Monthly Archives: May 2011

How the LinkedIn IPO benefits everyone

It’s only 9:30am and I’ve already seen 10+ articles disparaging the LinkedIn IPO, primarily on the basis of valuation and the huge jump on the open.  What these articles miss is that the primary purpose of an IPO is NOT to be beneficial or even fair to the investing public.  Instead it is to maximize profits for three distinct groups.

1.  Founders/Investors/Employees – This group owns all the shares prior to the IPO and the majority post-IPO.  They benefit from both a higher “official” IPO price as well as any increases in the price once trading begins.

2.  Underwriters – These are the investment banks that receive fees based on the price of the IPO.  The higher the “official” price, the bigger their fee.  They also have very strong incentives to make sure the stock doesn’t immediately fall below the IPO price.

3.  Institutions – These are the underwriter’s largest clients and in return for all the money they spend with the underwriter, they receive larger allocations of the stock at the “official” IPO price.  These institutions benefit from a higher trading price as they can “flip” their stock immediately on open for a nice profit.

Now the real question is where does all this money come from?  The answer of course is that the majority is coming straight out of the accounts of the investing public.  Every share of LinkedIn traded at the opening price of $83 provided the selling institution with an immediate 80%+ profit over the original price of $45.  Over the next few quarters as more insiders are allowed to sell, even larger sums of money will be transferred from the same investing public to LinkedIn’s investors, founders and employees.

Despite the above description sounding somewhat sinister or even underhanded, the net result is incredibly positive.  First and foremost, the largest amount of money will end up in the hands of VC’s, founders and employees of LinkedIn, a large % of which will undoubtedly be re-invested into the next round of Silicon Valley startups.  Historically, every large tech IPO has led to numerous new companies founded by now independently wealthy employees, this is a very good thing.  It also provides additional capital for the VC’s and their Limited Partners to invest in these and other companies.  For the other employees it acts like a large bonus (that the company doesn’t have to pay).  The spending of these bonuses will benefit numerous other entities – car dealerships, real estate agents, airlines, etc. – all good for economic activity.  The profits to the institutions and underwriters are far more concentrated and maintain the machine that makes this entire process possible.

While at first glance it would appear that the losers in this situation are the investing public, it is very debatable if buying a hot IPO is worse than buying leveraged commodity ETFs or trying to daytrade weekly options.   What is different in an IPO versus daily trading is not the amount lost by the trading public, but who the winners are.  On most stocks the vast majority of retail money is captured by Wall Street and HFTs, on an IPO this money instead manages to find its way out of Wall Street and into the “real” economy where it has the opportunity to provide substantial positive economic benefit.  This is a very, very good thing.

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