Side Lesson 13: IPOs and SPACs — The Math and the Hype

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1. Why This Is Important

Roughly 150 to 250 companies go public on US exchanges in a normal year. In bubble years it is closer to 600. The marketing materials — glossy roadshow decks, breathless CNBC segments, "lottery ticket" allocation chatter at the brokerage — are designed to make every single one of those listings feel like the next Amazon. The data, which goes back to Jay Ritter's IPO database at the University of Florida and now spans more than five thousand US offerings, says something else entirely: **the average IPO buyer who shows up on day one underperforms the broad market by about 10 percentage points over the following year**, and the dispersion is brutal.

This is one of the cleanest examples in the curriculum of two hard truths colliding — alpha is rare and *the irrational version of you can liquidate the rational one*. The IPO window is engineered to extract excitement from retail investors at the most dangerous price the security will ever trade at. Knowing how the machine works is how you stop being its product.

Four reasons this lesson earns a slot:

The first-day pop is not for you. The average +18% pop on US

IPOs from 2019-2024 went almost entirely to underwriter clients who got allocated shares at the offer price. Retail investors who buy when the stock opens for trading bought at the post-pop price — i.e., they are the ones who paid the +18%.

The one-year underperformance pattern is not a fluke. It has

shown up in every five-year window Ritter has measured back to 1980. The Renaissance IPO ETF (ticker IPO) — which holds new listings systematically — has underperformed VTI by about 5%/yr since its 2013 inception.

SPACs are worse, by a lot. The 2020-2021 SPAC vintage that

completed deSPAC mergers has a median 12-month return after the merger of roughly -50%. The bottom quartile is closer to -85%. This is not noise; it is the structure of the vehicle.

There is a clean retail playbook. Wait six months. Read at

least one quarterly earnings cycle. Then evaluate the stock as you would any other public company — using Week 8 (financial statements) and Week 21 (valuation) as your toolkit. The IPO window itself is for traders, allocators, and sponsors. The post-IPO market is for investors.

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2. What You Need to Know

2.1 How a Traditional IPO Actually Works

The textbook version is "the company sells shares to the public." The real machinery has six steps and three sets of incentives that matter for understanding why prices behave the way they do:

The company hires an underwriter — typically a syndicate led

by Goldman Sachs, Morgan Stanley, JP Morgan, or BofA. The lead underwriter takes a 5-7% gross spread on the offering and effectively decides the price.

Book-building. Over a roughly two-week roadshow, the

underwriter shows the deck to perhaps 100-200 institutional investors — large mutual funds, hedge funds, sovereign wealth funds. Those institutions submit indications of interest at various price points. The underwriter assembles the "book" — a demand curve.

Pricing. The night before listing, the underwriter and the

company set the offer price. Crucially, the underwriter *consistently prices the deal below the level the book would support* — typically by 10-20%. This is called intentional underpricing.

Allocation. The underwriter then allocates the shares —

this is a discretionary process. Shares go to favoured clients: the institutions that pay the firm the most commission, the ones that participate in the next deal, the ones that hold long-term without flipping. Retail allocations on hot deals are typically under 10% of the book and skew to the underwriter's wealth- management arm.

Listing day. The stock opens for public trading at whatever

price the order book on the exchange clears. If the deal was priced at $20 and there is real demand, the open might be $24 — a 20% pop. The institutional allocation just made an instant 20% gain on paper.

Lock-up. Insiders — founders, employees, pre-IPO investors —

contractually cannot sell their shares for 90 to 180 days. When the lock-up expires, a flood of insider supply hits the market. Lock-up expiry days are statistically associated with negative returns of 1-3% on average; the best-known IPOs sometimes drop more.

The economics for the underwriter are: collect a 5-7% spread, hand favoured clients a guaranteed +18% pop on average, get rewarded with trading commissions on the next deal, and never carry the inventory risk that an honest market-maker would. The economics for the company are: leave 18% of the day-one market cap on the table in exchange for a roadshow, regulatory cover, and an institutional shareholder base. The economics for retail buying at the open are: pay the post-pop price and discover that the average IPO from this vintage will trail the market by 10 points over the next year.

2.2 The First-Day Pop — Why It Exists and Who Captures It

The "average +18%" first-day pop is one of the most stable empirical facts in capital markets. Ritter's running average for US IPOs is:

• 1980-2000: +21% average first-day return
• 2001-2018: +14% average first-day return
• 2019-2021: +37% average (the COVID/SPAC-adjacent bubble)
• 2022-2024: +12% average (post-bubble normal)

The reasons it persists are well-studied:

Asymmetric information (Rock 1986). Underwriters cannot

distinguish "informed" from "uninformed" buyers in their book. Underpricing compensates uninformed institutions for the risk of being adversely allocated cold deals.

Insurance against a broken deal. A deal that prints below

the offer price — a "broken IPO" — damages the underwriter's franchise. Pricing 18% under fair value is cheap insurance.

Allocation as a currency. The underwriter uses the pop as a

gift to favoured clients. This bundles the IPO business with trading commissions, prime-brokerage relationships, and future deal participation. Retail does not pay commissions to investment banks; therefore retail does not get the gift.

The clean test of whether retail captures the pop: look at the return from the first-day opening price — the price retail can actually buy at — to one year later. That number is **approximately -10% relative to the broad market** in pooled US data 1980-2024. The +18% pop is a coupon paid by the company to allocated institutional clients. Retail pays full price.

2.3 The One-Year Underperformance Pattern

The pooled US IPO record from Ritter's dataset, measured from the first-day closing price to twelve months later relative to a matching size/style benchmark:

• Average: -10% three-year cumulative underperformance vs.

market, roughly half of which lands in the first year.

• Median: worse than -15% relative to the index — the

distribution is right-skewed (a few huge winners pull the mean up).

• Hit rate: only about 35% of IPO buyers at the first-day close

beat the market over the following 12 months.

• Vehicle proxy: the Renaissance IPO ETF (IPO), which buys all

US IPOs after their first close, has compounded at roughly **9%/yr since its September 2013 inception** versus VTI's roughly 14%/yr over the same window — a 5%/yr drag, before fees.

The reasons IPOs underperform are not mysterious:

Window-shopping effect. Companies time IPOs for their

benefit. They go public when their sector is hot and their recent operating numbers look great. Both conditions tend to mean-revert.

Disclosed-but-undigested information. The S-1 prospectus is

typically 200+ pages of risks, related-party transactions, and accounting choices. Retail does not read it. The first earnings call after the IPO is usually where reality lands.

Lock-up overhang. Insiders are sitting on huge unrealised

gains they cannot sell. The market knows this, and prices in selling pressure ahead of expiry.

Optimistic forecasts. Sell-side analysts at the underwriting

bank are required to wait 25 days before publishing research, and their initial coverage is overwhelmingly Buy-rated. The first downgrade from a major bank is often the moment the stock breaks.

Horace's framing: the IPO market is a beauty contest where the contestants — companies — get to choose the day they walk on stage and their hairstylists get to set the lighting. The judges — retail investors who buy in the open market — show up after the performance has been engineered. There is alpha here for the underwriter, the allocated institutions, and the company itself. There is on average negative alpha for the post-pop buyer.

There is a deeper version of the same point that connects this lesson to the rest of the course. The contrarian trade — the one that pays — is not buying brand-new listings on day one. It is buying abandoned names: the index deletion, the sector the model portfolios just dumped, the unloved compounder that nobody wants this quarter. Those are the cleanest mispricings the passive machinery itself creates, and they show up at the opposite end of the lifecycle from an IPO. Day-one IPO buying is the trade that looks contrarian — small, new, undiscovered — and is in fact the maximally crowded one, with the entire roadshow pointed at extracting your enthusiasm at the highest price the security will ever trade at. Same instinct, exact wrong end of the curve.

And then the size cut. Most IPOs in any given year price below a $1B market cap, and many of the rest are unseasoned even when the nominal cap is larger — wide bid-ask, manipulable float, thin disclosures, dominant participants who are not investors. That is my no-penny-stock rule with a different label on it. The sub-billion universe is the casino tier whether it arrives via an OTC listing, a hot IPO, or a deSPAC merger; the rule does not care which door it walks through. If you would not buy a $400M micro-cap on the open exchange, you should not buy a $400M company because someone put a roadshow deck in front of you the week before. The price tag is the same; only the marketing changed.

2.4 SPACs: The 2020-2021 Bubble

A Special Purpose Acquisition Company (SPAC) is a shell entity that raises cash in a vanilla IPO at $10 per share, parks the cash in T-bills, and then has up to two years to find a private company to merge with. When the merger closes — the "deSPAC" event — the private company becomes public via the shell.

The structural features that matter:

Sponsor promote. The SPAC sponsor (the team that organised

the shell) gets 20% of the post-IPO equity for nominal capital. This is an enormous transfer of value, paid for by the shareholders of the target company.

Redemption right. SPAC shareholders can redeem their $10 at

the merger vote and also keep the warrants attached to their original IPO units. This means the sophisticated SPAC arbitrage trade is essentially risk-free: buy at $10, redeem at $10 plus T-bill interest, keep free warrants. Hedge funds dominate this trade. By the time of the merger vote, the cash on the balance sheet is often 60-90% redeemed — meaning the deSPAC company arrives with a fraction of the cash it advertised.

Forecasts. Unlike traditional IPOs, SPAC mergers can include

forward-looking financial projections in the proxy statement. This regulatory loophole produced extraordinary fantasy forecasting in 2020-2021 — pre-revenue companies projecting eight-figure earnings five years out.

PIPE. A Private Investment in Public Equity (PIPE) is

typically arranged alongside the merger to backfill the cash that gets redeemed. PIPE investors usually get a discounted price ($8 or $9 vs the $10 nominal), further diluting public shareholders.

The SPAC boom of 2020-2021 produced 613 SPAC IPOs in 2021 alone versus 248 traditional IPOs that year. Most of those SPACs either liquidated (failed to find a merger) or completed mergers that performed disastrously. The de Bakker / Klausner / Ohlrogge "Spac Law and Myth" papers and Jay Ritter's SPAC tracker put the median 12-month post-merger return for the 2020-2021 cohort at roughly -50%, with the bottom quartile worse than -85%.

The takeaway is structural, not cyclical: even in the absence of a mania, SPACs transfer roughly 20-30% of public-shareholder value into sponsor and PIPE pockets before the underlying business has a chance to perform. The mania of 2021 simply made the transfer gigantic. The rational trade is the SPAC arbitrage that hedge funds run; the retail trade is buying the post-merger common, which is the structurally losing side.

2.5 Direct Listings — Bypassing the Underwriter Pop

Spotify (April 2018), Slack (June 2019), Palantir (September 2020), Coinbase (April 2021), and Roblox (March 2021) all went public via direct listing — no underwriter, no allocation, no first-day pop, no lock-up structured the traditional way. The mechanics:

The company files an S-1 like a normal IPO.

Existing shareholders can sell directly into the market on

listing day. There is no offer price; the exchange uses an opening auction to determine the first trade.

There is no underwriter buying shares to backstop the deal,

though banks are still hired as financial advisors at lower fees (typically 1% vs the 5-7% IPO spread).

The economic argument: direct listing avoids leaving the +18% pop on the table. In Spotify's case the company estimated it would have left close to $1 billion of value with allocated underwriter clients under a traditional IPO; direct listing kept that value with existing shareholders.

The empirical record on direct listings is short and mixed:

• Spotify: opened $165, traded as low as $109 (-34%) in late 2018,

recovered, currently around $700 — roughly tracking the Nasdaq since listing.

• Slack: opened $42, was bought by Salesforce 2.5 years later for

$26.79 cash equivalent. Pre-buyout it had underperformed the broader software index by about 30%.

• Coinbase: opened $381, traded down 80%+ to under $50 in late

2022 during the crypto winter, has since recovered with crypto.

• Palantir: opened $10, currently around $130 — one of the few

unambiguous post-listing winners in this group.

For the retail post-IPO investor, the direct-listing mechanism does not change the evaluation problem. The first earnings cycle still has to happen. The valuation still has to be justified by future cash flows. The base rate for newly public companies underperforming in the first 12 months still applies.

2.6 The Retail Playbook

Three rules.

Rule 1: Wait six months. Let the lock-up expire (90 or 180 days). Let at least one quarterly earnings release come out as a public company. Let the sell-side analysts initiate coverage and let the first downgrade land. Most of the structural overhang clears inside 90-180 days; the rest clears after the first earnings disappointment. The expected return from the first-day open to the six-month mark is roughly zero in pooled data — you are not giving up upside by waiting; you are skipping the noisiest window.

Rule 2: Evaluate the stock the way you evaluate any other stock. Once a name has reported one or two quarters of public financials, you can apply the Week 8 (financial statements) and Week 21 (DCF) toolkit. If the metrics look good and the price embeds a defensible growth path, buy it the same way you would buy any other equity. If the price still embeds the IPO-day excitement multiple, pass.

**Rule 3: If you must play the IPO window, size it like the lottery ticket it is.** No more than 1-2% of the portfolio in any single newly-public name. Treat it as a Tranche 4 / opportunistic allocation. Never use leverage. Never use a margin account for IPO buying. Never replace your indexed core with a basket of recent IPOs.

The Renaissance IPO ETF is available and arguably superior to hand-picking IPOs (it diversifies across the full cohort). Its record — 5%/yr drag versus VTI — is the best-case outcome for a systematic IPO strategy. The hand-picked IPO portfolio of a typical retail investor is statistically much worse, because selection bias pushes the picks toward the most exciting (and therefore most overpriced) names.

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3. Common Misconceptions

1. "I can buy at the IPO price through my broker." Almost certainly not. Retail allocations on hot deals are well under 10% of the book and concentrate at the underwriter's own wealth management arm. The "IPO access" feature on retail platforms is best-efforts; you typically get filled only on the deals nobody else wants.

2. "The first-day pop proves the company is undervalued." It proves the underwriter underpriced the deal — deliberately, as a gift to favoured clients. The pop is paid by the company, captured by allocated institutions, and largely missed by retail.

3. "If I miss the IPO, I miss the run." The Renaissance IPO ETF buys after the first close — the same entry point a retail investor gets — and underperforms the market by roughly 5%/yr. There is no systematic "IPO run" that retail captures; the run is the +18% pop that already happened by the time you can place an order.

4. "SPACs are like a private equity fund I can buy." No. A SPAC sponsor takes 20% of the equity for nominal capital. A real PE fund's GP is paid 2 and 20 on contributed capital, vests over time, and the GP is investing alongside the LPs. The sponsor promote is a one-shot 20% gift to the SPAC sponsor that hits public shareholders on day one of the merger.

5. "The redemption right protects SPAC shareholders." It protects the original SPAC IPO shareholders, who can pull their $10 out before the merger vote. It does not protect the post-merger common shareholder — the person who bought the deSPAC stock at $15 in the secondary market. By that point the cash is gone, the warrants are out, the dilution is locked in.

6. "Direct listings are riskier than IPOs." They are different, not riskier. There is no underwriter buying shares to support the deal in the early days, but there is also no lock-up flood at day 90 and no allocated-insider gift transfer. The post-listing fundamentals do all the heavy lifting in either mechanism.

**7. "I should buy the IPO of the next Amazon, Google, or Tesla."** Survivorship bias. For every Amazon there are 100 Pets.com, Webvan, eToys.com, and Vonage. The base-rate retail return on hand-picked IPOs is negative; the few moonshots do not compensate.

8. "Spin-offs are like IPOs." They are not, and the empirical record is the opposite: spin-offs from large parents have outperformed the market by 3-5%/yr in the following two years (Cusatis-Miles-Woolridge 1993 and successors). Spin-offs are covered in their own side lesson; IPOs and SPACs are this lesson.

9. "Lock-up expiry is priced in." Partially. The day itself is typically associated with -1% to -3% returns; in the worst names — ones with very thin float pre-expiry and large insider stakes — the selloff into expiry can run 10-20%. The market knows it is coming; that does not eliminate the price effect.

10. "Just buy IPOs through the ETF and forget it." A defensible position. The Renaissance IPO ETF (IPO) is at least diversified and mechanical. Just understand: you are paying a 0.60% expense ratio to systematically underperform VTI by about 5%/yr. The diversification is genuine; the alpha is negative. If you want exposure to the factor without the negative alpha, just hold VTI — the next Microsoft is already inside it.

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4. Q&A

Q1: What was the average IPO first-day pop in 2024?

About +12% for traditional IPOs, well below the +37% of the 2020-2021 bubble but in line with the long-run 1980-2024 average of roughly +18%.

Q2: How long is the typical lock-up?

90 days is now common for direct listings and a growing number of traditional IPOs. 180 days remains the historical default for traditional IPOs and is still the most frequent. Some deals incorporate staggered releases — e.g., 25% at 90 days, balance at 180 days.

Q3: What is the Renaissance IPO ETF and should I buy it?

Ticker IPO. Holds the largest US IPOs after their first-day close and rebalances quarterly, dropping names after about two years. Expense ratio 0.60%. Has compounded at roughly 9%/yr since September 2013 versus VTI at roughly 14%/yr — a 5%/yr drag. As a diagnostic of "IPOs as an asset class" the answer is: do not overweight them. As an active position, only if you specifically want a thematic newly-public-company tilt and are willing to give up 5%/yr to get it.

Q4: Can I short an IPO?

Not on day one — the shares typically have to settle for several days before they are available to borrow. By the time you can short, the easy mean-reversion trade has often happened. Some hedge funds short via single-stock options or futures on the underlying index to fade the IPO pop in the broad sense. Retail investors generally should not short newly-public stocks; the borrow cost can spike to 50%+ annualised on hot names and the upside risk is unbounded.

**Q5: What is the difference between an IPO and a follow-on offering?**

An IPO is the first time the company sells shares to the public. A follow-on (or secondary) offering is a subsequent capital raise once the company is already public. Follow-ons typically price at small discounts (3-5%) to the prevailing market and do not exhibit the +18% pop pattern of IPOs because there is already a market clearing price. The selection effects are also different — companies do follow-ons when they need cash, which can be a negative signal.

**Q6: Why are SPACs so bad for retail when hedge funds use them profitably?**

They are bad for retail buying the post-merger common (the deSPAC stock at $15 in the secondary market). They are good for hedge funds running the SPAC arbitrage at $10 (redeem your money back, keep the free warrants). These are two completely different trades. The structure that makes the arbitrage work — sponsor promote, dilutive warrants, PIPE backstop — is exactly the structure that hits the post-merger common.

Q7: What about IPOs of foreign companies on US exchanges?

US-listed IPOs of foreign issuers (especially from China — Alibaba, DiDi, Luckin) have broadly the same first-day pop pattern but worse one-year underperformance and substantially worse fraud risk. The US-investable universe should be your benchmark; if you must touch foreign IPOs, treat them as Tranche 4 opportunistic positions with even tighter sizing.

Q8: How do I read an S-1?

If you only read three sections: (1) Risk Factors — the legally mandated list of everything that could go wrong. (2) Use of Proceeds — how the company plans to spend the cash you are giving it (paying down debt and cashing out insiders is bad; growth capex is good). (3) Management's Discussion and Analysis — the prose explanation of the financials, including any qualifiers about non-recurring items. The Side Lesson 02 (Reading 10-Ks) toolkit applies directly to S-1s; the structure is similar.

Q9: What about IPOs in tax-advantaged accounts?

A single IPO position is exactly the kind of high-variance opportunistic bet that should go in a Roth IRA if you are going to take it (tax location matters). The expected return is mediocre but the variance is enormous; a 10x bagger in a Roth is forever tax-free. A 10x bagger in a taxable account costs 23.8% LTCG when you sell. That said: this is sizing advice for a position you would have taken anyway, not a reason to take the position.

Q10: What does the interactive lab show me?

It compares two strategies: an allocated investor (gets shares at the offer price, captures the +18% pop) and a retail day-one investor (buys at the post-pop open price). You set the assumed first-day pop, the lock-up overhang drift through month 6, and your holding horizon. The lab computes the terminal wealth on $10,000 deployed under each strategy. The default settings reproduce the empirical pattern: the allocated investor finishes the year up, the retail day-one investor finishes the year down by roughly the historical 10%.