Fast Entry IPOs
Who benefits? and why the rush?
Matt Levine this week writes about the possibility of ‘Fast IPOs’. That is, IPOs where index funds essentially get to buy into the primary offering. The conventional way, as he explains in Wednesday’s column, is that the company IPOs to the market first, and based on meeting certain requirements is later added to indexes.
Naturally, this creates all sorts of incentives for all the participants involved. The IPO bankers can sell this better as the buyers of the IPO today can be rest assured there will be another buyer three to six months down the road, that is, the liquidity for the security should exist. And the more prospective buyers are convinced of this, the greater the demand generated for the IPO, which could in itself lead to a greater possibility of being included into indexes in the near future.
So far this works for the offering company and its investors, it works for its employees and their equity, and it works for the intermediaries, i.e. the investment banks and the exchange who help take the company public.
But does this work for the eventual index fund buyer as well? There’s two ways to think about this IPO-to-index pipeline:
The argument for would go something like; this helps the index investor as it gives the newly public firm time to mature into the market. The stock gets some level of price discovery, and the management learns to deal with public disclosures, regulations, and reporting cycles. All of this gives the indexing firms and the index buyers time and space to decide on whether the said security is the right product for them.
The argument against goes something as; this reduces the index buyers to a status of (in crude terms) bagholders. The early investors, the employees, the bankers, and the IPO buyers, in a sense, all get to dump their holdings onto the eventual index buyer, who misses out on the real gains from a company going public. The former group would argue, that’s the compensation they get for taking on higher risk. But what if the index holder doesn’t mind the higher risk?
That’s the proposal Nasdaq is testing with the SpaceX IPO:
“Earlier this week, the Nasdaq Stock Market shared proposals to update some of the Nasdaq-100 index methodology and asked for feedback from market participants.
Among the proposals is a potential “fast entry” process. Under this option, companies whose market capitalizations rank in the top 40 of the Nasdaq-100’s constituents could be added to the index after 15 trading days. Companies typically now must wait at least three months to be added to the index. At their current valuations, SpaceX, OpenAI and Anthropic would all qualify.
Depending on the kind of person you are and your risk tolerance, this is either incredibly exciting or downright terrifying. Exciting because you think that companies nowadays remain private for too long and it’s about time the markets let you have a share of some of that growth by letting you invest as soon as they go public. Terrifying because you believe in testing the waters before jumping in and don’t want to be made to participate into a blackhole of information.
The incentive for SpaceX here is straightforward. The firm is the one pushing NASDAQ to reconsider the traditional index inclusion process, as the price support from passive fund inflows early on would help funnel retail and institutional capital cashflows sooner into the SpaceX shares, feeding into the demand and momentum generated by the IPO.
There is debate on what the incentives are for the listing exchange for such a move. The proposal itself for the early index entry could be to test the risk appetite of retail and institutional investors. One could argue that in the light of increasing flows into sports betting, prediction markets, short-term options products; the risk tolerance for investors has grown in recent years. Why not test it with a proposal.
The other incentive could be, the listing exchange wants the attention of private firms looking to public markets for increased liquidity. Following SpaceX; OpenAI, Anthropic, and DataBricks all are expected to go public later this year:
“Conversations between the rocket maker’s advisers and indexes are part of a broader industrywide discussion about ways to get investors in buzzy startups access to liquidity from public markets earlier.”
In any case, it will be fascinating to watch how this dynamic unfolds at SpaceX’s IPO later this summer. The market, private and public alike, will be monitoring whether this proposal materializes and how investors, regulators, and competitors respond to this precedent-setting situation.