When a company decides to go public by launching an Initial Public Offering (IPO), it’s not just about getting a slice of the pie. It’s crucial to understand the various risks associated with investing in a new public company. While quantitative risks—like financial ratios and debt levels—are frequently discussed, qualitative risks, which pertain to more intangible factors, can be just as impactful.
Here’s a deep dive into some key qualitative risks that retail investors should consider before investing in an IPO:
- Management Quality and Experience
Example: Imagine a tech start-up with an excellent product but with a management team that has never run a public company. They may face challenges in scaling, addressing investor concerns, and meeting regulatory requirements.
How to Assess: Look into the professional history of top executives. Have they managed public companies before? Do they have industry experience? Strong leadership can steer a company through rough waters.
- Company Reputation and Public Perception
Example: If a social media company, ahead of its IPO, is embroiled in controversies around user privacy, it could face backlash both in terms of user trust and potential regulatory actions.
How to Assess: Monitor news articles, customer reviews, and expert opinions about the company. A company with a damaged reputation could face challenges in gaining market trust.
- Regulatory and Legal Risks
Example: A biotech company gearing up for an IPO might have a groundbreaking drug. But if it hasn’t received FDA approval or is facing potential patent lawsuits, its future revenues could be at risk.
How to Assess: Delve into the company’s prospectus or S-1 filings, which will list potential legal and regulatory risks.
- Market Acceptance and Product Viability
Example: A company creating a revolutionary new gadget might sound exciting, but if the market isn’t ready for it, or there’s no clear need for the product, it might struggle post-IPO.
How to Assess: Survey the competitive landscape, and understand potential demand. Check if there are any pilot studies or market testing results available.
- Dependence on Key Clients or Partners
Example: A software company that derives 70% of its revenues from a single client can face significant risks if that relationship sours.
How to Assess: Examine the client distribution. If the company is overly reliant on a few key customers or partners, it could be a warning sign.
- Cultural and Ethical Considerations
Example: A company with a toxic work culture can face high employee turnover, bad press, and potential lawsuits—all of which can hurt its bottom line.
How to Assess: Employee reviews on platforms like Glassdoor or anecdotal insights from industry insiders can provide valuable information on a company’s culture.
- Supply Chain and External Dependencies
Example: A fashion retailer sourcing all its materials from a particular region might face disruptions if there are geopolitical tensions or natural disasters.
How to Assess: Research the company’s supply chain dependencies, and understand how diversified and resilient it is.
- Competitive Landscape
Example: A new streaming service entering a market dominated by giants like Netflix and Disney+ may find it challenging to carve out a significant market share.
How to Assess: Analyze the competition. If the market is already saturated or if there are dominant players, the company must have a unique value proposition to thrive.
- Scalability Concerns
Example: A meal kit delivery service might be popular in one city, but scaling it nationally or internationally could present unforeseen challenges.
How to Assess: Understand the company’s growth strategy. Does it have the infrastructure, partnerships, and strategy to grow beyond its current operations?
- Geopolitical Risks
Example: An e-commerce company focusing on cross-border trade might be vulnerable if trade relations between two countries deteriorate.
How to Assess: Understand the regions the company operates in, and stay updated on global events that could impact its operations.
Investing in IPOs can be a lucrative endeavor, but it comes with its unique set of challenges. Beyond crunching the numbers, it’s vital to analyze these qualitative risks to make an informed investment decision. As always, diversifying investments and consulting with financial advisors can further mitigate risks and align investment choices with individual financial goals. Learn more about over 300 types of enterprise-wide risks with IRM’s Level 1 Global ERM Examination and learn to identify risks from the IPO filings / DRHP and annual reports with ease.
