Initial Public Offerings (IPOs) are often thought of as the perfect way to jump into the stock market and make quick profits. All the media buzz, success stories, and excitement can easily pull you in. Yet, before you get swept up in the thrill, understand that even if the rewards look tempting, you cannot undermine the risks of IPO investing. 

In our share market blog, you will find out the IPO investment risks, what to look out for, and the pitfalls that many people miss. Let’s get started. 

What is an IPO?

When a company decides to raise money from everyday investors like you, it can do so by offering a slice of ownership. This process is known as an Initial Public Offering or IPO. It marks the moment a private business becomes accessible on the stock exchange, allowing you to invest in its journey from the very beginning.

Firms usually opt for an IPO in order to raise funds for growth, pay off outstanding liabilities, or gain visibility and credibility in the market. It also provides an opportunity for the original promoters and investors to sell out partly and earn returns. Going public, however, comes at the cost of compliance with regulations and subjecting themselves to greater scrutiny by shareholders and the market. 

Why Do IPOs Attract So Much Investor Attention?

IPOs are highly exciting since IPO allotment presents a unique opportunity to purchase shares at the offer price when the company initially issues them before the shares become tradable on the open market. Pre-opening price access generates a sense of opportunity since investors anticipate making listing-day profits and long-term appreciation. 

IPOs are also usually accompanied by extensive promotion and endorsement by well-known investors or institutions, which tends to generate optimism. The hype may, however, occasionally be excessive and result in overpricing and unrealistic expectations. It is beneficial for investors to overlook the fanfare and objectively evaluate the company’s fundamentals and risks of IPO investing

What are the Real Risks or Downsides of IPOs?

Before you dive into an IPO, you must know what you are getting into, especially if you are investing with limited funds or without expert insight. Here are some key risks investors must be aware of IPOs that you shouldn’t overlook:

1. Price Fluctuations and Market Oscillations

IPO shares witness wild price fluctuations, particularly in the listing period. While some go sky-high on account of investor mania, others fall steeply immediately after. Volatility is more a function of speculation and hype rather than the company’s underlying health. Steep falls in stocks can be caused by initial investors selling out or adverse market sentiment, and hence IPOs are extremely risky for individuals looking for quick returns. As newly listed companies take some time to settle down under the glare of the public market, their volatility has the potential to increase volatility.

2. Limited Distribution for Individual Investors

Even if you invest and apply for a promising IPO, there are no assurances that you will be allotted the shares you desire. On account of oversubscription, retail investors are allotted only a portion or none of the shares applied for. This can be disappointing, particularly when institutional investors are allotted higher amounts. Non-allotment can lead to retail investors purchasing shares on the listing day at higher prices, with the potential for short-term losses.

3. Lack of Solid Financial History

The companies going public with an IPO may be in the early stages of their growth and might not have a record of consistent profits, well-tracked long-term earnings data, or comprehensive financial disclosure. This limited financial history makes it difficult for investors to assess the company’s true value or future potential, increasing the uncertainty and risk associated with the investment.

4. Liquidity Concerns

Not all IPOs attract enough attention. Some end up being hard to sell later. If liquidity is low:

  • You may struggle to sell your shares, especially if you need quick access to your money.
  • Trading might become more expensive due to big spreads between bids and asks.

So, if flexibility matters to you, assess the risks of IPO investing properly before making a decision.

5. Insider Selling & Lock-Up Periods

Insiders like company employees and early backers are usually restricted from selling their shares for the first 3–6 months after the IPO. This is called the “lock-up” period. So, if you fall into this category, you would not be able to book early profits and may have to bear the losses if the IPO shares tumble after listing. 

The insiders also have information about the company’s loopholes and may start panic-selling their shares after the lock-in period. Or they might sell once the shares reach a particular price where they can book profit. Bulk selling of shares can lead to stock crashing and you may lose your money.

Once the lock-in period ends, a surge of shares can suddenly hit the market, potentially causing a flood of supply that affects the share price. It often causes a dip in overall share value. This is one of the most overlooked issues by new investors.

6. Hype and Overpricing

IPOs are launched with highly publicised marketing campaigns and exaggerated price expectations to generate excitement and create interest. This tends to create a herd mentality, where investors rush in with the hope of making a quick profit or joining the bandwagon without adequate analysis. But when the initial excitement subsides, the stock is typically compelled to correct its price, and late investors are left exposed to losses.

7. Competitive and Industry Risks

Some IPO firms are in rapidly changing or highly competitive businesses. Without a clear competitive advantage or in a highly saturated industry, an enterprise’s future for profitability and growth is uncertain. Market forces, regulatory changes, or disruptive technologies can quickly shift the rules of the game, leaving the company’s long-term success highly uncertain.

8. Long-Term Underperformance

Believe it or not, studies have shown that IPOs often underperform compared to the overall market or their own sectors over time. But why does this happen?

  • Companies might overreach early on.
  • Companies could face issues with growth or leadership.
  • If a company is not transparent or does not keep investors in the loop, it can seriously damage your trust and confidence in them.

Should You Be Worried as a Retail Investor?

If you are a retail investor, IPOs are riskier. You usually can’t access the initial offer price, so you end up buying once shares start trading publicly, often at inflated rates.

Here are some common issues retail investors face:

  • Making decisions with limited information.
  • Paying more because of first-day price spikes.
  • Dealing with high risk and low flexibility.

It is absolutely essential to do your research and know what you are getting into before investing in any IPO. You cannot neglect the downsides of IPOs just because you think that being an early investor in IPOs can help you earn big! 

Final Thoughts

IPOs might seem like a fast track to owning a slice of an exciting company, but there is no guaranteed payday. Risks like price volatility, limited financial data, and market hype can leave you out of pocket. If you are a retail investor thinking about jumping into IPOs, take the time to understand every detail. 
Know your risk tolerance, financial goals, and whether you are investing based on facts and not due to Fear of Missing Out (FOMO). Learning the ropes of IPO investing now could save you major regrets later. Do you want to start your investment journey but are not sure where to start? Check out Share.Market for real insights into stocks, IPOs, and numerous other financial securities.

FAQs

1. What should I be most cautious about with IPOs?

Major concerns include market volatility, inflated pricing, limited financial records, post-lock-up share dumps, and poor long-term returns.

2. Is IPO investing risky for beginners?

IPOs can be unpredictable and complex, making them tricky for newcomers to navigate safely.

3. Why do IPO shares often drop after listing?

Many IPOs are initially overpriced due to hype. When the market adjusts or insiders start selling, prices usually fall.

4. Can IPOs offer long-term gains?

Some companies, like Infosys, TCS, and HDFC Bank, have delivered solid returns over time but many others haven’t lived up to the hype. Always evaluate the downsides of IPOs by studying their business and financials well before it gets too late!

5. Should I invest in every IPO?

Definitely not. You should only invest after analyzing your goals, market conditions, and whether the company aligns with your investment strategy.