Investing in a company when it first issues shares to the public can present a great opportunity to grow your wealth. The company is usually at the beginning of its business journey and may have years of strong growth ahead of it.
But while this process of stock issuance in the stock market is called an Initial Public Offering (IPO), there’s usually little “public” about it. This is because ordinary investors like you and me can be unfairly barred from buying stocks.
Companies almost always offer first dibs to large institutional investors who have more financial clout and buy large shares of stock. Ordinary investors invariably don’t get a peek until the company is listed and shares can be bought and sold on the secondary market.
Chained: Although the process of issuing shares in the stock market is called an IPO, there is usually little “public” about it
The Treasury has become aware that this system is unfair. It is currently discussing changes to the IPO process that would make it easier for ordinary – often referred to as retail investors – to be invited to the IPO party.
John Glen, the Treasury Secretary of the Treasury, writes in the consultation, which closes next Friday, that the government wants to facilitate wider participation in public company ownership.
‘This way, a wider cross-section of society can benefit from their growth,’ he explains. “It will also enable companies themselves to access a broader investor base, and improve the general functioning of the market by increasing the liquidity of the markets.”
How investors can profit from an IPO
UK IPO activity is booming. It was quiet during the early months of the pandemic, but has since recovered beautifully. Darktrace, Deliveroo, Dr Martens, Moonpig and PensionBee are among the companies listed on the London Stock Exchange this year.
In the first quarter of this year, IPO activity reached levels not seen since 2007, raising £5.6 billion.
Oxford Nanopore, which provides rapid Covid-19 testing to the NHS, has just announced plans to float – and there are rumors of IPOs from companies like Brewdog, Gousto, Oaknorth, PureGym and Starling Bank.
However, of the IPOs so far, only Deliveroo and PensionBee have included regular investors from the start.
Of course, not all IPOs lead to a bumper return for investors. But research by investment analyst Stockopedia shows that stocks tend to rise after the initial IPO and peak about six months later.
It also found that in the past five years, smaller companies that have gone public generally have the highest success rate, next to those in the health and technology sectors. One of the more recent IPO successes has been software development company Dev Clever, which has seen its share price rise more than 300 percent to 33p since its listing in January 2019.
Why are ordinary investors left out?
So why does it matter whether ordinary investors can invest from day one or be forced to wait in the back? After all, stock prices can fall as well as rise in the first trading days.
First, it is a matter of honesty. Right now, regular investors are treated like second-rate and have to wait until their bigger cousins have had enough before they can take a look. Dan Lane, senior analyst at investment platform Freetrade, says: “Retail investors are right to ask why there is one rule for them – the people who often use and promote the products and services behind these stocks – and another for the big banks and investment funds that move in. fall, see through the IPO and achieve the highest returns. Why should everyday investors be left with the dregs after institutions have had their fun and made their money by the time private investors can finally buy?’
Foreclosure of ordinary investors can also act as a barrier to capital markets.
Richard Wilson is chief executive of the wealth platform Interactive Investor, which last week won a shareholder engagement award from the trade association Association of Investment Companies.
He believes that omitting ordinary investors can harm entrepreneurship. “We are disrupting the economy by limiting the match between supply and demand,” he says. “And we frustrate the entrepreneurial process by limiting the flow of capital to companies that should succeed.”
Letting regular investors take a look can also benefit the publicly traded company – and its clients too.
For starters, regular investors are likely to be in it for the long haul and be loyal shareholders, as opposed to professional investors who may be more focused on trading to make a quick buck.
Romi Savova is chief executive of pension provider PensionBee, which offered its clients the opportunity to invest when it went public on the London Stock Exchange in April. She says PensionBee has seen plenty of benefits. “Our IPO was such an important part of our journey that we wanted to ensure that customers could participate,” she says. “It’s one of many actions we’ve taken to strengthen our long-standing customer relationships.”
Savova adds that more than 9,000 clients participated in the IPO and had been with PensionBee for an average of one and a half years when they bought shares.
She believes being able to invest in an IPO is another way people can exercise power over the companies they interact with. She adds: ‘Individuals are becoming more and more interested in and involved in the business around them. People do a lot to express their values - through the foods they eat, where they shop, and what they teach their children.
“Being an active shareholder is another way to channel your views on the impact you have on the world around you. It enables you to get involved in the business world – as a shareholder you get a voice.’
Rules in Brussels get in the way
Mike Coombes is head of external affairs at PrimaryBid, a technology platform that helps ordinary investors access IPOs. He believes that the barriers have “as much as something rational to do with archaic rules.” He says: The system hasn’t changed in decades. There are rules previously imposed by Europe that no longer make sense. The Treasury and the industry authorities are working their way out of the Brussels rules.’
One of the Rules of Change requires companies to publish a prospectus if they raise more than €8 million (£6.8 million) by issuing new shares. But if ordinary investors are excluded, they can raise significantly more — up to 20 percent of their share capital — without issuing a prospectus.
This may not seem like a particular hindrance until you see what is involved in issuing such a prospectus. They are often large volumes, with legal requirements so strict that there are prison terms for those wrong. Prospectuses may be designed to provide investors with transparency about what they are buying, but in reality they are full of legal texts and generally impenetrable.
Coombes adds that the management teams of companies on the list are also not incentivized to include private investors. He says, “Advisors say not to worry, and since they’re unlikely to have done an IPO before, the management team doesn’t know any better and sends it off.”
So what must be done to end dishonesty?
The Treasury is currently discussing a review of the prospectus process, which it believes could contribute to a level playing field between institutional and ordinary investors.
While Wilson of Interactive Investor says such a move would help reduce the friction of getting mainstream investors involved, it’s not the solution.
He says: ‘We could spend a lot of time sweating over simplifying prospectuses, only to find that, lo and behold, after two years of rowing hard to fix it, the result is not beneficial.
“Companies are still not opening to retail investors because they are advised by banks who are incentivized not to see the money go to retail investors.
“The vast majority of CEOs going to market have done zero or one IPO before and rely on the experts for their advice.
“If retail isn’t part of the field, it won’t be included.”
Wilson believes that a quota system would mean that companies would be obliged to engage ordinary investors when they float.
Coombes agrees, pointing out that in France a mandatory allocation of ten percent is made to ordinary investors, while in Singapore it is 25 percent.
Savova proposes that companies on that list should be forced to “comply or explain” – either open their offerings to ordinary investors or explain why they don’t.
In this way, the default position shifts from opt-in to opt-out.
For now, investors are still missing out
The city’s regulator, the Financial Conduct Authority, warned last week that there are nearly 8.6 million savers who currently have more than £10,000 in cash that could be put to better use if invested. The aim is to reduce this figure.
At the same time, it warned that too many people are investing in higher-risk products that aren’t tailored to their financial needs.
Yet investors are locked out of one of the most regulated investment environments in the world: the London Stock Exchange.
Government stocks are the most democratic asset class,” said Coombes. “They are highly regulated and offer all investors equal and full disclosure.
“Investors are bombarded with advertisements for everything but stocks and shares.”
Not all stocks issued at the IPO are suitable for ordinary investors – some may be too niche, even for experienced investors.
And investors buying stocks need to make sure they have a balanced portfolio so they aren’t over-exposed to the fate of a small number of companies.
However, if we want to encourage share ownership from ordinary investors, it’s time to level up the playing field.
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