For the average investor, buying stock shares through underwriters is akin to winning a lottery jackpot: It almost never happens. To understand why, you have to know how underwriting works. It’s a game played by investment bankers and their best clients. Unless you are one of these, you’re unlikely to have a chance in this semi-private market.
Initial Public Offering
An underwriter is an investment bank. Corporations enlist underwriters to help sell stock shares through an initial public offering, which transforms a privately held corporation into a publicly traded one. The Securities and Exchange Commission must approve and register the IPO shares before the issuing corporation can publicly offer them. The issuer hires a lead underwriter to help prepare a registration statement for the SEC. The issuer and underwriter negotiate how many shares to offer to the public and the highest share price that buyers will accept.
The lead underwriter may make a firm commitment to buy some or all of the shares from the issuer at the negotiated price. The underwriter then invites other investment banks and brokers, known as a “syndicate,” to help sell the shares to the public. If the lead underwriter is uncertain about the demand for the new shares, it can sell them on a “best-efforts” basis that doesn't guarantee the price.
The Road Show
Before the SEC registers the shares, it requires a “cooling-off period” in which it verifies the information in the registration statement. The syndicate prepares a preliminary prospectus -- the “red herring” -- and holds a series of presentations -- known as the “road show” -- with potential buyers. To get IPO shares, you must have a significant relationship with a syndicate member. This means you are an institutional investor -- for example, a mutual fund, state pension plan or employee union -- or an individual with a large and active trading account.
The Little Guy
You might be able to buy IPO shares from the syndicate, so it’s worth asking your broker – especially if his firm is part of the syndicate. Even so, do some serious research. Sometimes a new stock is not well received. It’s not unusual for new issue prices to rise on IPO day only to fall back after the excitement wears off. If the syndicate feels a stock may fall into this category, it sells these shares on a best-efforts basis to smaller clients. If you’re a “little guy” with a modest trading account, you should do serious research if your broker offers you IPO shares.
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