Different types of IPO Investor

Investing in IPOs can be a thrilling yet complex journey, and understanding the players involved is essential.

There are various types of IPO investors, each with its own approach and influence on the market.

I will break down these investor types for you, helping you make informed decisions in the IPO landscape.

Why do investors choose an IPO as an investment avenue?

When it comes to expanding one's investment portfolio, Initial public offerings (IPOs) often stand out as an attractive option. But why is that?

Let's look at the benefits:

Getting in on the action early

Investing in an IPO allows you to start at the foundation level of a company that could show significant growth.

If you place your bet on, say, a fledgling company promoting a disruptive technology and it succeeds in capturing the market's attention, your investment could multiply as the company thrives.

Imagine reaping the rewards from the success of a company you believed in from the start.

Meet long-term goals

Investments in IPOs fall under equity investments. They possess the potential for substantial returns over time, making them ideal for meeting major financial goals, be it planning for retirement or purchasing a home.

To put it in perspective, the Indian IPO market saw tremendous growth in 2017, with the stock market raising close to $11 billion through IPOs alone.

More price transparency

One of the strengths of IPOs is the clarity in pricing. Each security's price is detailed in the IPO order document, levelling the playing field between you and bigger investors.

After the IPO, share prices are influenced by fluctuating market rates and what stockbrokers can offer, but at the IPO stage, everything is transparent.

Buy cheap, earn big

Often, the IPO price tag is the most affordable one will find, especially if it's a smaller company with vast potential. Companies might offer securities at a discounted rate during the IPO. Waiting too long might mean missing out, especially if the stock's price shoots up.

For some inspiration, consider Amazon. When it launched its IPO in 1997, shares were priced at $18 each. A $5,000 investment back then would have been valued at a staggering $2.5 million by April 2018.

Diversification for the portfolio

One of the golden rules of investing is diversification – not putting all your eggs in one basket. By adding IPOs to your investment mix, you're essentially broadening your portfolio's horizon. Different sectors and industries go public every year, giving investors a chance to invest in diverse fields, and reducing the overall risk.

Potential for high liquidity

Post-listing, a company's shares can be easily bought or sold on the stock exchange, offering high liquidity to the investors. This means if you need to convert your shares into cash, you can do so more easily, especially with companies that generate significant interest.

Early insights into promising ventures

Getting a first look at a company's operations, financials, and strategies is another advantage of IPO investments. The mandatory disclosures that companies make during the IPO process can give investors a deeper understanding of the company, helping them make more informed decisions.

Enhanced regulatory scrutiny

Companies going public are subjected to stringent checks and audits by regulatory bodies. This ensures that the information they provide is accurate and that they comply with the necessary financial and operational standards.

Opportunity for oversubscription benefits

If an IPO is oversubscribed (demand for shares exceeds the number available), it's a sign of high interest and trust in the company from the market. Investors in such IPOs may receive additional shares, which can further increase the potential for profits.

Stimulating economic growth

On a broader level, investing in IPOs contributes to economic growth. When you invest in a company's IPO, you're providing them with capital that can be used for expansion, research, or paying off debt. It can lead to job creation, innovations, and more, benefiting the larger community and economy.

Different types of IPO investors you need to know

Each type of investor brings a unique set of characteristics, motivations, and influences, and their involvement can profoundly shape the trajectory and outcome of an IPO.

Let’s look into a few examples of investors in IPOs that are often talked about.

Institutional investor or qualified institutional investor

Institutional investors or Qualified Institutional Investors (QIIs) are entities or organizations that pool together funds to invest them in securities, real properties, and other investment assets.

These can include banks, insurance companies, pension funds, hedge funds, REITs, investment advisors, endowments, and mutual funds.

Characteristics:

• Large capital base: Typically, they manage vast amounts of money and can make substantial investments in IPOs.
• Professional management: They often have teams of analysts and portfolio managers who conduct thorough due diligence before investing. This makes their investment decisions more data-driven and researched.
• Long-term perspective: Unlike some individual investors who might look for short-term gains, many institutional investors have a longer-term perspective, often seeking stable returns over extended periods.
• Regulatory oversight: In many jurisdictions, QIIs are subject to more rigorous regulatory oversight compared to retail investors, ensuring transparency and accountability.

Given their substantial purchasing power, institutional investors can significantly influence the success or failure of an IPO. Their involvement often boosts the confidence of other potential investors.

Non-institutional investors (NIIs)

Non-Institutional Investors (NIIs) are individuals or entities that are not classified under retail individual investors or qualified institutional buyers. They generally invest a larger amount than retail investors but do not have the scale of institutional investors.

Characteristics:

• Varied capital allocation: They might have more funds to allocate than retail investors but less than QIIs.
• Diverse strategies: Their investment strategies can range from short-term trading to long-term holding, based on individual or entity preferences.
• Less regulatory protection: While still subject to financial market regulations, NIIs might not always benefit from the same level of protection as retail investors.

Their participation can act as a bridge between retail and institutional investors. They might bring additional liquidity and depth to the market.

Retail individual investor (RII)

Retail Individual Investors (RIIs) are everyday individuals who invest their capital into stocks, bonds, and other assets, including IPOs. They don't have the financial clout of institutional or non-institutional investors.

Characteristics:

• Limited capital: Typically, RIIs have a smaller amount of capital to invest compared to NIIs or QIIs.
• Dependent on brokerage services: Most retail investors use brokerage services or platforms to make their investments.
• Emotion-driven decisions: While many RIIs make informed decisions, some can be influenced by market sentiments, emotions, or trends rather than in-depth analysis.
• Greater protection: Due to their vulnerability, many regulatory frameworks offer heightened protection to retail investors, ensuring they aren't taken advantage of.

Retail participation in an IPO can be a sign of public confidence in the company. A high RII involvement can also mean more liquidity in the stock once it starts trading, but their participation might also lead to more volatility.

Anchor investor

An anchor investor is an institutional investor who commits to purchasing a substantial number of shares in an IPO before the actual listing of the shares. Their early commitment often sets a positive tone for the IPO and helps in price discovery.

Characteristics:

• Reputation & Influence: Anchor investors are typically well-regarded entities in the financial world, such as mutual funds, insurance companies, and pension funds. Their participation can enhance the credibility of the IPO, attracting other potential investors.
• Large ticket size: The commitment from an anchor investor usually involves a substantial amount, reflecting confidence in the offering.
• Lock-in period: Often, shares purchased by anchor investors come with a lock-in period, meaning they can't sell their shares immediately after the IPO. This ensures a level of stability post-listing.
• Price discovery role: Their early commitment helps the issuing company and its investment bankers gauge the demand and set an appropriate price for the shares.

Anchor investors play a pivotal role in boosting the confidence of other potential investors. Their involvement is often viewed as a seal of approval, suggesting that the IPO is a worthy investment.

Insider investor

Insider investors refer to individuals or entities that have a pre-existing relationship with the company going public. This can include the company's executives, employees, board members, or early-stage private investors.

Characteristics:

• Deep knowledge: Unlike external investors, insiders have an intimate understanding of the company’s operations, its strengths and weaknesses, and its prospects.
• Long-term perspective: Insiders often have a long-term association with the company and might be more inclined to hold onto their shares for extended periods, even after the IPO.
• Regulatory restrictions: Insider trading regulations are in place to prevent unfair advantage. Insiders are often restricted from selling their shares for a specified period after the IPO (known as the lock-in period) to ensure they don't take undue advantage of their inside information.
• Potential conflict of interest: There can be instances where the interests of insiders might not align perfectly with those of new external shareholders. Hence, their actions and decisions are closely watched and sometimes met with scepticism.

The participation level and behaviour of insider investors can send strong signals to the market. If insiders are heavily selling, it might be perceived as a lack of confidence in the company's prospects, whereas minimal selling or additional buying can be seen as a bullish sign.

2 different types of IPOs

Taking a company public is a monumental decision, marking a transformative phase in its lifecycle.

However, the path to going public is not one-size-fits-all. Companies are faced with two primary routes when they decide to initiate an Initial Public Offering (IPO): the Fixed Price Issue and the Book Building Issue.

Both these mechanisms come with their distinct methodologies, advantages, and considerations.

As we study deeper, we'll understand the nuances of each approach, highlighting how they can shape the IPO's trajectory and the subsequent market reception.

1. Fixed price Issue

In a fixed price issue, the company determines a specific price for the shares it will offer to potential investors. To determine this price, a company brings on board a merchant banker. This entity evaluates the current and potential value of the company.

They also assess the risks associated with the investment to ensure that investors are adequately compensated for any potential risks they might undertake. After thorough research and evaluation, the merchant banker helps the company decide on the optimal share price.

For investors, the advantage here is clarity; they know the exact price of the share before the company goes public and pay the predetermined price when subscribing to the IPO.

2. Book building issue

The book-building issue takes a more dynamic approach to pricing. Instead of setting a fixed price, the company establishes a price range with a lower limit, known as the "floor price," and an upper limit called the "cap price."

Potential investors then place their bids within this range over a specified period. These bids indicate the price they're willing to pay for the shares and the number of shares they wish to purchase.

Once the bidding phase concludes, the company reviews all the bids to decide on the final price.

The eventual share price rests on the demand from the investors and the bids they placed within the defined range.

Final thoughts

The journey through the various facets of IPO investing has revealed its undeniable appeal. From understanding the reasons behind an investor's inclination towards IPOs to exploring the distinct types of IPO investors, the landscape of initial public offerings is vast and varied.

With numerous IPOs dotting the horizon, it's imperative to grasp the differences between the types and to recognize the unique advantages each presents.

Trade on the most buzzworthy companies going public and harness the potential of the IPO market.

Happy investing!

“When considering initial public offering (IPO) for trading and price predictions, remember that trading CFDs involves a significant degree of risk and could result in capital loss. Past performance is not indicative of any future results. This information is provided for informative purposes only and should not be construed to be investment advice.”