The 6 Biggest IPO Mistakes Every Investor Needs to Know
It’s no secret that Initial Public Offerings, or IPOs, can be big money-makers when handled properly, with some stock investors making triple-digit returns on their investment in under a year’s time. However, these opportunities also come with unique pitfalls that inexperienced and amateur investors can fall into without even realizing it. Read on to learn about the 6 biggest IPO mistakes every investor needs to know about before investing in these high-risk stock opportunities.
Investors might also be expecting a much higher return on their investment, or are underestimating the risk of investing in a new company. Or they may think that an overpriced offering will lead to higher profits down the line. But this is often not the case. For example, when Google went public, it priced its shares at $85 when it only cost around $1 per share to buy them privately (as measured by enterprise value). Other examples include Tesla Motors, which made a really expensive mistake when it priced shares at $17 each. On paper, that meant it was worth about $4 billion. Then reality hit and the stock plunged 40% in just two days. The company’s market cap fell to about $2 billion and a third of its employees had been laid off. That’s why big investors like Warren Buffett are wary of IPOs: I’ve never bought any shares of Facebook, he said at Berkshire Hathaway’s annual meeting on May 4th.
2) Undervaluing the company
The best stocks in the world have been undervalued at some point. This is because of investors’ anticipation that bad things will happen, and they want to buy their shares at a discount. However, it’s still a good idea to use similar valuation techniques on an IPO so you’re not overpaying or selling your shares too early on the open market. -An overambitious financial plan. You should also be aware of how long companies take to make profit, which means comparing ROE (return on equity) with WACC (weighted average cost of capital). Without a plan that lays out both future profits and costs, companies are unable to evaluate their investments properly and can go bankrupt without having accomplished anything worthwhile.
3) Failing to listen to investors
Failing to listen is the number one mistake in any business. Shareholders are a major stakeholder, and you need them on your side in order for your business to grow. Don’t be surprised if you find your venture put on ice because investors are dissatisfied with you, even if the stock market loves what you’re doing. CEOs have learned this lesson the hard way many times over and a couple of their mistakes have made it into our top six! You can avoid these pitfalls by listening to your shareholders when they speak up, but also don’t forget that they aren’t always right either. Withhold too much information: One thing CEOs must understand is that shareholders will be asking questions about anything from quarterly earnings to how employees are compensated. If you withhold too much information or make decisions without input from shareholders, they will see this as an attempt to deceive them. And given all the data breaches in recent years, protecting confidential company data is more important than ever before. On top of that, if someone becomes disgruntled with how things are going at your company and they happen to be one of your major shareholders, they may turn around and do something like buy out other shares or try to buy control of the company themselves just so that they can get rid of you.
4) Failing to handle concerns
Many investors think that the only way they’ll lose money is by getting something wrong in their stock picks. But as companies go public, it’s easy for insiders and managers to take advantage of unsuspecting investors, by hiding information about how successful a company will be or purposefully moving ahead with an unrealistic plan.
Even when investments appear sound on paper, corporate actions can help doom an investment. The three worst mistakes that can happen in a public offering are: rolling out the initial public offering (IPO) too soon; not raising enough funds; and having non-core investors fund the IPO. If these things happen, one of two things will happen: either the company’s shares may drop below what the original investors paid for them or the company will fail altogether.
5) Over-emphasizing fees and valuations
One of the first mistakes people make is to focus too much on fees and valuations. How much you make from an investment matters, but how quickly you start getting that money back is just as important. What’s worse, valuations can vary dramatically from one investor (or investing firm) to another. A $10,000 investment in company A might be valued at $11,000, while the same amount invested in company B may not give you as much bang for your buck at just $5,000. In both cases the projected return is 10%, but we’d obviously rather earn 10% a little faster by choosing company A over company B because they are more likely to grow in value fast enough to pay off our initial investment before we have time to invest it again elsewhere.
6) Mishandling communications
Understand that investors are going to have concerns about an investment. If a company does not address those concerns, issues or problems head on with honesty and transparency, then it is going to become a bigger issue. Not addressing any issue will lead many prospective investors to believe that there is a much deeper problem at hand. Investors can be hesitant about making an investment in a company if they do not feel like the communications coming from the company are honest and transparent.
Investors also want information on how their money will be used as well as what percentage of ownership they will receive in return for their investment. The only way they will know this information is if they ask so this should be included in any communication made by the company when seeking investments.
Now that you know about the top mistakes, make sure you have a good plan. Keep your company’s future in mind and focus on the long-term game, not just immediate profits. And don’t forget: no one is a guaranteed success. There are always going to be risks and uncertainties, but if you’re willing to work hard enough at it, it might just pay off in the end.