Episode #10 - Pour out some Lemonade
Why a cool summer drink looks piping hot and an intro into the world of IPOs
Intro:
Welcome (back) to Winnings! About 20% of you are receiving your first episode, and I do hope you go back to catch-up. You’re only ten episodes behind and a bit of binge-reading might do you some good.
The sub-bump came from my departure of my day-job at the Tikvah Fund, and I do hope you folks will find the time to share this letter with your friends. Who knows? Perhaps by the close of July we’ll hit 250 subscribers.
For this episode I want to bring Initial Public Offerings (IPOs) to your attention. While there are many stages before a company can “go public,” most of us private investors only get a chance at to invest in specific stocks at the public offering. As you likely recall from previous episodes, I don’t typically encourage stock-picking as an enterprise, but part of this letter is to understand how the market works and what makes up the different indices you want to invest in. Each index contains tens of companies that at one point or another went through the IPO process, so let’s take a few minutes to learn about it.
Background:
In what shouldn’t come as a surprise, that AP European history class about the Dutch East India Company stands as the earliest MODERN public offering coming in at March 1602. Thanks to Wikipedia, I’ve also discovered the first known ancient IPO took place in Rome known as the publicani. It took the form of partes like shares, that would be traded in the Forum. (Rome was ahead of the curve on a bunch of things, so add this one to your “Rome was first” lists at home.)
I’m on the IPO train this week specifically because the most successful IPO of 2020 is upon us with the launch of Lemonade_Inc. They’re an insurance company mainly operated by bots. As I’ll say in the next section, I definitely don’t make stock recommendations, but I like to look at current happenings in the market as a way to ground our study together, so, please continue through this short journey.
What happens when you’re public?
Well, you can just ask the folks at recently IPO-ed Lemonade. If you’ve never heard of them, it’s probably worth a listen to this podcast with their CEO Daniel Schreiber. Again, I’m not in the market of stock picking and wouldn’t see this in that vein either, but I do think it’s good to use current examples of what happens to a company when it gets listed on the open market.
Into the nitty-gritty: The early investors (seed round, Series A, B, C, etc) get a chance to monetize their investment. Up until the IPO (barring some other non-public purchasing of shares), early investors hold on to the unlisted stock with the hope that the company will make it to the open market. If the investors feel the company will get even bigger after it goes public, they can hold on to their shares, but then they face the price fluctuation and risk any shareholder would have in the open market.
In terms of upsides, the company can now raise capital through dilution of the stock, i.e. offering more shares, which usually will garner buyers who are excited to have a piece of the action. By raising more money from the public they can invest in new capital projects and growth without going to larger institutional investors and losing stake in their company (though they do lose some stake every time they offer more shares).
One of the downsides (kind of, at least) that comes with an IPO comes in the form of stricter scrutiny by the Securities and Exchange Commission (SEC). The oversight incurs higher costs for auditing and checking financial records. The agency helps protect the average investor from fraudulent activity. If you’re looking to take your own company public, you’ll need to know more about the details here, but for the average investor the safeguards in place help you avoid getting burned. Similarly, because more information needs to be out there for the taking, competitors get more of a sense of what you’re working on. Stealth mode no longer rules the day the way it might have before an IPO.
A quick philosophical point, you might be familiar with Milton Friedman’s shareholder theory that a company’s main responsibility is to increase shareholder value. Even if you’re not, you might be able to imagine why at times shareholder value might hurt others like employees and consumers. One company worth following is called the Long Term Stock Exchange. They utilize a different incentive structure that allows success to be measured over years instead of quarters, which could allow for longer term growth and take a moment to sacrifice immediate profits. Just wanted to drop this in so you can expand your understanding and see the scope of a broader investment landscape.
Takeaway:
IPOs are typically big moments in the history of a company. It means that you’re not longer in JV, you need to answer to the big institutions and to thousands of investors. You no longer control who can invest in your company the way you can when you first get started and you need to exact extra vigilance to ensure you make the goals you attempt to achieve. Now that you know about IPOs, I have something for you to follow-up with for the next issue.
Interact:
Check out Lemonade or the other IPOs in the 2020 class (you might surmise that it’s been a tougher year than usual for IPOs based on the challenges facing the economy).
What normally happens to their share prices when they go on the market?
Find three IPOs from 2020 and see where they ended up at the one week, one month, and three month points.
What do you notice?
Did the IPO go well for the company?
Please comment below with what you find!
Gratitude:
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