Everything You Ever Wanted to Know About Initial Public Offerings (IPOs) and SPACs

In Brief:

IPOs offer early access to high-growth companies but are risky and often volatile.
Do thorough research, scrutinize the prospectus, and favor companies with strong underwriters.
Be cautious of hype and understand allocation challenges.
Consider waiting for post-IPO volatility to settle before investing.
IPOs are best suited for experienced, risk-tolerant investors with time for due diligence.
A Special Purpose Acquisition Company (SPAC) is a way to go public without going through the IPO process and carries higher risk for investors due to the reduced scrutiny.

NOTE: Not every IPO is the next Amazon or Alphabet. Many fall short of expectations. They can also be subject to manipulation, insider trading or other distortions and are therefore particularly risky for beginners or unsophisticated investors. Be particularly wary of SPACs. Invest carefully and with a long-term perspective.

Investing in initial public offerings (IPOs) has long captured the imagination of investors seeking early access to the next big thing. The allure of buying shares in a company just as it goes public—and potentially reaping large gains—remains strong.

Yet, IPO investing is far from a guaranteed path to riches. It requires careful research, a clear understanding of the risks, and a disciplined approach.

Even in otherwise very successful IPOs, the price may be highly volatile, creating winners and losers. Often the actions of pre-IPO investors seeking to cash out are behind much of that volatility.

An initial public offering (IPO) is the first sale of a company’s shares to the public, marking its transition from a privately held entity to a publicly traded one.

Companies pursue IPOs to raise capital for growth, pay down debt, provide liquidity for early investors, and increase their visibility and credibility in the marketplace.

Understanding the IPO process helps investors appreciate the risks and opportunities:

Preparation: The company organizes financials, selects underwriters (usually investment banks), and prepares for regulatory scrutiny.
Due Diligence: Audits, legal review, and regulatory filings (notably the S-1 prospectus with the SEC in the U.S.).
Marketing: Roadshows and pre-marketing to gauge investor demand and set an offering price.
Pricing & Allocation: Underwriters set the IPO price based on demand, company valuation, and market conditions.
Public Trading: Shares begin trading on an exchange (e.g., NYSE, Nasdaq). Early investors may face a “lock-up period,” restricting insider sales for several months.
Post-IPO: The company must meet ongoing reporting and governance requirements as a public entity.

How to Invest in an IPO

1. Open an Eligible Brokerage Account. Not all brokers offer IPO access, and those that do may reserve shares for high-net-worth or active clients. Some popular brokers offering IPO access include Robinhood, Charles Schwab, Fidelity, TradeStation, SoFi, and Webull. Even if a broker offers access to upcoming IPOs, availability may be limited on an issue-by-issue basis.

Requirements may include:

Minimum account balances (e.g., $100,000+ at some brokers).
Status as a premium or private client.
Completion of eligibility and risk questionnaires.

2. Research Upcoming IPOs. Use financial news sites, broker IPO calendars, and the SEC’s EDGAR database to identify upcoming IPOs. Look for companies with:

Strong business models and growth history.
Reputable underwriters (e.g., Goldman Sachs, Morgan Stanley).
Clear plans for using IPO proceeds (preferably for growth, not just debt repayment).

3. Read the Prospectus. The IPO prospectus (part of the S-1 filing) is your primary source of information. It details:

Company financials and management.
Risks and competitive landscape.
How the IPO funds will be used.

Be wary of:

Overly optimistic projections.
IPO proceeds primarily going to insiders or debt repayment.
Limited operating history or lack of profitability.

4. Submit an Indication of Interest (IOI). If you want to participate, submit an IOI through your broker. This is a request to buy a certain number of shares but does not guarantee allocation.

5. Place Your Order. After pricing is finalized, place your order. You may receive all, some, or none of the shares you request, especially for popular IPOs. In many cases, retail investors must buy shares on the open market after trading begins.

8 Tips for Investing in IPOs

Dig Deep for Objective Research. Unlike established public companies, IPOs often lack extensive analyst coverage. Rely on independent research, industry news, and competitor analysis.
Favor Companies with Strong Underwriters. Top-tier investment banks are more selective and have reputations to protect, though even they are not immune to failures.
Scrutinize the Prospectus. Look for red flags such as excessive insider selling, weak financials, or unclear growth plans. Favor companies using IPO proceeds to expand operations, not just pay off insiders or debt.
Be Cautious of Hype and Broker Pitches. If a broker is pushing an IPO hard, it may be because institutional investors have passed on it. Don’t confuse a company’s brand or product popularity with investment merit.
Consider Waiting Until After the Lock-Up Period. After the IPO, insiders are typically restricted from selling shares for 90–180 days. When this lock-up expires, share prices often drop as insiders sell. Waiting can help you avoid early volatility.
Compare Valuations. Use ratios like price-to-earnings (P/E), price-to-sales (P/S), and price-to-book (P/B) to compare the IPO’s valuation with industry peers. Overvalued IPOs often underperform.
Invest in Stages. Rather than going all-in, consider buying shares gradually as the stock establishes a post-IPO trading range.
Have an Exit Strategy. Set clear goals for holding or selling, and use stop-loss orders to manage risk.

Pros of Investing in IPOs

Pro	Explanation	Example
Early Access to High-Growth Companies	Potential to invest in innovative firms before widespread public ownership	CrowdStrike, which surged 97% on its first trading day
Potential for Quick Gains	IPOs often experience significant first-day price “pops”	CoreWeave’s IPO jumped 40% by its third trading day
Opportunity to Buy at Offering Price	If you secure an allocation, you may pay less than the initial market price
Long-Term Wealth Creation	Early investment in successful IPOs can yield substantial long-term returns	Facebook, Amazon, Alphabet

Cons of Investing in IPOs

Con	Explanation	Example
High Volatility	IPO stocks can swing dramatically in price, especially in the first days/weeks	Facebook dropped from $38 to $17.58 after its IPO
Limited Information	Less analyst coverage and operating history make due diligence harder
Overvaluation Risk	IPOs can be priced aggressively, leading to declines after the initial excitement fades	VA Linux, theGlobe.com
Allocation Challenges	Retail investors often get limited or no shares in high-demand IPOs
Lock-Up Period Effects	Expiry of insider selling restrictions can depress prices
Hype and Herd Behavior	Investor excitement can push prices above intrinsic value
Uncertain Long-Term Prospects	Many IPOs underperform after the initial pop
Time-Consuming Due Diligence	Thorough research is needed due to limited public information

Risks of IPO Investing

Overvaluation. IPO prices are often set high to maximize proceeds for the company and early investors. If demand is driven by hype rather than fundamentals, prices can drop sharply after the initial excitement.
High Volatility. IPOs are subject to large price swings, especially in the first days and weeks of trading. This volatility can be exacerbated by limited public float and speculative trading.
Insufficient Information. Private companies have fewer disclosure requirements before going public. The lack of a long track record and limited analyst coverage make it harder to evaluate risks and opportunities.
Allocation and Liquidity Risks. Retail investors may not receive the number of shares they request, or any at all, in popular IPOs. Thin trading volumes can also lead to illiquidity and price manipulation.
Lock-Up Period Effects. When the lock-up period expires and insiders can sell, prices often decline due to increased supply.

Investing in IPOs is not for everyone. Conservative investors, those with low risk tolerance and those who don’t have a long timeframe for their investments should generally avoid IPOs.

But, if you are an experienced investor who is willing to do the thorough due diligence and is willing to hold on through high volatility and remain focused on the fundamental business opportunity, an IPO can be a very successful investment.

IPO Performance

Many IPOs experience a strong first-day pop. U.S. IPOs averaged a 15% gain in the first three days of trading (historically). That often doesn’t hold up, however.

Studies show that, on average, IPOs underperform the broader market over the following 3–5 years, especially if they were aggressively priced or overhyped.

And, of course, the end of the lock-up period is often a point of downward pressure on price, which can take a while to bounce back from. There are undoubtedly many reasons for this, but IPOs led by reputable underwriters, with institutional backing and a strong growth record, tend to outperform.

Some IPO Investment Outcomes

Company	IPO Price	1st Day Close	1-Year Return	5-Year Return	Notes
CrowdStrike	$34	$63.50	120%	344%	High-growth cybersecurity
Facebook	$38	$38.23	-37%	430%	Early drop, long-term gain
VA Linux	$30	$239.25	-80%	-98%	Bubble-era cautionary tale
Beyond Meat	$25	$65.75	163%	-40%	Early pop, later decline

IPO investing can be rewarding, but it is not for everyone. The potential for quick gains comes with equally significant risks—overvaluation, volatility, and limited information.

If you choose to participate, approach each IPO with skepticism, do your homework, and be prepared for the possibility of losses. For most investors, waiting until after the initial excitement fades and a company proves itself as a public entity may be the wiser course. That is why, in most cases, the analysts at Cabot Wealth Network watch IPOs from the sidelines for the first 12-18 months.

What Is a SPAC, and Why Should Investors Be Wary?

Over the past several years, Special Purpose Acquisition Companies (SPACs) have surged in popularity as an alternative route for bringing private companies to the public markets. Sometimes described as “blank-check companies,” SPACs promise a faster, simpler, and potentially more lucrative path to public listing than the traditional IPO process. Yet as with many financial innovations that attract widespread enthusiasm, SPACs come with substantial risks that investors should understand before committing capital.

What Is a SPAC?

A SPAC is a publicly traded shell company with no commercial operations—its sole purpose is to raise money through an IPO and then use those funds to acquire or merge with an existing private business. When investors buy into a SPAC, they are essentially placing trust in the SPAC’s management team (often referred to as the “sponsor”) to identify an attractive target company and negotiate a value-enhancing merger.

SPACs typically have 18 to 24 months to complete a deal. If they fail to merge with a target within that timeframe, they must return the capital raised to shareholders.

How a SPAC Works

The SPAC process unfolds in three broad stages:

Formation and IPOThe sponsors create the SPAC and take it public, raising capital from investors. Because the SPAC has no operations or assets beyond the cash raised, the IPO disclosures focus heavily on the sponsors’ track record and investment strategy.
Target Search and Merger AnnouncementAfter going public, the sponsors seek out a private company to merge with. Once they identify a target, they negotiate a deal and announce it to SPAC shareholders, who then vote on the merger. Investors may choose to redeem their shares and get their money back if they do not like the proposed deal.
De-SPAC TransactionWhen the merger is approved, the SPAC combines with the target, and the private company effectively becomes publicly traded. This phase is referred to as the de-SPAC process. The newly merged entity begins trading under its own name and ticker symbol.

SPACs have produced a handful of success stories, but many have struggled. Two well-known examples illustrate both sides of the trend.

Virgin Galactic (SPCE) – A High-Profile Launch
One of the earliest high-visibility SPAC deals came in 2019 when Virgin Galactic, Richard Branson’s space tourism venture, merged with a SPAC led by investor Chamath Palihapitiya. Initially, the deal generated tremendous excitement. Virgin Galactic became the first human-spaceflight company to go public, and its stock surged amid hopes of commercial space tourism becoming a reality.
However, operational delays, cash burn, and shifting investor sentiment caused the share price to decline significantly from its highs. While the company remains publicly traded, early expectations proved overly optimistic—highlighting the disconnect that can occur between SPAC projections and business realities.

Nikola (NKLA) – A Warning Story
Electric truck maker Nikola became one of the most controversial SPAC deals. After merging with a SPAC in 2020, Nikola’s valuation soared as investors bet on its hydrogen-powered vehicles. Soon after, allegations surfaced that the company had misled investors about its technological capabilities—including claims that a demonstration video showed a truck rolling downhill rather than driving under its own power.
The fallout led to investigations, executive departures, and steep declines in the stock price. Nikola serves as a stark reminder that SPACs, which face lighter scrutiny during the listing process than traditional IPOs, can allow companies with limited oversight to reach public markets.

Why Investors Should Be Wary of SPACs

While SPACs may appear innovative and efficient, several structural features can make them less attractive for ordinary investors.

Misaligned Incentives: Sponsors often receive 20% of the SPAC’s shares for free, regardless of how the investment performs. This structure can encourage them to close a deal—even a poor one—simply to avoid liquidation.
Dilution Hits Regular Investors Hard: When the merger occurs, the value of shares is frequently diluted by sponsor shares, warrants issued during the IPO, and PIPE (private investment) deals added to finance the merger. This dilution can significantly reduce the value of an investor’s original stake.
Overly Optimistic Projections: Traditional IPOs have tight restrictions on forward-looking statements, but SPAC mergers do not. As a result, companies going public via SPAC often publish aggressive revenue and growth forecasts that may be unrealistic—as seen in several high-profile failures.
Poor Long-Term Performance: Numerous studies have shown that most SPACs underperform the broader market after the merger is complete. While shares may spike on initial excitement, merged companies frequently struggle to meet expectations, leading to disappointing returns.
Limited Due Diligence: Because SPACs bypass parts of the traditional IPO vetting process, investors may have less reliable information when evaluating the target company.

SPACs: The Bottom Line

SPACs can provide an accessible route to investing in early-stage or high-growth companies before they reach the traditional IPO pipeline. However, the risks—including incentive misalignment, dilution, unrealistic projections, and historically poor returns—mean investors should approach SPACs with an abundance of caution. For this reason, Cabot does not recommend investing in SPACs.

Before investing in any SPAC, it’s essential to research the sponsor’s track record, evaluate the target company’s fundamentals, and understand the structural risks involved. As the SPAC boom has shown, not every innovative financial vehicle leads to investor success—and sometimes the simplest path to the public market comes with hidden pitfalls.