This wouldn’t actually work, I don’t think, but here’s a fun way to do an initial public offering. You write a prospectus describing your business and then you do a two-track IPO process. On one track, you hire Morgan Stanley or Goldman Sachs Group Inc. or whoever, and they go out and market your IPO to big institutional investors, and you do a roadshow and meet with those investors, and your banks build a book of demand and come to you with a market-clearing price for a billion-dollar IPO. On the other track, you hire Robinhood Markets, and Robinhood features your stock prominently on its retail trading app for a week, and its customers can bid on the stock and see how many other bids there are and for what price, or maybe even shadow-trade it in a sort of when-issued market, and then Robinhood comes to you with a market-clearing price for some amount of stock, maybe $200 million.
And then Morgan Stanley is like "you can do a billion-dollar IPO at $50 per share" and Robinhood is like "you can do a $200 million IPO at $100 per share" and you get to pick. (Note that a billion-dollar IPO at $50 per share is 20 million shares; a $200 million IPO at $100 is 2 million shares, 20% as much money for 10% as many shares.) You can raise a lot of money to fund your operations for a long time, from big institutions that will be long-term shareholders, at a price that is palatable to those big institutions. Or you can raise a smaller amount of money at a super high stock price, from smaller investors, with less dilution. If you really need the money, you take the money. If you’re fine with less money and you want to maximize price, you take Robinhood.
One problem here is that if you take the Morgan Stanley deal, the next morning some of the institutions that bought the stock at $50 will turn around and sell it in regular trades on the stock exchange. That is after all the point of the IPO, to get your stock listed and trading on a stock exchange. You know who’s going to buy it? That’s right, the Robinhood people who wanted to buy it for $100. You know much they’re going to pay for it? That’s right, $100.
The result is that you will sell $1 billion of stock to institutions at $50 per share, and then some of the institutions will turn around and sell 10% of it to Robinhood traders at $100 per share. And then people will come to you and say "why didn’t you sell your stock at $100 per share?" And you will say, well, we thought about it, but we wanted more money, and the clearing price to institutions for a big chunk of money was lower than the clearing price to some Robinhood traders for a smaller chunk of money. Neither you nor your critics will be all that satisfied with that answer. And you’ll be pretty annoyed that those institutions made a 100% profit in one day.
Now none of this is exactly real. This two-track IPO idea wouldn’t really work legally or mechanically. (Certainly "shadow-trade it in a sort of when-issued market" is not gonna fly; price discovery from the retail traders will be hard.) Robinhood is not actually in the business of doing IPOs, except maybe for itself, though I have suggested that it should be. My divide between "institutions" and "Robinhood" is silly and reductive: On the one hand, lots of big IPOs do allocate some shares to retail investors (usually not as price-setters though); on the other hand, when the stock opens for trading plenty of the buyers will be hedge funds and under-allocated institutions and high-frequency traders and all sorts of other professionals, not just retail investors. (Also probably some retail investors who don’t use Robinhood.) And my purely binary model for price—institutions pay $50, retail pays $100—doesn’t make a lot of economic sense.
And yet. The basic rule in recent high-profile U.S. IPOs is pretty much that companies sell big blocks of stock to institutions, and then the next day the stock opens for trading and those institutions sell some stock for twice what they paid for it, and it’s awkward all around. Here’s another one:
Affirm Holdings Inc. almost doubled in its public market debut, the latest multibillion-dollar technology company to start trading significantly higher than its initial public offering price.
Shares of the San Francisco-based company, which provides installment loans to online shoppers, closed up 98% to $97.24 in New York trading after rising as much as 110% earlier Wednesday. The company sold 24.6 million shares at $49 each in Tuesday’s IPO to raise $1.2 billion, pricing the stock above a range that had already been increased.
A few points here. One is that my advice to companies on how to avoid an "IPO pop" like this has consistently been just to price the stock higher than your banks think you should. Like your banks come to you and say "we have demand from institutions to price this deal at $44" and you’re like "no $49" and they grumble but do it and then you have more money and, hopefully, less of an IPO pop. I have … no reason to think Affirm didn’t do this? Affirm was planning to go public in December, but delayed the deal because it saw so many big IPO pops and wanted to find a way to get more money. It eventually launched its IPO last week with a price range of $33 to $38 per share. This Monday, it increased that to $41 to $44. On Tuesday it priced the IPO at $49 per share. Probably at that point everyone felt a little nervous: They thought it was worth $33ish two weeks ago, so it’s a little presumptuous to ask $49 now. Didn’t matter, stock doubled the next day.
This suggests that my advice is not wrong, exactly, in this burning-hot market—asking for more money is good, if it gets you more money!—but it does not actually avoid the IPO pop. The way the IPO pop works is that, whatever the IPO price is, the stock doubles the next day. Valuation has nothing to do with it; it is just a law of physics in this "stocks only go up" market. (Good lord is this not investing advice.)
Another point is about the mechanics and numbers here. When this IPO priced on Tuesday evening, Affirm’s banks allocated 28,290,000 shares to buyers at $49 per share, for a total of about $1.4 billion. When the stock opened for trading on Wednesday morning, 3,706,057 shares crossed in the Nasdaq opening auction, at a clearing price of $90.90, for a total trade size of about $337 million. There is no reason to think that those are all the shares that became available for trading on Wednesday; presumably some institutions bought shares for $49 on Tuesday night, saw the stock open at $90.90 on Wednesday and climb above $100 within half an hour, and decided maybe they should sell a bit too. Still those numbers give you a sense of the different magnitudes: Affirm sold 28.3 million shares to institutions for $49 on Tuesday night, and most of those institutions were—as most newly public companies prefer—long-term investors who had no plans to flip the stock the next day. Some of those institutions turned around and sold 3.7 million shares to the market for $90.90 on Wednesday morning. Wednesday’s price was much higher, but for many fewer shares.
This suggests that the problem of the IPO pop is not exactly that the bankers and company value the company incorrectly in the IPO. It’s just a matter of supply and demand: The price at which you can sell 28.3 million shares is lower than the price at which you can sell 3.7 million shares.
A third point is that Affirm raised $500 million in a private Series G funding round in September. That was about four months ago. The venture capitalists that bought in that round—including Founders Fund, Lightspeed Venture Partners and Spark Capital, all of which have seats on Affirm’s board of directors—paid $19.93 per share. Affirm first filed papers for its IPO in November; presumably it was pretty far along in planning the IPO when it raised that round in September. The Series G investors were not making a long-term investment in a speculative illiquid private company; they were tiding it over for a few months until the IPO. When the IPO launched with a $33-to-$38 range, those Series G investors had a 66%-to-91% paper profit. When it priced at $49, they had a 146% profit. When the stock closed at $97.24 yesterday, they had a 388% profit. In four months.
The biggest complainers about IPO pops tend to be venture capitalists, who are repeat players in the IPO game and who are angry that Wall Street rewards its favored institutions—the big asset managers that buy shares at the IPO price—by pricing IPOs too low. "Wall Street should price the IPO at the real price, not an artificially low price to reward its investor customers," is the implication—and also that it’s easy to figure out the real price. But when Affirm negotiated its valuation with its most loyal venture capitalists, several of whom are on its board, just four months ago, it came to a price that was 59% below the IPO price, and 80% below the "real price" (as measured by yesterday’s close). Affirm raised $500 million in its Series G, but it left $1.9 billion on the table.
This suggests that either (1) valuation is hard, whaddaya gonna do, or (2) the valuations that venture capitalists are willing to pay for just-about-to-go-public companies are much lower than the valuations that institutional investors are willing to pay for just-going-public companies, which are in turn much lower than the valuations that smaller investors are willing to pay for just-having-gone-public companies. The people who buy stocks just after the IPO are way more enthusiastic than the people who buy in the IPO, who in turn are way more enthusiastic than the people who buy before the IPO.
Or consider SPACs. Special-purpose acquisition companies are an alternative mechanism for going public: A sponsor takes a SPAC public by raising a pool of money, and then goes out to find a target company to merge with the SPAC. In the merger, the target company gets the cash in the pool (like raising money in an IPO), and the SPAC shareholders get shares of the target company (allowing those shares to trade on the stock exchange).
Most SPACs initially sell their stock for $10, so they have $10 per share in the pot. They go to a target company and negotiate a price for the target company’s shares, based roughly on how much is in the pot: If a SPAC has 100 million shares, it’s a $1 billion SPAC and can pay $1 billion for target-company shares, and the SPAC sponsor and target company will negotiate how many shares that $1 billion will buy. Often the SPAC sponsor will also bring in other big institutional investors who will invest alongside the SPAC (in a PIPE, a private investment in public equity) to bring more cash and certainty to the deal. They will agree to invest their own $10 per share alongside the SPAC.
The SPAC sponsor and institutional investors will negotiate a price with the target, and then they will announce the deal, and then there will be a delay of a few months for merger approvals and such before the deal closes and the target gets the money. But in the meantime the SPAC’s shares will still be trading, on the stock exchange, to whoever wants to buy them. Before there is a deal, the SPAC’s shares represent claims on a pile of cash, so they should be worth about $10. After the deal is announced, though, the SPAC’s shares represent (if nothing goes wrong) shares in the target company, so they should effectively trade like public stock in that company.
If you squint, this is like an IPO: The target company negotiates a price with a limited list of big institutional investors (the SPAC sponsor and the PIPE investors), and then the stock opens for trading and anyone who wants to can buy it. The negotiated price, with the institutional investors, is effectively always $10 per share, since that’s the nominal price at which most SPACs are priced, and the amount of cash that the SPAC pays the target in exchange for its shares; it’s just a question of what percentage of the target company a share represents.
But then the SPAC and the target company announce the deal, and what happens? Well, here’s a SPAC deal that was announced on the same day as Affirm’s IPO:
Proterra Inc., which makes electric buses and battery systems, on Tuesday said it will go public through special purpose acquisition company ArcLight Clean Transition Corp., the latest in a wave of deals between automakers and SPACs.
ArcLight Clean Transition Corp. closed at $12.19 per share on Monday. That’s above its $10 cash value, presumably because investors had high hopes for a good deal, but still close enough. On Tuesday it closed at $25.20. That’s a 107% IPO pop, a little bigger than Affirm’s. (Or arguably a 152% pop?) The SPAC deal underpriced Proterra more than the IPO underpriced Affirm.
Or here’s a rumored SPAC deal from the weekend:
Electric vehicle maker Lucid Motors Inc. is in talks to go public through a merger with one of Michael Klein’s special purpose acquisition companies, according to people familiar with the matter.
The SPAC is Churchill Capital Corp IV. It closed at $10.03, basically cash value, on Friday. By Wednesday, on rumors of a deal—not a signed deal—it closed at $16.72. That’s a 67% IPO pop, I guess, but notice that Churchill and Lucid haven’t gotten the valuation wrong, because no valuation has been announced. It is impossible that investors looked at the Churchill/Lucid deal (which does not exist) and said "ah, this severely underprices Lucid’s potential, I need to buy." Instead they looked at the prospect of a deal and said "ah, cool, electric cars, I gotta buy that." Valuation couldn’t have entered into it! Just, whatever price big institutions will pay for Lucid, small public investors want to pay more.
My conclusion here is that the marginal buyer in the public market, who may or may not be day-trading on Robinhood, really really likes buying stocks, especially exciting new stocks, and is going to pay a lot for those stocks and drive them up rapidly. And if a private company does any sort of transaction to sell a stake in itself to institutional investors—a late pre-IPO funding round with venture capitalists, a SPAC with a PIPE, or a regular old IPO—it is quickly going to feel foolish, because the price it gets from those institutions is going to be lower than what the marginal public buyer will pay.
These are not universal truths or anything; they just seem to be true right now. We were talking not all that long ago about how private-market valuations seemed to be much higher than what public markets would support. Tech unicorns would raise billions from venture capitalists, from public institutions stricken with fear of missing out, from private-wealth customers excited to get access, from SoftBank, from SoftBank, from SoftBank, from SoftBank. People worried that the prices companies got in these deals didn’t reflect what public markets would pay: Public investors, the theory went, were careful and cared about results, and they wouldn’t ascribe as much value to faraway dreams as Masayoshi Son did. These worries sometimes proved true! The word "undercorn" was coined, meaning a tech unicorn that went public for less than its last private valuation, and it ended up applying to several of the biggest tech names of recent years. Also WeWork happened!
Nobody worries about those things anymore. Now you go public way above your last private round, and then the stock doubles
I don’t know what you do about this, by the way, if you’re a company looking to go public. My dual-track IPO is not realistic. Just accept that there’ll be a big pop and enjoy the ride? I suppose one answer is a direct listing, possibly with a primary capital raise? IPOs and SPACs both involve negotiating prices with big institutions and then watching your stock open for public trading, probably much higher. The direct listing skips that and plops your stock right on the stock exchange, where it can just trade higher immediately—and you can be the one selling. If small public-market buyers are the ones who are most enthusiastic about buying stock these days, you might as well go straight to them.
Here’s a theory I have. There are two fairly general regimes for governing the world, call them Finance and Politics. (Others too, Religion and certainly Social Media, but let’s stick with those two.) The government—Politics—tells you what you can and can’t do in some circumstances, and providers of capital—Finance—tell you what you can and can’t do in some other circumstances, and the circumstances are different but there is a lot of overlap. If the government says you can’t buy an assault weapon then you probably can’t buy an assault weapon. If your bank won’t let you use a credit card to buy an assault weapon then you also may not be able to buy an assault weapon; if no bank will process any payments for assault weapons then it will be really tough.
One aspect of this theory is that Finance tends to be biased toward action and Politics tends, in the U.S., not to be. The U.S. government has checks and balances and partisan gridlock and low-information voters and other problems, and tends to have trouble coming up with ambitious ways to address big new problems. Finance has annual bonuses and competitive markets and tends to be ambitious and action-oriented. If there’s a thing that appeals to a lot of people, Politics will slowly and agonizingly grind toward doing the thing, while Finance will compete to offer it first and monetize it.
A second aspect of this theory is that the people who run Finance, and the people who choose those people, are different from the people who run Politics, and from the people who choose those people. Simplistically, the people who run Finance are chosen by a series of quasi-democratic processes that weight preferences by wealth: The more money you have, the more say you have in how banks and corporations are run. The people who run Politics are chosen by a series of quasi-democratic processes that weight preferences mostly by population, but with biases toward rural areas and older people. You might expect Finance to reflect the preferences of rich college-educated urban professionals, and Politics to reflect the preferences of older rural voters.
A third aspect of this theory is that Politics sometimes gets jealous of Finance and wants to defend its turf. If Politics likes a thing, and Finance doesn’t like it, Politics might encourage it and Finance might try to ban it. But since Politics runs the actual government, it can regulate Finance too; it can, if it wants, try to make rules to ban Finance from banning the thing. (Of course Finance has a certain amount of power to regulate Politics too.)
So we talked in June about a proposed rule from the U.S. Department of Labor that would limit 401(k) retirement plans from investing in environmental, social and governance (ESG) funds. ESG funds, on my theory, use Finance to regulate behaviors—pollution, gender equality, etc.—that are more traditionally regulated by the government, and, given Finance’s bias toward (1) doing stuff and (2) doing stuff that urban professionals like, they regulate those behaviors more strictly than the current U.S. government would like. So the current U.S. government tried to—not ban ESG funds, exactly, but certainly crack down on them, so they’d back off the government’s turf.
And now there’s this:
Were history a guide, Brian Brooks would be spending the last days of the Trump administration enjoying the Washington view from his spacious government office and contemplating his next career move. Instead, the chief overseer of the largest U.S. banks is infuriating Wall Street.
As acting head of the Office of the Comptroller of the Currency, Brooks is expected to pass a rule Thursday that would force banks to lend to gun manufacturers, oil drillers and other controversial industries that some have refused to do business with. …
There’s little that can be done to stop Brooks, a situation that has left many firms threatening lawsuits and prompted furious letters to the OCC and critical commentary, like one web post from a leading bank trade association that said the agency was demonstrating "a shocking ignorance of how banking is prudently conducted." …
"Are they angry?" Brooks, 51, asked sarcastically. "If there was some myth that the OCC or my political team are too cozy with big banks, you can put that to rest."
The OCC has spent recent weeks going through thousands of comments it received on the proposal, most of them from gun enthusiasts applauding the plan. The high public interest is likely attributable to Brooks himself. He has publicized his effort through speeches, interviews and op-ed articles. Bank lobbyists on the other side of the debate have been watching with a mixture of horror and fascination, emailing around some of Brooks’s greatest hits.
There was his article in Game & Fish magazine — likely a first for an OCC chief — that argued banks are harming hunters by "suffocating" gun manufacturers’ capital needs. "We can’t rely on all bank executives to be as strong and courageous as American sportsmen," Brooks wrote.
Yes, right, see, if you are doing Politics you want to appeal to the readers of Game & Fish, while if you are doing Finance you want to appeal to the readers of, uh, I guess I am going to say Bloomberg? Anyway.
Here is the proposed rule. One can see the banks’ point. One problem here is that the government suspects, with some reason, that the banks are cracking down on guns and oil for political and social reasons: Bankers don’t like guns, there’s public-relations pressure not to fund oil, that sort of thing. But the banks can say, also with some reason, that they are making these decisions on purely financial grounds: They judge that the long-term business risks of guns and oil make the expected returns on gun and oil lending unattractive. It is commonplace for ESG investors to argue that good ESG practices will provide higher long-term returns, because if you pollute or discriminate or whatever your business will eventually suffer for it.
Similarly here, banks could rationally conclude that gun companies have unpriced business risks that make lending to them particularly unsafe, purely as a financial matter. Or at least they can argue that. The OCC thinks they’re lying:
It is our understanding that some banks have taken these actions based on criteria unrelated to safe and sound banking practices, including (1) personal beliefs and opinions on matters of substantive policy that are more appropriately the purview of state and Federal legislatures; (2) assessments ungrounded in quantitative, risk-based analysis; and (3) assessments premised on assumptions about future legal or political changes.
Ordinarily the way one thinks of safe-and-sound banking regulation is that banks want to do a lot of lending, and regulators say "actually some of that is too risky and you should cut it back." Banks have incentives to be aggressive: If risky loans work out the bankers get rich, if they go poorly they get bailed out; the bankers have unlimited upside and limited downside. Regulators have incentives to be conservative: If risky loans work out the regulators don’t get a bonus, but if the banks need bailouts the regulators get blamed; they have no upside and lots of downside.
From a strict safety-and-soundness perspective, if a bank says to its regulator "hey we think these loans are too risky and we’re going to stop doing them," it would be weird for the regulator to second-guess the bank and say "no actually those loans are fine, load up on them, I insist." At least in ordinary times, bank regulators do not normally call on bank executives to be courageous. But of course financial regulation is all-purpose meta-regulation, and this is not really about safety and soundness.
Here is a Cboe Exchange Inc. disciplinary action (from October, but new to me) against a floor broker at the Chicago Board Options Exchange who traded options contracts in the VIX pit. VIX trading is high-stakes and much scrutinized, there have been allegations over the years about shadowy cabals manipulating VIX prices, and spoofing has gotten a lot of traders in trouble recently. So what did this guy do? Apparently he cursed a lot at the other VIX traders:
On September 26, 2018, Moran engaged in verbal argument, abusive language and unbusinesslike comments to the VIX trading crowd regarding the allocation of contracts among the in-crowd market participants. … He continued to yell expletives at the crowd while allocating the order and also after confirming the quantities with the other trading crowd participants.
The part I cut out of the middle of that paragraph is about how he said he wanted to do something that is mildly not allowed (keep too much of the order for his own account rather than trading it on the exchange), but then he backed off and allocated the trade properly. His allocation was not the problem. The problem is that he cursed a lot while doing it, and also afterwards.
Also he repeatedly made fun of another person on the floor—"Market Maker B"—for not trading enough:
On March 20, 2019, Moran made an unbusinesslike comment to Market Maker B in the VIX trading crowd when allocating a trade to him, which appeared to be an attempt to insinuate that the resulting trade would likely be the last one Market Maker B planned on participating on that day, in light of a perception by Moran that Market Maker B did not sufficiently participate on trades in the trading crowd. Specifically, after allocating the trade to Market Maker B, Moran said "last time I’m going to hear from you to today." …
On May 15, 2019, … Moran told Market Maker B to pay more attention to what he was saying (with the use of an expletive) and that "It’s the only thing I’ve heard out of you in three days."
On May 21, 2019, … Market Maker B provided a market wider than that offered by the trading crowd as a whole, but one that was within the NBBO. In response, Moran responded to Market Maker B: (with the use of an expletive), "why don’t you just go home?"
On June 19, 2019, … Market Maker B offered to participate on the trade initially but realized during Moran’s allocation of the trade that the trade was not tied to stock, and put down his hand to indicate he did not want to be allocated on the trade. In response, Moran said to Market Maker B, "hand up hand down."
I read a lot of enforcement actions from financial regulators and I think this is the pettiest one I’ve ever read. This guy and his firm were fined $20,000 for saying "hand up hand down" and "why don’t you go home?" and "last time I’m going to hear from you today." I love it.
One lesson here is that if you work at a normal job and you are rude to your coworkers you might be reprimanded or eventually fired, but there will not be a formal public enforcement procedure against you by a regulator. Working in a regulated industry is not for the, uh, sweary and easily embarrassed.
The other lesson here is … look, yesterday, if you had asked me questions like "do pit traders on the CBOE swear a lot at work?" or "do pit traders on the CBOE give each other grief for perceived weakness?" I would have said, yes, absolutely, my impression of pit traders is that they spend all day cursing and hazing each other. If you had asked me "would CBOE regulators step in to stop a trader from saying ‘hand up hand down,’ because another trader would be offended at the implication that he was cowardly and indecisive?" I would have said, no, absolutely not, surely CBOE regulators understand that a major purpose of floor traders, second only to their role in the efficient allocation of capital and hedging of risk, is offending and belittling each other. But no, here we are, apparently this is illegal.
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 The IPO was for 24,600,000 shares, but there was also a customary 15% "greenshoe" over-allotment option: The banks have an option to buy 3,690,000 more shares in the weeks after the IPO, at the IPO price. The purpose of this is to help them stabilize the stock in the aftermarket. The banks allocate the greenshoe in the IPO: Investors get filled on orders for 28,290,000 shares, the full amount including the greenshoe; if the banks need to stabilize by buying back stock, they effectively buy back some of the shares that they allocated for the greenshoe. When the stock doubles on the first day the banks obviously do not need to do this, so they quickly exercise the greenshoe option and buy the extra 3.7 million shares from the company.
 Actually the stock opened at 12:20 p.m. but it just *feels* like "the next morning," you know?
 Total volume on Wednesday was 25,158,956 shares, though of course shares will trade multiple times over the day; I suspect the number of shares that "came free" on Wednesday was closer to 3.7 million than 25.2 million.
 I’ve cited it before, but this post by Alex Rampell and Scott Kupor of Andreessen Horowitz is very good on these and other mechanics behind the IPO pop.
 See page 172 of the IPO prospectus.
 I am being a little non-technical here. In fact, in the de-SPAC merger, each SPAC share could convert into, like, half a share of the target company, making the nominal valuation of a target company share $20. (Or two shares and $5, whatever.) But *between announcement and closing*, each SPAC share trades as one SPAC share—representing one or multiple or fractions of target shares—so its nominal value should be $10. Also here I am ignoring SPAC structural features—bankers’ fees, SPAC sponsor’s free shares, warrants, etc.—that we have discussed before, and that in the real world should bring *down* the SPAC’s nominal value: The SPAC actually has more shares than it has $10 bills in its pot, so the real price that it pays for the target is less than $10 per SPAC share.
 This analysis is not quite right, because part of the reason IPOs and SPACs trade higher than institutional rounds is scarcity: The institutions are buying more stock than the marginal retail buyer. If you do a huge direct listing you lose that advantage. I suppose if you do a direct listing and don’t allow very much stock to be sold that could work.
 The main source of this power is that Finance, broadly speaking, has a lot of money to spend on campaign contributions and lobbying. Also like "Now I would like to come back as the bond market, you can intimidate everybody." There are other mechanisms.