Comment by a13n | Hacker News Reader

Comment by a13n | Hacker News Reader

While that sounds great for Twilio (and in some ways it is), it's actually a bit of a bummer because this means they left around $90M on the table.

This is because of how IPOs work:

In an IPO, the company (eg. Twilio) sells the issued shares to an underwriter (eg. JP Morgan) at an agreed amount (eg. $15) and then the underwriter turns around and sells those on the market for whatever people will pay for them (eg. $24).

If those first shares get bought for less than the offering price ($15) the company got a good deal on their shares and the underwriter loses money. If the shares get bought for more than the offering price, the company loses money and the underwriter profits.

This is one way underwriters make money, by being able to turn around and sell those shares to the public market for more than they bought them for.

Twilio issued $10m shares at $15 and the market opened up 60%, so they raised $150M and left $90M on the table.

10m shares * (24 - 15) $/share = $90M

This is almost completely backwards. Here's an example from the Facebook IPO: http://blogs.reuters.com/felix-salmon/2012/05/21/morgan-stan....

This is how an IPO works:

1. The underwriters talk to potential buyers to gauge how much interest there is and how much they're willing to pay.

2. The underwriters set the IPO price in consultation with the company. Then they buy X shares from the company at the IPO price minus a fixed-percentage underwriter's fee, and sell Y shares at the IPO price to investors. Since the percent fee is negotiated ahead of time, the underwriters have an incentive to price the IPO as high as possible so that their fee is higher.

3. In step 2, Y is typically greater than X, by up to 15%. The underwriters sell more stock than they bought, so they make money if the price falls after the IPO. The reason that the company allows (or encourages) this is so the underwriters can buy back the stock after it opens, at or slightly below the IPO price, and prevent the stock price from falling.

So: the underwriters make larger fees if the IPO prices higher, and they make larger trading profits if the price drops following the IPO.

A big (and important) reason IPOs are frequently priced below where they open is that the underwriter is try to ensure that the IPO is fully subscribed. If the IPO opens below the IPO price, then the new shareholders won't be too pleased, and will be less likely to purchase shares of the next IPO.

Too many investors losing money on IPOs --> less demand for IPO shares --> less capital available to (generally) smaller companies.

On the other hand, if investors are constantly making money from IPOs, there will be much more demand in the future, and capital will be much easier for these companies to access.

But why should Twilio care about the next guy in line? Their job is to get the best deal on capital they can get and giving some of that available capital to the underwriters is a bad idea from a shareholders perspective.

These days, the purpose of an IPO is as much or more to provide liquidity to insiders as it is to actually raise capital.

This was the same thing with Facebook. This is how the financial banks that prepared the IPO are making a lot of money easily and probably how Twilio negotiated a low price for the IPO.

LinkedIn too, if I remember correctly. Underwriters make a killing off these IPOs.

Which makes me wonder... are there any safeguards in place to make sure that companies don't get ripped off? In would seem like it would be in the underwriters best interest to value the stocks at a very low price so they can make a lot of money from an IPO.

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