Finance

Fintech darlings Robinhood and SoFi want to democratize IPOs next. Here’s how they’re trying to beat Wall Street at its own game.

Summary List PlacementFintechs are hitting public markets. And they're also plotting ways to get their own users in on hot IPOs.  In March, both SoFi and Robinhood announced plans to allow their customers to buy into companies' initial public offerings, a privilege typically reserved for asset managers and the wealthiest of investors.  Retail brokerages — like Schwab, TD Ameritrade, and E-Trade — offering their customers shares from IPOs is nothing new. But two of the largest startup brokerages are now looking to open up the IPO market to much smaller investors, while traditional brokerages typically require customers to have upward of...

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Summary List Placement

Fintechs are hitting public markets. And they’re also plotting ways to get their own users in on hot IPOs. 

In March, both SoFi and Robinhood announced plans to allow their customers to buy into companies’ initial public offerings, a privilege typically reserved for asset managers and the wealthiest of investors. 

Retail brokerages — like Schwab, TD Ameritrade, and E-Trade — offering their customers shares from IPOs is nothing new. But two of the largest startup brokerages are now looking to open up the IPO market to much smaller investors, while traditional brokerages typically require customers to have upward of $100,000 in assets to participate in premarket offerings.

While Charles Schwab does not detail the minimum account balance necessary to participate in IPOs, it does describe an asset threshold in its disclosures. Fidelity, meanwhile, allows only the investors in its private client group with either $100,000 or $500,000 in assets (depending on Fidelity’s underwriting partner) to buy IPO shares. At TD Ameritrade, the threshold is either a $250,000 account balance or a minimum of 30 trades over the prior three months. 

Customers of SoFi will need a minimum account balance of only $3,000 (and to be a SoFi Active Invest customer) to participate in IPOs. Robinhood has not disclosed the minimum balance that it would require to participate.

But breaking into the IPO hierarchy will be tough. Industry experts told Insider that while SoFi and Robinhood might represent a welcome challenge, it will be difficult for the upstart brokerages to compete in the highly competitive IPO marketplace.

Ahead of its own IPO, a spokesperson for Robinhood declined to comment, given the quiet period that surrounds a company going public.

But SoFi, which is also set to debut on the public markets via a SPAC offering, has its own investment-banking ambitions that include actually underwriting IPOs itself, potentially pitting the fintech against Wall Street’s top investment banks.

In a statement accompanying the IPO access announcement, SoFi said the firm already “anticipates offering several initial public offering securities in the coming months.”

SoFi and Robinhood will face stiff competition 

The simplest path for SoFi and Robinhood to offer early IPO access to their customers is operating like any major brokerage and grabbing a slice of the small portion of shares that underwriters can typically offer to retail investors during an IPO. 

That share is usually about 10%, Jay Ritter, a professor of finance at the University of Florida, told Insider. But when an IPO is particularly well-known and oversubscribed, he said, it becomes all the more difficult for brokerages to get in on the action, at least relative to a less-attractive IPO in which shares are less likely to pop after trading — a phenomenon he termed the “adverse-selection” problem.

“That’s the big problem for a Robinhood or a SoFi. How do we get a representative sample so that our clients do as well as the average, rather than getting stuck with the lemons?” Ritter said.

A key obstacle, Ritter also said, will be that traditional underwriters — the largest investment banks — have vested interests in maintaining their dominance in the IPO market. It’s an issue that arose back in 2018, for example, when Charles Schwab and TD Ameritrade sued Goldman Sachs for what they said was a violation of a 2001 agreement to reserve at least 15% of IPOs for the brokerages.

For one, these banks typically provide IPO allocations to their prime-brokerage customers. Doing so serves as a key selling point when trying to nab lucrative trading business from hedge funds that generate fees for banks’ trading desks. 

And with entrants like Morgan Stanley recently joining the retail-trading fray — the bank bought E-Trade for more than $13 billion last year — and existing players like Bank of America Merrill Lynch having their own brokerage clients, there’s likely little incentive to embrace upstarts in the IPO market.

To that end, the entrance of SoFi and Robinhood — and the legions of retail traders they represent — into the world of IPOs does represent a challenge to those vested interests.

But it also offers fresh potential partners for issuer companies to work with as they explore going public. 

The more competition for banking services, “the more choice companies have in terms of how they obtain capital and who their stock is held by,” Bloomberg Intelligence’s Larry Tabb told Insider. 

The lawyer Trace Schmeltz, a partner at Barnes & Thornburg overseeing the firm’s financial and regulatory litigation group, echoed Tabb’s sentiment. New entrants into the space could spark some changes.

“The big banks that do IPO financing aren’t going to walk away from that market. It may drive some market change. You may see new pricing and IPOs as a result. You might see greater competition for more middle-market, smaller IPOs, which would be good for everyone,” Schmeltz said.

But Tabb also views the adverse-selection problem — where the most powerful banking firms and asset managers get their choice of the best IPOs — as a real one that could affect which shares SoFi and Robinhood customers are offered. 

“The challenge is, by the time the traditional syndications get around to calling Schwab or E-Trade or Ameritrade, the question is, ‘Why isn’t there enough institutional demand to soak up the whole IPO?’ If the product’s good enough to get to me, what’s the matter with it?” Tabb said.

Can SoFi and Robinhood cut out the investment banks that typically underwrite public offerings?

One hedge against adverse selection is getting in on the ground floor. 

SoFi has said it is looking to compete against the largest investment banks by underwriting IPOs of certain companies itself, in addition to participating in IPOs like other retail brokerages.

This would allow SoFi to control the IPO process because the firm would get to decide which issuers to work with and the proportion of shares that would go to its clients during a public offering. 

But a few sticking points might arise as SoFi looks to build out its banking capabilities. Compensation structure, for one, will present challenges, Tabb said. 

In order to compete for IPOs, the firm would likely have to bring on investment-banking pros who expect to earn high six- or seven-figure compensation while potentially going months without a deal. That’s in contrast to existing compensation typical at tech-oriented companies that’s more stable as a result of consistent work on updates or new features. 

“This is a very hot-and-cold sector, and unless you have tremendous deal flow, and unless you can soak up a significant amount of these IPOs, you can create some tremendous conflicts within your organizational pay structures that are really hard to get around,” Tabb said. 

While SoFi already has a capital-markets team that primarily works on securitization around the startup’s loan portfolio — and is currently searching for a senior legal counsel in charge of capital markets — a spokesperson for SoFi confirmed the startup will not be hiring for a team specifically meant to source IPOs. 

Instead, that task will fall to SoFi CEO Anthony Noto and his executive team.

Noto, who became SoFi’s CEO in 2018, was previously the chief financial officer and chief operating officer of Twitter, and before that the co-head of global technology, media, and telecommunications banking at Goldman. While at Goldman, Noto oversaw more than 50 IPOs, according to a SoFi spokesperson.

He’s since been joined at SoFi by CFO Chris Lapointe, who previously headed corporate finance at Uber and before that also worked in TMT investment banking at Goldman. Michelle Gill, who heads lending and capital markets at SoFi, was previously at TPG’s Sixth Street Partners and, before that, a Goldman Sachs partner and co-head of the firm’s structured-finance business.

As for Robinhood, Ritter noted that as part of its own upcoming IPO, the company could look to negotiate a deal with its underwriters and grab a slice of other IPOs the banks have in their pipeline (which Robinhood could then offer to its own customers down the line). Robinhood has reportedly hired Goldman Sachs to lead its upcoming IPO. 

At a February panel hosted by Insider, Kim Posnett, Goldman Sachs’ head of investment banking services, described the growing influence of retail investors in public-market debuts and said that the bank was exploring ways to incorporate retail interest into the IPOs it leads, but she did not mention Robinhood by name.

Seeking out the ‘Robinhood crowd’

Another potential path forward for SoFi might include issuer companies that think their stock will get a boost specifically from retail traders. 

Typically, going public with a top-tier investment bank brings with it “panache and brand identity,” Tabb said.

Put another way, “it’s hard to undersell the value of Goldman Sachs,” Schmeltz said.

That being said, Schmeltz said the market dynamics of IPO issuance could change over the next 10 years. “I wouldn’t have, 10 years ago, told you I see SoFi as a future IPO underwriter.”

That change could be driven by startups seeking out more of the retail-oriented Robinhood investor base instead of the hedge funds and asset-manager clients typical to the largest investment banks. 

But that might not be fit for everyone. 

“If I was an issuer, the Robinhood crowd would not be my desired shareholder base,” Ritter said. But for specific companies operating in slices of the market that have seen outsized investor enthusiasm, he continued, “the Robinhood crowd might be that target audience right now.”

SoFi and Robinhood might also benefit from the high visibility into the whims of retail traders that they can offer issuing companies, like access to data that will gauge retail sentiment ahead of an IPO, which they can then use to adjust the float of shares offered to the public accordingly.

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