sell roughly 15% more shares, which they use to stabilize trading in the first weeks.
Why IPOs Pop: The Cost Behind the Headline
A first-day pop is not an accident or a gift from an enthusiastic market. It is, on average, a predictable consequence of deliberate underpricing — the practice of setting the offer price below where the stock is expected to trade. Decades of US data put the long-run average first-day return at roughly 18-19%, meaning a typical IPO opens and closes its first day well above its offer price.
Economists have documented several mutually reinforcing reasons for underpricing:
- Information asymmetry and the winner's curse. In a classic 1986 model, Kevin Rock showed that if some investors are better informed than others, uninformed buyers get full allocations only in the deals the informed buyers avoid. To keep ordinary investors willing to participate at all, issuers must price deals at a discount on average. You get filled completely on the IPOs nobody else wanted.
- Buying truthful information. Book-building only works if institutions honestly reveal what they would pay. Research by Benveniste and Spindt established that banks reward investors who share optimistic information with allocations of underpriced shares — the pop is, in part, a payment for honest price discovery.
- Marketing and momentum. A big first-day pop generates headlines, a sense of success, and a shareholder base of clients who made money and feel warmly toward the deal.
- Banker incentives. Underwriters' fees are a percentage of proceeds, but a smooth deal that rewards their best institutional clients protects a far larger stream of future business.
Now the crucial reframe. Money left on the table is real money. When a company sells 15 million shares at $20 and the stock opens at $28, the $8 gap multiplied by 15 million shares — $120 million — is value that the company's existing owners gave up and that allocated buyers received. During 1999-2000, academic estimates put the aggregate money left on the table in US IPOs in the tens of billions of dollars. The pop is the company paying for distribution, information, and goodwill. If you did not receive an allocation at the offer price, the pop is not your profit — it is the premium you pay the moment you buy at the open.
What the Performance Evidence Actually Says
The statistical record on IPO investing is unusually consistent, and it splits cleanly into two stories: the first day belongs to allocated buyers, and the years after belong to nobody in particular.
Short run: strong average pops
Jay Ritter of the University of Florida maintains the most widely cited US IPO dataset. His figures (approximate, and updated regularly on his IPO Data page) show how persistent underpricing is across eras:
| Period | Average first-day return (US IPOs, approx.) |
|---|---|
| 1980-1989 | ~7% |
| 1990-1998 | ~15% |
| 1999-2000 (dot-com peak) | ~65% |
| 2001-2023 | ~14% |
| 2024 | ~15% |
| 2025 | ~29% |
Underpricing has been documented in essentially every stock market ever studied — it is a structural feature of the IPO mechanism, not a quirk of one era. But remember who earns that average: the investor who received shares at the offer price. If you buy at the open, your entry is the post-pop price, and your expected first-day return is roughly zero before costs.
Long run: historically disappointing
The longer-horizon evidence is sobering. In a landmark 1991 Journal of Finance study, Ritter examined more than 1,500 IPOs from 1975-1984 and found that, measured from the first-day closing price, the issuing firms substantially underperformed matched non-issuing companies over the following three years — by roughly 27 percentage points in his sample. Follow-up research across later decades and other countries has found a similar pattern on average: IPO cohorts tend to lag comparable stocks or the broad market over one- to five-year horizons, with the weakest results concentrated in hot-issue periods and in small, young, unprofitable companies.
Three honest caveats matter here. First, averages hide enormous dispersion: some of the best-performing stocks of the modern era were IPOs, and a handful of huge winners can dominate a portfolio. The problem is identifying them in advance, when the loudest marketing surrounds the least proven businesses. Second, methodology debates are real — results vary with the benchmark, weighting, and sample window chosen. Third, none of this predicts any individual deal. What the evidence does support is a behavioral conclusion: buying the average IPO at the open of its first day, because of the pop, has historically been a losing trade on average. The excitement you feel at a hot debut is the product being sold.
Lock-Up Expirations and the 180-Day Cliff
When a company goes public, its insiders — founders, employees, and early investors — usually cannot sell immediately. They sign lock-up agreements with the underwriters, almost always for 180 days after the IPO (sometimes 90 days, sometimes with staggered early-release provisions). The stated purpose is reasonable: it prevents a flood of insider selling into the first fragile weeks of trading and signals commitment. The side effect is a predictable event six months down the road.
The numbers involved can be dramatic. An IPO typically floats only 10-25% of the company's total shares. That means that when the lock-up expires, a supply of shares several times larger than the entire public float suddenly becomes eligible for sale. It is the closest thing public markets have to a scheduled supply shock.
The most cited academic study of the phenomenon, by Laura Casares Field and Gordon Hanka (Journal of Finance, 2001), examined hundreds of lock-up expirations and found an average abnormal price decline of roughly 2% around the expiration date, accompanied by a large, persistent increase in trading volume — and the effect was worse for venture-backed firms. More recent samples broadly agree on direction: on average, stocks soften into and around expiration, though any individual stock can shrug it off, and insiders often choose not to sell (which itself is read as a signal).
The practical lesson is not to mechanically short or avoid every stock near day 180. It is that the lock-up expiration is a known date on the calendar that changes the supply picture, and there is rarely a reason to rush into a recent IPO in the weeks just before it. Patience has, on average, been cheap.
Direct Listings and SPACs: The Alternative Routes
The traditional underwritten IPO is no longer the only door to the public market. Two alternatives matter, and each rearranges who bears the underpricing cost.
Direct listings
In a direct listing, a company simply lists its existing shares on an exchange and lets the opening auction set the price — no underwriters setting an offer price, no book-built allocation, and historically no capital raised and no standard 180-day lock-up. Spotify (2018), Slack (2019), and Coinbase (2021) are the best-known examples, and since 2020 the SEC has approved NYSE and Nasdaq rule changes allowing companies to raise fresh capital through direct listings as well. Because there is no discounted offer price handed to institutional clients, there is no systematic "money left on the table" problem — but also no underwriter stabilization and no allocation process, which can mean a more volatile open. For retail buyers, the practical difference is that everyone faces the same opening auction; nobody got in cheaper by invitation.
SPACs
A SPAC (special purpose acquisition company) is a shell company that raises money through its own IPO, then hunts for a private company to merge with, taking that company public through the merger (a "de-SPAC" transaction). SPACs exploded in 2020-2021 — more than 600 SPAC IPOs raised on the order of $160 billion in 2021 alone — then collapsed in popularity as post-merger results disappointed. Academic work, notably by Michael Klausner, Michael Ohlrogge, and Emily Ruan, documented that SPAC structures carry heavy dilution from sponsor shares and warrants, and that post-merger returns for investors who bought at typical prices were poor on average. The SEC adopted rules in January 2024 tightening SPAC disclosure and liability. The lesson generalizes: whenever a structure routes around the traditional IPO's scrutiny, ask who benefits from skipping it.
| Feature | Traditional IPO | Direct listing | SPAC merger |
|---|---|---|---|
| Price set by | Underwriter book-building | Opening market auction | Negotiated merger valuation |
| Underwriting discount | Yes — the pop, on average | No offer price, so no systematic underpricing | Hidden in sponsor dilution and warrants |
| Typical lock-up | 180 days | Historically none | Varies by deal terms |
| Regulatory path | Full S-1 review, roadshow | Full registration, no roadshow pricing | Merger proxy/registration; lighter than an IPO historically |
| Best known examples | Most large tech listings | Spotify, Slack, Coinbase | 2020-2021 boom cohort |
The Allocation Reality for Retail Investors
Here is the part most IPO coverage skips: you almost certainly cannot buy at the offer price. Allocations are made by the underwriters, overwhelmingly to institutional clients — the funds that participated in the roadshow, shared information during book-building, and generate commission business for the banks all year. Some brokers now run retail IPO-access programs, which is genuine progress, but allocations to retail channels are typically a small slice of each deal, minimums and eligibility rules apply, and hot deals are heavily oversubscribed.
This creates the retail version of the winner's curse described earlier. In the most sought-after deals — the ones with the biggest expected pops — your allocation, if you get one at all, is tiny. In the deals with weak demand, you can have as much as you want. An investor who applies for every IPO indiscriminately ends up systematically overweight in the offerings that informed buyers chose to avoid. The system rations the good deals and rations nothing else.
So for most individuals, "IPO investing" in practice means buying a recently public company in the open market — at or after the pop. That reframing matters, because it converts a question of access ("how do I get in?") into an ordinary question of value ("is this business worth this price?"). And that second question has no deadline. The stock will still be there next quarter, with more information attached.
Red Flags to Hunt for in the S-1
The S-1 is long, but it is organized, and an hour with the right sections tells you more than a week of news coverage. Every filing is free on SEC EDGAR. A practical checklist:
- Who is selling? Check whether the proceeds go to the company (primary shares, funding growth) or to insiders cashing out (secondary shares). A deal dominated by secondary sales means the people who know the business best are reducing their exposure — at the very moment you are being asked to increase yours.
- Use of proceeds. Vague language like "general corporate purposes" is weaker than a specific plan. Proceeds earmarked mainly to repay insiders or fund buybacks of private shares deserve scrutiny.
- Losses and the path to profit. Many IPOs are unprofitable; that is not disqualifying by itself. What matters is whether gross margins are healthy and improving, whether losses shrink as revenue grows, and whether the "adjusted" metrics management prefers flatter the real, accounting-standard figures.
- Governance structure. Dual-class or multi-class share structures give founders voting control far beyond their economic stake, diluting the influence of public shareholders indefinitely. Also check for staggered boards and related-party transactions with executives or their families.
- Customer and revenue concentration. A company whose top three customers are half its revenue carries a fragility that growth headlines obscure.
- Dilution waiting in the wings. Outstanding employee options, RSUs, and convertible instruments can expand the share count meaningfully after listing. Compare the "fully diluted" share count, not just the headline one.
- Auditor and accounting choices. A recent auditor change, a disclosed material weakness in internal controls, or unusually aggressive revenue-recognition policies are all worth their weight in caution.
- "Emerging growth company" status. Smaller issuers may file under reduced-disclosure rules — less executive-compensation detail, no auditor attestation of internal controls. Legal, common, and worth knowing.
No single flag is a verdict. But flags cluster: a company with heavy secondary selling, widening losses, dual-class shares, and vague use of proceeds is telling you, in its own legal documents, how it views the buyers of this deal.
When Waiting Beats Buying on Day One
Everything above converges on one practical discipline: for most retail investors, most of the time, waiting beats participating in the debut. Consider what waiting buys you. After one or two quarters as a public company, you have earnings reported under public-company standards, guidance you can hold management to, an analyst record to compare against reality, and a chart that shows where real buyers and sellers have actually met — rather than a single price negotiated in a conference room the night before. After six months, the lock-up has expired and you have seen whether insiders sold into strength or held. None of this is a promise of a better entry; it is simply more information at no cost.
Waiting also neutralizes the two structural disadvantages retail buyers face: you cannot get the allocation in the good deals, and the pop means your day-one price already reflects the excitement premium. The historical evidence reviewed above — strong average first-day returns accruing to allocated buyers, followed by weak average multi-year returns measured from the first-day close — describes exactly what day-one open-market buyers have tended to experience.
When might earlier participation be more defensible? A few situations at least deserve the analysis: a profitable, established business with a long operating history coming public primarily to raise growth capital; a direct listing where no allocation process enriched anyone ahead of you; or a deal that prices modestly and trades sideways, leaving no excitement premium to pay. Even then, the checklist above applies in full, and position sizing should reflect that young public companies have short track records and wide outcome ranges. For broad context on evaluating any stock once it trades normally, see our research framework for finding quality stocks, our guide to ETFs for lower-maintenance alternatives, and the 360head Stockiq research tools, top signals, methodology, and public track record.
Frequently asked questions
An IPO (initial public offering) is the first time a private company sells shares to the general public on a stock exchange. Investment banks underwrite the deal, regulators review a detailed registration statement (the S-1), and after pricing, the shares begin trading so anyone with a brokerage account can buy them.
Because underwriters deliberately price most deals below where they expect the stock to trade. Underpricing rewards institutional clients for participating in price discovery, compensates uninformed investors for the winner's curse, and generates positive headlines. Long-run US data put the average first-day return near 18-19% — value transferred from the company's selling owners to allocated buyers.
Usually not in meaningful size. Allocations are controlled by underwriters and flow overwhelmingly to institutional clients. Some brokers offer retail IPO-access programs, but retail slices are small and the hottest deals are heavily rationed — so most individuals effectively buy in the open market at or after the pop.
Typically 180 days after the IPO, insiders become free to sell shares that often total several times the public float. Academic research (Field and Hanka, 2001) found an average abnormal price decline of roughly 2% around expiration with a surge in volume. Individual stocks vary, but it is a known supply event worth having on your calendar.
On average, the historical evidence is unflattering: research going back to Ritter (1991) found IPO cohorts substantially underperforming comparable companies over the following three years, measured from the first-day closing price. A small number of IPOs become enormous winners, which is why averages and individual outcomes can differ so sharply.
In a traditional IPO, underwriters price and allocate new shares. In a direct listing, existing shares simply begin trading via a market auction with no discounted allocation — Spotify and Coinbase took this route. A SPAC is a shell company that merges with a private firm to take it public; post-merger returns in the 2020-2021 SPAC boom were poor on average, and the SEC tightened SPAC rules in 2024.