All Resources
Confusing Topics Explained

IPO Investing: How to Evaluate a Company Going Public

4 min read

What an IPO Actually Is

An initial public offering is the first time a private company sells shares to the public. Before the IPO, the company's stock was held by founders, employees, and early investors — venture capital firms, private equity, angel investors. The IPO creates a public market where anyone can buy and sell shares.

The company hires investment banks (underwriters) to manage the process. The underwriters determine the offering price, buy the shares from the company, and resell them to institutional investors. This matters because retail investors almost never get shares at the IPO price. By the time you can buy on a brokerage app, the stock has already been allocated to mutual funds, hedge funds, and high-net-worth clients of the underwriting banks — often at a lower price than where it opens for public trading.

The S-1: Your Only Real Source of Truth

Before an IPO, the company files a registration statement with the SEC called Form S-1. This is the prospectus — a legally required document that discloses the company's business, financials, risks, and ownership structure. Everything else you read about the IPO — analyst reports, media coverage, fintech hot takes — is marketing. The S-1 is the legally binding document, and executives can be personally liable for material misstatements in it.

Here is what to actually look for in an S-1:

Revenue and growth rate. Is the top line growing, and at what pace? Is growth accelerating or decelerating? A company growing revenue 60% year-over-year that suddenly drops to 15% in the most recent quarter is waving a red flag.

Gross margin and operating margin. High growth with terrible unit economics is a pattern you should recognize. If the company loses money on every sale and the margins are not improving with scale, ask yourself when exactly that is supposed to change.

Use of proceeds. The S-1 must state what the company plans to do with the money it raises. Are they funding operations because they are running out of cash? Paying down debt? Expanding into new markets? Be skeptical of "general corporate purposes" — it means they have not committed to anything specific.

Risk factors. This section is written by lawyers and covers every conceivable thing that could go wrong, from regulatory changes to key-person dependency to geopolitical events. Read it seriously. The risks that actually matter are often buried among boilerplate.

Related-party transactions. Does the CEO's brother own a supplier the company pays above-market rates to? Are executives getting personal loans from the company? These disclosures are not merely colorful — they are signals about governance.

The Lockup Period

After an IPO, insiders — founders, executives, employees, and early investors — are typically prohibited from selling their shares for 90 to 180 days. This is the lockup period, and it exists to prevent a flood of shares from hitting the market immediately after the offering.

When the lockup expires, share prices often decline. Early employees and pre-IPO investors have been waiting years for liquidity. Many will sell at least some of their holdings regardless of the stock price. The market anticipates this and prices it in. If you are considering buying shares near the lockup expiration date, understand that additional selling pressure is coming.

Why Retail Gets the Worst Allocation

The IPO process is structurally tilted. Underwriters allocate shares to their best institutional clients — the ones who generate trading commissions, banking fees, and future deal flow. Retail brokerages that do offer IPO access typically receive a tiny allocation, and only from less desirable deals where institutional demand was weak.

This matters because IPOs exhibit a well-documented pattern: they pop on the first day of trading and underperform over the following three to five years. The pop goes to institutional allocators who bought at the offering price and can flip shares to retail buyers at the open. The subsequent underperformance lands on retail investors who bought after the pop and held.

Research by Jay Ritter at the University of Florida, who maintains the most comprehensive IPO database, shows that the average first-day return for US IPOs is roughly 18%. That is the amount of money left on the table by the issuing company and captured by institutional allocators. Over three years, the average IPO underperforms the market by a significant margin.

A Saner Approach

Wait. You do not need to buy on day one. A company with durable competitive advantages will still have them six months or a year after the IPO. Waiting lets you observe several quarters of public-company earnings, see how management handles the scrutiny of quarterly reporting, and avoid the post-lockup selling wave. Statistically, waiting improves your odds. The pop is already priced in, and the underperformance has not started yet by the time you buy — if you wait long enough.

Related Reading