Sep
11
2023

What Are Mortgage Reserves and How Much Do You Need?

By | Family Finances, Home Ownership, mortgage | Comments Off on What Are Mortgage Reserves and How Much Do You Need?

You’ve saved for a down payment, and you’re ready to cover closing costs. But do you have enough cash and assets to cover your mortgage reserves?

Lenders sometimes require mortgage reserves from home buyers in order for the loan to be approved at application and then funded on the day of closing. But what are mortgage reserves, and how much might you need to have set aside? Below, we’ll review what assets qualify as mortgage reserves and when you might need them.

What Are Mortgage Reserves?

Mortgage reserves are the cash and other assets that home buyers can access in the event they need help covering their mortgage payments for a set number of months. Such reserves are a kind of fail-safe in the event a buyer is laid off or otherwise loses a revenue stream.

In some cases, lenders require you to prove you have such reserves before funding your home mortgage loan. Requirements can range from as little as one month of reserves (i.e., all your mandatory housing costs for a month) to six months or more.

Luckily for home buyers, lenders consider more than just the money in your checking and savings accounts as mortgage reserves. Cash and assets that can be classified as mortgage reserves include:

•   Money in a deposit account (not only checking and savings, but also money market accounts and certificates of deposit)

•   Stocks and bonds

•   Trust accounts

•   Cash value in a life insurance policy

•   Vested retirement funds, such as money in 401(k)s and IRAs

Keep in mind that money in your savings account that you’ll use for the down payment and closing costs does not count toward your mortgage reserves. Mortgage reserves are money and assets that you will have access to after closing.

Still crunching the numbers on your dream home? Use our mortgage calculator to understand just how much you might spend.

First-time homebuyers can
prequalify for a SoFi mortgage loan,
with as little as 3% down.

Recommended: What Is a Bank Reserve?

Do All Types of Mortgages Require a Reserve?

Not every borrower will need mortgage reserves when buying a home. Requirements depend on the type of mortgage you’re applying for, as well as your overall financial picture (credit score, debt-to-income ratio, and size of your down payment, for instance).

The table below breaks down potential mortgage reserve requirements by loan type:

Type of Mortgage

 Mortgage Reserve Requirements
Conventional 0 to 6 months
FHA (Federal Housing Administration) 0 to 2 months for one- and two-unit properties
3 months for three- and four-unit properties
VA (U.S. Department of Veterans Affairs) N/A for one- and two-unit properties
Variable for three- and four-unit properties
USDA (U.S. Department of Agriculture) N/A

Why do these requirements vary? Lenders may have different rules depending on whether a government agency is guaranteeing the loan, or whether the home will be your primary residence or if it’s an investment property.

Lenders may also have stricter mortgage reserve requirements if you’re making a small down payment, you have a high debt-to-income ratio, or if your credit score is too low (typically anything below a 700 credit score can warrant larger reserves if the borrower is making a down payment of less than 20 percent).

Recommended: Tips to Qualify for a Mortgage

Tips for Building Your Mortgage Reserves

Saving up for a down payment can be challenging on its own, but cobbling together enough cash reserves for a mortgage loan can make it even tougher. Here are some tips for building your home loan reserves:

Decrease Spending

Take a good, hard look at your budget to figure out how to stop spending money that you could be saving. Common culprits include dining out, streaming services, cups of coffee on your way to work, and memberships and subscriptions. Determine what you can cut out of your life — just for now — to reduce your monthly spending.

You may also be able to lower your utility bills by making some simple, eco-friendly updates in your current home. Also consider carpooling or using public transportation to reduce fuel costs, and raise your deductible on your car insurance to get a lower monthly premium. Finally, clip coupons and look for deals when shopping for groceries.

Use a Certificate of Deposit

If you know you’ll be buying a home within a few years, store some savings in a certificate of deposit (CD). Though the money is less liquid than funds in a savings account, it still counts toward your mortgage reserves and a CD may offer a higher interest rate, so your money will grow faster.

Set Aside a Chunk of Your Income

When you get each paycheck, intentionally move some into a high-yield savings account that’s earmarked for your mortgage reserves. (You can also do this when saving for the down payment on your home.)

Automatically setting aside some of your income for a specific purpose can make it a lot easier to resist the temptation to spend it on other things, like clothes and vacations.

Take Up a Side Gig

If you’ve cut all the expenses you can and you’re still coming up short, think about how you can earn more money. You can always ask for a raise at work, but you may have more luck taking on a side hustle to earn extra income. That doesn’t always mean getting a second job — there are passive income ways to build wealth.

Boost Your Retirement Contributions

Mortgage reserves don’t have to be money in your bank account. Retirement contributions to IRAs and 401(k)s (if vested) also count toward your reserves, and these may grow faster than money in a high-yield savings account, depending on how the market is doing.

Even better, if your employer matches contributions to a 401(k), that’s an easy way to quickly increase your mortgage reserves. And it’s free money!

What Happens If You Don’t Meet the Mortgage Reserve Requirements?

Mortgage reserve requirements are called that for a reason: They’re required. Just like the down payment and closing costs, you will absolutely need your mortgage reserves if your lender asks for them in order to have your mortgage loan funded. You’ll be asked to note these assets on a mortgage application.

If the lender discovers prior to the closing that you don’t have the reserve for the mortgage, the lender can back out.

The Takeaway

Depending on your credit score, down payment, the type of property you’re purchasing, and the type of mortgage loan you’re looking for, you may need to have mortgage reserves set aside to get approved. Mortgage reserves are cash and assets you can use to cover your housing costs for a set number of months if something happens and you suddenly can’t afford your mortgage.

Looking for an affordable option for a home mortgage loan? SoFi can help: We offer low down payments (as little as 3% - 5%*) with our competitive and flexible home mortgage loans. Plus, applying is extra convenient: It's online, with access to one-on-one help.

SoFi Mortgages: simple, smart, and so affordable.

FAQ

What is the difference between cash reserves and mortgage reserves?

Mortgage reserves are a type of cash reserves. Cash reserves broadly refers to money set aside for short-term needs and emergencies, like sudden job loss; cash reserves can get you through a set number of months’ worth of expenses.

Mortgage reserves are specifically money set aside to cover housing costs for a set number of months and may be required for some home loans.

Can I use retirement savings as mortgage reserves?

Retirement savings can count toward your mortgage reserves. If you’re using 401(k) funds in the total calculation, they must be vested.

How long do I need to maintain mortgage reserves?

How long you need to maintain mortgage reserves depends on the type of mortgage loan you’re using and factors like your credit score and debt-to-income ratio. Typical conventional loan reserve requirements are two months of mortgage reserves after closing, but it’s possible to need up to six months of reserves for a conventional mortgage.

Can I use gift funds for mortgage reserves?

You can use gift funds for mortgage reserves for an FHA loan, as well as certain other loans with some restrictions. Gift funds refers to money or assets donated to a home buyer, usually from a loved one, without the expectation of repayment.

Photo credit: iStock/FilippoBacci

*SoFi requires Private Mortgage Insurance (PMI) for conforming home loans with a loan-to-value (LTV) ratio greater than 80%. As little as 3% down payments are for qualifying first-time homebuyers only. 5% minimum applies to other borrowers. Other loan types may require different fees or insurance (e.g., VA funding fee, FHA Mortgage Insurance Premiums, etc.). Loan requirements may vary depending on your down payment amount, and minimum down payment varies by loan type.

SoFi Mortgages
Terms, conditions, and state restrictions apply. Not all products are available in all states. See SoFi.com/eligibility for more information.

SoFi Loan Products
SoFi loans are originated by SoFi Bank, N.A., NMLS #696891 (Member FDIC). For additional product-specific legal and licensing information, see SoFi.com/legal. Equal Housing Lender.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

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Sep
11
2023
Shorting an IPO: When Can You Do It?

Shorting an IPO: When Can You Do It?

By | Growing Wealth, invest, Investing | Comments Off on Shorting an IPO: When Can You Do It?

IPO stocks can be sold short once they are trading on public markets, known as the secondary market.

While traders can sell short IPO shares, investors allocated IPO shares may have to wait for a lock-up period to expire before they can sell.

Selling short an IPO on the listing day also has extra challenges you should know about. This article will cover how it works, when to do it, and any possible complications you might encounter in the process.

Key Points

•   It’s possible to short an IPO once it starts trading on the public market, with some limitations.

•   IPO stocks are heavily regulated and it can be difficult to borrow the shares needed to do a short sale.

•   Investors should do their due diligence before investing in any kind of stock, as there are no guarantees.

Can You Short an IPO?

IPO stocks can be sold short once they are trading on public markets, known as the secondary market. Shorting IPO shares on the listing day can be done, though there are some challenges.

Shorting a Stock

Shorting a stock is a strategy traders use to profit from a decline in the price of a stock. Any stock available for trading can be shorted. It is risky considering that the stock price can only go to zero — in which case a profit of 100% is realized (not including taxes and commissions). The risk is that the stock price increases. There is no theoretical limit to how high a share price can go.

A short sale happens when you borrow a stock and repay it in the future. The goal is to see the stock drop in value. When you sell short, you buy the shares, immediately sell them, then buy them back later. You want to buy the shares back at a price less than at which you lent them.

There is a fee for borrowing when selling shares short. That cost can be as low as 0.3% (on an annualized basis) for stocks with very little short interest, but it can soar to 30% for hot stocks with extremely high short interest. You might also be required to post collateral to sell short.

For example, let’s say you want to sell short shares of XYZ stock that currently trade at $100 per share. You enter an order to sell short the shares and you receive $100 per share. A month later, the stock price has dropped to $80, and you decide to close your short position by repurchasing the shares in the market. You buy back the shares for $80. Your profit on those stocks is $100 – $80 = $20.


💡 Quick Tip: Investment fees are assessed in different ways, including trading costs, account management fees, and possibly broker commissions. When you set up an investment account, be sure to get the exact breakdown of your “all-in costs” so you know what you’re paying.

Challenges of Shorting an IPO

While shorting an IPO on listing day is allowed, there are practical limitations that could make it difficult.

A critical facet to shorting IPO shares is being able to borrow the shares from a brokerage firm. A broker needs an inventory of stock from which to lend and a company often only takes a small part of the company public, which can limit shorting opportunities. On IPO day, the two primary entities holding an inventory of shares are the underwriting banks and investors (both institutional and retail).

The IPO underwriters cannot lend shares for short sale for 30 days, per U.S. SEC rules. Investors can lend out their shares to investors seeking to short the IPO stock. That said, some shareholders might be unwilling to lend their shares.

IPO stocks are considered high-risk investments, and while some companies may present an opportunity for growth, there are no guarantees. Like investing in any other type of stock, it’s essential for investors to do their due diligence.

The Takeaway

You can short an IPO once it starts trading on the public market. But it’s worth remembering that shorting carries risk and there might be a high cost to borrow shares. In addition, IPO stocks are heavily regulated, which can make it difficult to borrow the shares needed to do a short sale.

Whether you’re curious about exploring IPOs, or interested in traditional stocks and exchange-traded funds (ETFs), you can get started by opening an account on the SoFi Invest® brokerage platform. On SoFi Invest, eligible SoFi members have the opportunity to trade IPO shares, and there are no account minimums for those with an Active Investing account. As with any investment, it's wise to consider your overall portfolio goals in order to assess whether IPO investing is right for you, given the risks of volatility and loss.

Invest with as little as $5 with a SoFi Active Investing account.

FAQ

How soon can you short an IPO?

You can short an IPO once it begins trading on the public stock market. The IPO lock-up period typically lasts from 90 to 180 days. It is intended to prevent too many shares from flooding the market in the early days of the IPO. A high supply of shares could drive down the price of the IPO stock.

Can you sell an IPO immediately?

An investor who purchases shares on the secondary market can sell shares immediately. Investors who were allocated IPO shares have a lock-up period before they can sell. Learn more about selling an IPO.

How long until you can sell an IPO?

A company founder, a longtime employee holding company stock, or an investor allocated IPO shares must wait for the lock-up period to elapse before selling their shares. The IPO lock-up period might last anywhere from 90 to 180 days after the IPO. There might be multiple lock-up periods that end on different dates, too.

Photo credit: iStock/MarsBars

SoFi Invest®

INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE

SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

Investing in an Initial Public Offering (IPO) involves substantial risk, including the risk of loss. Further, there are a variety of risk factors to consider when investing in an IPO, including but not limited to, unproven management, significant debt, and lack of operating history. For a comprehensive discussion of these risks please refer to SoFi Securities’ IPO Risk Disclosure Statement. IPOs offered through SoFi Securities are not a recommendation and investors should carefully read the offering prospectus to determine whether an offering is consistent with their investment objectives, risk tolerance, and financial situation.

New offerings generally have high demand and there are a limited number of shares available for distribution to participants. Many customers may not be allocated shares and share allocations may be significantly smaller than the shares requested in the customer’s initial offer (Indication of Interest). For SoFi’s allocation procedures please refer to IPO Allocation Procedures.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

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Sep
11
2023
What is IPO Subscription Status?

What Is IPO Subscription Status?

By | Growing Wealth, invest, Investing | Comments Off on What Is IPO Subscription Status?

An IPO subscription status describes the position of a company’s initial public offering (or IPO), as it relates to how many committed investors it has prior to the actual IPO.

For example, an IPO may be “fully subscribed,” “undersubscribed,” or “oversubscribed.”

Many investors are intrigued by IPOs, because it’s an opportunity to put money into a relatively early-stage company that has room to grow over time. Some companies draw more investor interest than others, and the IPO’s subscription status is one way to gauge that, because investors sign up with the intent to purchase a certain number of shares.

A company’s IPO subscription status doesn’t guarantee that the stock will perform one way or another. It’s just a preliminary indicator that may help interested investors navigate a potentially risky investment move.

Key Points

•   An IPO subscription status describes the position of a company’s initial public offering (IPO) with respect to how many committed investors it has before the actual IPO.

•   An IPO is when a company offers shares for sale to members of the general public through a stock exchange.

•   Knowing an IPO’s subscription status can give investors an indication of how much demand there is for shares, and how an IPO stock may perform once it hits the exchanges.

•   Typically, only certain investors can participate in IPO bidding and subscribe to an IPO.

•   Individual investors may not have access to IPO subscriptions in the U.S., but research can help them find the right companies to invest in as they go public.

IPO Review

“IPO” is an acronym that stands for “initial public offering.” It represents the first time that a company offers shares for sale to members of the general public through a stock exchange. Prior to an IPO, you would not be able to find a company’s stock trading on an exchange such as the New York Stock Exchange, for example.

Prior to going through the IPO process, a company is private, and its investors usually include its founders, employees, and venture capitalists. A private company usually decides to go public to attract additional investment.

But it’s the tricky period before an IPO, when a company is still private, that many prospective investors look to make a move and get in early. This is when investors “subscribe” to an IPO, which means they’re agreeing or signaling their intent to buy a company’s stock prior to its IPO.

When the IPO executes, those investors may be able to purchase the number of shares to which they previously agreed. Typically, only certain investors can participate in IPO bidding and subscribe to an IPO.

💡 Quick Tip: Keen to invest in an initial public offering, or IPO? Be sure to check with your brokerage about what’s required. Typically IPO stock is available only to eligible investors.

IPO Subscription Status Defined

A company’s IPO subscription status refers to how investors have subscribed to a public issue. The goal of an IPO is to sell all of its shares — or, to reach an IPO subscription status of fully subscribed, and a valuation in line with its calculations for pricing its IPO.

In that event, all of a company’s shares are spoken for prior to hitting the exchanges, and any leftover shares won’t see their values reduced in order to attract buyers. Early investors looking to cash out after an IPO typically must wait for the lock-up period to expire before they can sell their shares.

Keep in mind that many IPO stocks in the U.S. are gobbled up by large, institutional investors involved with the IPO’s underwriter. But although the average retail investor is not typically included in an IPO roadshow, they may still be able to buy an IPO stock at its offering price.

Some brokerages have programs that allow qualified investors to request IPO stocks at their offering price, but there’s no guarantee those investors will actually get the shares.

Why IPO Subscription Status Matters

An IPO’s subscription status matters in that it can provide investors a sense of how an IPO stock may perform once it hits the exchanges. That’s pretty important, especially for traders or investors who are looking to earn a profit flipping IPO stocks.

Shows Demand of IPO Shares

Knowing an IPO’s subscription status can give investors an inkling as to how much demand there is for shares — if demand is high (an IPO is fully or oversubscribed), it’s a signal that an IPO stock may gain value after its market debut. But it’s not a guarantee.

Conversely, an undersubscribed IPO sends a signal that investors aren’t that interested. And when stocks do hit the exchanges, they may see a price reduction soon thereafter.


💡 Quick Tip: How do you decide if a certain trading platform or app is right for you? Ideally, the investment platform you choose offers the features that you need for your investment goals or strategy, e.g., an easy-to-use interface, data analysis, educational tools.

The Takeaway

While individual investors may not have access to IPO subscriptions in the United States, you can still participate in the IPO market. The key is doing your research to find the right companies to invest in as they go public.

Whether you’re curious about exploring IPOs, or interested in traditional stocks and exchange-traded funds (ETFs), you can get started by opening an account on the SoFi Invest® brokerage platform. On SoFi Invest, eligible SoFi members have the opportunity to trade IPO shares, and there are no account minimums for those with an Active Investing account. As with any investment, it's wise to consider your overall portfolio goals in order to assess whether IPO investing is right for you, given the risks of volatility and loss.


Invest with as little as $5 with a SoFi Active Investing account.

FAQ

How many times can an IPO be oversubscribed?

IPOs get oversubscribed frequently, which means that more investors want to buy shares than a company has available to issue. There isn’t really a limit as to how many times it can be oversubscribed, but depending on the category of investor, it’s not uncommon for IPOs to be oversubscribed dozens or even hundreds of times.

What is an IPO subscription rate?

IPO subscription rates are an estimate of how many bids are received for each investor category, divided by the number of shares allotted for each category by the company. This helps determine the level of participation among investors in each category.

Photo credit: iStock/SeventyFour

SoFi Invest®

INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE

SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

Investing in an Initial Public Offering (IPO) involves substantial risk, including the risk of loss. Further, there are a variety of risk factors to consider when investing in an IPO, including but not limited to, unproven management, significant debt, and lack of operating history. For a comprehensive discussion of these risks please refer to SoFi Securities’ IPO Risk Disclosure Statement. IPOs offered through SoFi Securities are not a recommendation and investors should carefully read the offering prospectus to determine whether an offering is consistent with their investment objectives, risk tolerance, and financial situation.

New offerings generally have high demand and there are a limited number of shares available for distribution to participants. Many customers may not be allocated shares and share allocations may be significantly smaller than the shares requested in the customer’s initial offer (Indication of Interest). For SoFi’s allocation procedures please refer to IPO Allocation Procedures.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

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Sep
11
2023
padlock with keys red background

Navigating the IPO Lock-up Period

By | Growing Wealth, invest, Investing | No Comments

Following an initial public offering, or IPO, many companies and investment bankers will tie your stock up in a lock-up period to stop you from cashing out too quickly and help keep the share price steady.

That may be frustrating if you’re an early employee and investor in a company that’s about to go public, as you may be expecting the value of your stock to skyrocket after the initial public offering, and were hoping to sell some shares. But lock-up periods serve a purpose, and stakeholders will need to know how to navigate them.

Key Points

•   An IPO lock-up period is a period after a company goes public during which some early employees and investors aren’t allowed to sell their shares.

•   Companies or investment banks self-impose the lock-up period contractually, usually lasting between 90 and 180 days.

•   The purpose of the lock-up period is to stop early investors from cashing out too quickly and maintain a steady share price.

•   Companies may also use the lock-up period to avoid flooding the market with shares and to prevent insider trading.

•   Regular investors may want to pay attention to the lock-up period when investing in IPOs, as it can affect the risk of investing in the company.

What Is an IPO Lock-up Period?

As a part of the IPO process, the IPO lock-up period is the length of time after a company goes public, during which some early employees or investors in the company aren’t allowed to sell their shares.

These restrictions are not mandated by the Securities and Exchange Commission (SEC), but rather are self-imposed contractually by companies or the investment banks that were hired to advise and manage the IPO process.

Lock-periods can be any length of time, but usually they’re between 90 and 180 days after the IPO. Companies may also decide to have multiple lock-up periods that end on different dates and allow different groups of people to sell their shares at different times.

How the IPO Lock-Up Period Works

Here’s an example of an IPO lock-up period: When one lock-up period ends company executives might be allowed to sell their shares, while a subsequent lock-up ending means regular employees can sell their shares.

What Does “Going Public” Mean?

When a company has an IPO, it is offering shares of the company for sale to the public stock market for the first time. The company is shifting at this point from a privately held company to a publicly traded company. This is the origin of the phrase “going public,” which you may have heard bandied around in reference to IPOs.

When a company is private, ownership is limited and can be tightly controlled. But when a company goes public, anyone can buy shares. But at this point there may be a lot of fingers in the pie already. Company founders, early employees, and even venture capitalists may already own shares or have stock options in the company.

💡 Quick Tip: Before opening an investment account, know your investment objectives, time horizon, and risk tolerance. These fundamentals will help keep your strategy on track and with the aim of meeting your goals.

What Is IPO Underwriting?

Before a company goes public it often goes through an underwriting process in which an underwriter — usually an investment bank — advises the IPO process and helps come up with the business’ valuation. The most common way they do this is by agreeing to buy a company’s entire inventory of stock.

Then to alleviate the risk of holding all of this stock, the underwriter will allocate shares of the company to institutional investors before the IPO.

The underwriter will try to drum up so much interest in the stock that more people will want it than there are shares available. This will lead to the stock being oversubscribed, which will hopefully support its price when it hits the market.

Recommended: What Sets IPO Valuations

How IPO Lock-ups Get Used

A company or its underwriters might use the lock-up period as another tool to bolster the share price during the IPO.

Shares held by the investment bank or institutional investors can be sold during an initial public offering, but the shares held by company insiders — including founders, executives, employees, and venture capitalists — may be subject to a lock-up period.

With Silicon Valley tech startups in particular, a greater proportion of compensation may be paid out with equity options or restricted trading units. In order to avoid flooding the market with shares when employees exercise these contracts, the lock-ups restrictions mean that these shareholders are not able to sell their stock until this period is over.

Recommended: Guide to Tech IPOs

What Is the Purpose of a Lock-up Period?

Ensuring Share-Price Stability

Insiders, like employees and angel investors, can potentially own far more shares in a company than are initially available to the general public. The last thing a company wants during an IPO is to have these extra shares flood the market.

Since share price is set by supply and demand, extra shares can drive down the price of the stock. And that’s not a good look, especially when a company is trying to impress investors and raise capital.

Avoiding Insider Trading

Company insiders may face other restrictions beyond the lock-up period. That’s because they might have information that can help them predict how their own stock might do that is not available to the general public.

Though insider trading can be legal if properly controlled and documented, it is not legal when based on information the public doesn’t have yet. So, depending on when a lock-up period ends, company insiders may have to wait extra time before selling their shares.

For example, if a company is about to report its earnings around the same time a lock-up period is set to end, insiders may have to wait for that information to be public before they can sell any shares.

Public Image

Finally, lock-up periods can be a way for companies to keep up appearances. When those closest to the company hold their shares, it can signal to investors that they have confidence in the strength of the company.

If company insiders start to dump their stock, investors may get suspicious and be tempted to sell their shares as well. As demand falls, the price of the stock usually does, too.

Even if the insiders were trying to cash in their stocks for no other reason than simply wanting the money, public perceptions may change and damage the company’s reputation. The lock-up period may have an effect by keeping this from happening — at least while the newly public company gets off its feet.


💡 Quick Tip: Keen to invest in an initial public offering, or IPO? Be sure to check with your brokerage about what’s required. Typically IPO stock is available only to eligible investors.

What’s an Example of a Lock-up Period?

For example, let’s say Business X — a unicorn company — went public with an IPO in March 2022. The company used a system of multiple lock-ups with different expiration dates. The first lock-up expired in July 2022, and allowed early investors and insiders to sell up to 400 million shares of the company.

As new shares hit the market the stock dropped by as much as 5%, and it closed the day down just over 1%. A second lock-up expired in August 2022, allowing regular employees to sell their pre-IPO shares in the company. When this lock-up ended, employees were allowed to sell more than 780 million shares of Business X on the open market.

What Does the Lock-up Period Mean for Employees with Stock Options?

Restrictions imposed during a lock-up period usually apply to any stock options someone has been given as an employee before an IPO. Stock options are essentially an agreement with a company that allows its employees to buy stock in the company at a predetermined price.

The thinking behind this type of compensation is that the company is trying to align employees’ incentives with its own. Theoretically, by giving employees stock options, the employees will have an interest in seeing the company do well and increase in value.

There’s usually a vesting period before employees can exercise their stock options, during which the value of the stock can increase. At the end of the vesting period, employees are able to exercise their options, sell the stock, and keep the profits.

It’s possible that the company will issue stock options before it goes public. If stock options vest before the IPO, employees may have to wait until after the lock-up period to exercise their options. However, stocks may not vest until after the lock-up period, in which case the restrictions don’t have much bearing on the employee’s ability to exercise their stock options.

How Does the IPO Lock-Up Period Affect Investors?

When buying IPO stocks as a regular investor, you likely don’t have access to shares of a company before it goes public. Even so, you still might want to pay attention to the lock-up period. Investing in IPOs can be tricky and are generally considered risky.

The underwriters will probably do everything they can to make sure that stock prices go up when company shares hit the market. But in the end, no one really knows what will happen during an IPO.

Reading the IPO Prospectus

What’s more, investors interested in buying a stock that’s about to go public don’t really have much information to go on to help them figure out what kind of value they’re getting. When they’re private, companies don’t have to divulge very much information about their inner workings to the SEC.

However, before going public they will make documents available, including the Form S-1 and the red herring prospectus that can give investors some clues about a company’s business model and what they plan to do with the money they raise. Investors can also look at what happened when similar companies went public and whether they did well.

Waiting to Buy Until After Lock-ups End

This is all to say that with little idea of what a company’s stock will do when the company goes public, regular investors may want to hold off before they invest. Investors may even want to hold off until the lock-up period is over.

When the lock-up ends and insiders and employees can finally sell their shares, the stock price may experience some volatility as the new shares enter the market, potentially causing drops in a stock’s price.

Some investors may try to take advantage of the dip that can occur when a lock-up period ends. For example, if investors see that a company’s financial health is good during the first stages of its public life, they may use the expiration of the lock-up period as a chance to buy shares at a “discount.”

They may feel that if the stock’s fundamentals were good before the lock-up ended, the company is in good financial health and the stock should rebound. Timing the market, however, isn’t necessarily a good idea for all investors, especially those not used to taking a deep dive into the fundamentals of a company’s financials. It’s also not guaranteed to produce good results.

The Takeaway

Lock-up periods are agreed-upon periods between early investors and employees of a company and underwriting investment bankers during which selling of shares is prohibited. Having such stakeholders hold off on selling their shares can help the stock price of a newly public company stay more stable.

An initial public offering’s lock-up period can be hard to navigate. Yet, they can be really exciting for investors looking to get in on the ground floor and employees or insiders looking to cash in on their shares or stock options.

Ready to invest in your goals? It’s easy to get started when you open an investment account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).

For a limited time, opening and funding an Active Invest account gives you the opportunity to get up to $1,000 in the stock of your choice.

SoFi Invest®

INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE

SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Investing in an Initial Public Offering (IPO) involves substantial risk, including the risk of loss. Further, there are a variety of risk factors to consider when investing in an IPO, including but not limited to, unproven management, significant debt, and lack of operating history. For a comprehensive discussion of these risks please refer to SoFi Securities’ IPO Risk Disclosure Statement. IPOs offered through SoFi Securities are not a recommendation and investors should carefully read the offering prospectus to determine whether an offering is consistent with their investment objectives, risk tolerance, and financial situation.

New offerings generally have high demand and there are a limited number of shares available for distribution to participants. Many customers may not be allocated shares and share allocations may be significantly smaller than the shares requested in the customer’s initial offer (Indication of Interest). For SoFi’s allocation procedures please refer to IPO Allocation Procedures.

Probability of Member receiving $1,000 is a probability of 0.028%.

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Sep
11
2023
What is an IPO Underwriter? What Do Underwriters Do?

What Is an IPO Underwriter and What Do They Do?

By | Growing Wealth, invest, Investing | Comments Off on What Is an IPO Underwriter and What Do They Do?

An initial public offering (IPO) underwriter is typically a large investment bank that works closely with a company to issue stock on the public markets. They are almost always IPO specialists who work for an investment bank.

Underwriters can also be financial professionals that evaluate risk and then determine a price for financial transactions such as purchasing an insurance policy or taking out a mortgage.

In the world of equities, underwriters work with private companies to value their operations, connect with potential investors, and issue stock on a public exchange for the first time.

Key Points

•   An IPO underwriter is typically a large investment bank that works closely with a company to issue stock on the public markets.

•   An underwriter helps create the market for the stock by contacting potential investors and setting the IPO price.

•   IPO underwriters need a Bachelor’s degree, but it helps to have certain other skills and experience in economics and math.

•   The IPO underwriting process takes as little as six months from start to finish.

•   The underwriter’s stabilization responsibilities only last for a short period.

What Is an IPO Underwriter?

Stock underwriters guide the company that’s issuing stock through the IPO process, making sure they satisfy all of the regulatory requirements imposed by the Securities and Exchange Commission (SEC), as well as the rules imposed by the exchange, such as the Nasdaq or the New York stock Exchange (NYSE).

Recommended: What Is an IPO?

Role and Benefits of an IPO Underwriter

Aside from the fact that an underwriter is required during the IPO process, there are many benefits to this role. An IPO’s underwriter helps create the market for the stock by contacting a wide range of institutional investors, including mutual funds, insurance companies, pension funds and more.

Key Functions of an IPO Underwriter

They first reach out to this network of investors to gauge their interest in the company’s stock, and to see what those investors might be willing to pay. The underwriter uses those conversations to set the price of the IPO.

From there, the underwriter of an IPO works with the company issuing the stock through the many steps that lead up to its IPO. On the day of the IPO, the underwriter is responsible for purchasing any unsold shares at the price it set for the IPO.

The way that IPO underwriters get paid depends on the structure of the deal. Typically, IPO underwriters buy the entire IPO issue and then resell the stocks, keeping any profits, though in some cases they receive a flat fee for their services.

💡 Quick Tip: Look for an online brokerage with low trading commissions as well as no account minimum. Higher fees can cut into investment returns over time.

What Is IPO Underwriting?

An IPO is the process through which a private company “goes public”, and has its shares sold to regular investors on a public market. The company issuing stock works with the IPO underwriters throughout the process to determine how to price their stock and stir interest among potential investors.

Most companies find their way to the investing public through a group of underwriters who agree to purchase the shares, and then sell them to investors. But only a few broker-dealers belong to this “underwriting syndicate,” and some of them sell exclusively to institutional investors.

What Does an IPO Underwriter Do?

In essence, an underwriter in an IPO is the intermediary between a company’s executives and owners, such as venture capitalists, seeking to issue shares of stock and public-market investors.

When a company seeks funding from the capital markets, it must make dozens of decisions. How much money does the company want to raise? How much ownership will it cede to shareholders? What type of securities should it issue? Those are just a few, including what kind of relationship the company wants to have with its underwriter.

Underwriting agreements take different forms, but in the most common agreement, the underwriter agrees to purchase all the stock issued in the IPO, and sell those shares to the public at the price that the company and the underwriter mutually agree to. In this agreement, the underwriter assumes the risk that people won’t buy the company’s stock.

Sometimes a company works with a group of underwriters, who assume the risk, and help the company work through the many steps toward an IPO. This involves issuing an S-1 statement. This is the registration form that any company needs to file with the SEC to issue new securities.

The S-1 statement is how companies introduce themselves to the investing public. S-1 requires companies to lay out plans for the money they hope to raise. The IPO underwriter also creates a draft prospectus for would-be investors.


💡 Quick Tip: IPO stocks can get a lot of media hype. But savvy investors know that where there’s buzz there can also be higher-than-warranted valuations. IPO shares might spike or plunge (or both), so investing in IPOs may not be suitable for investors with short time horizons.

What Qualifications Does an IPO Underwriter Need?

Underwriters work in many roles across the finance sphere. You could be a mortgage underwriter, assessing the creditworthiness of certain borrowers. You could work in the insurance industry. Becoming an IPO underwriter, and bringing private companies into the public marketplace, requires understanding how businesses work, and how the equity markets function.

At minimum an IPO underwriter needs a Bachelor’s degree, but it helps to have certain other skills and experience. For example, would-be underwriters might consider a background in economics as well as math. Underwriters generally need good analytical, communication, and computer skills.

Educational and Professional Requirements

There are a number of certifications that apply in the underwriting field in general, but there isn’t a specific designation for IPO underwriters. It’s more common for someone who wants to work with IPOs to get their Masters in business administration (MBA), and from there to work at an investment bank.

The IPO Underwriting Process

Underwriting an IPO can take as little as six months from start to finish, though it often takes more than a year. While every IPO is unique, there are generally five steps that are common to every IPO underwriting process.

Step 1. Selecting an Investment Bank or Broker Dealer

The issuing company selects an underwriter, usually an investment bank. It may also select a group or syndicate of underwriters. In that case, one bank is selected as the lead, or book-running, underwriter.

One kind of agreement between the issuing company and the underwriter is called a “firm commitment,” which guarantees that the IPO will raise a certain sum of money. Or they may sign a “best efforts agreement,” in which the underwriter does not guarantee the amount of money they will raise. They may also sign in “all or none agreement.” In this agreement, the underwriter will sell all of the shares in the IPO, or call off the IPO altogether.

There is also an engagement letter, which often includes a reimbursement clause that requires the issuing company to cover all the underwriter’s out-of-the-pocket expenses if the IPO is withdrawn at any stage.

Step 2. Conduct Due Diligence and Start on Regulatory Filings

The underwriter and the issuing company then create an S-1 registration statement. The SEC then does its own due diligence on the required details in that document. While the SEC is reviewing it, the underwriter and the company will issue a draft prospectus that includes more details about the issuing company. They use this document to pitch the company’s shares to investors. These roadshows usually last for three to four weeks, and are essential to gauging the demand for the shares.

Step 3. Pricing the IPO

Once the SEC approves the IPO, the underwriter decides the effective date of the shares. The day before that effective date, the issuing company and the underwriter meet to set the price of the shares. Underwriters often underprice IPOs to ensure that they sell all of their shares, even though that means less money for the issuing company.

Step 4. Aftermarket Stabilization

The underwriter’s work continues after the IPO. They will provide analyst recommendations, and create a secondary market for the stock. The underwriter’s stabilization responsibilities only last for a short period of time.

Step 5. Transition to Market Competition

This final stage of the process begins 25 days after the IPO date, which is the end of the “quiet period,” required by the SEC. During this period, company executives can not share any new information about the company, and investors go from trading based on the company’s regulatory disclosures to using market forces to make their decisions.

After the quiet period ends, underwriters can give estimates of the earnings and stock price of the company.

Some companies also have a lock up period before and after they go public, in which early employees and investors are not allowed to sell or trade their shares.

The Takeaway

The IPO underwriter, typically a large investment bank, plays a vital role in the process of taking a company public.

They help to guide the company through the many hurdles required to go public, including making sure the fledgling company meets all the criteria required by regulators and by the public exchanges. The IPO underwriter helps drum up investor interest in the new company and thereby setting the initial valuation for the stock.

IPOs are an important part of the stock market, and they present an opportunity for investors to get in on a company that may be entering a growth phase by allowing them to buy IPO stocks.

Whether you’re curious about exploring IPOs, or interested in traditional stocks and exchange-traded funds (ETFs), you can get started by opening an account on the SoFi Invest® brokerage platform. On SoFi Invest, eligible SoFi members have the opportunity to trade IPO shares, and there are no account minimums for those with an Active Investing account. As with any investment, it's wise to consider your overall portfolio goals in order to assess whether IPO investing is right for you, given the risks of volatility and loss.


Invest with as little as $5 with a SoFi Active Investing account.

FAQ

What are the responsibilities and duties of an IPO underwriter?

IPO underwriters have numerous responsibilities. They not only shepherd the private company through the IPO process, they reach out to institutional investors and mutual funds to gauge interest and set the initial price of the stock. They buy the securities from the issuer, and sell the IPO stock to investors via their distribution network.

Can multiple underwriters be involved in an IPO

Yes. Sometimes more than one underwriter is required to help a company meet all the criteria set by the SEC and by the public exchanges.

What criteria do companies consider when selecting an IPO underwriter?

The experience and reputation of the underwriter is an important criteria companies use when establishing this relationship.

Can the performance of an IPO underwriter impact the success of the IPO?

Yes. Some industry data suggests that the better an underwriter’s reputation, the more accurate the initial pricing is, and the less likely there will be long-term underperformance.

Photo credit: iStock/katleho Seisa

SoFi Invest®

INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE

SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

Investing in an Initial Public Offering (IPO) involves substantial risk, including the risk of loss. Further, there are a variety of risk factors to consider when investing in an IPO, including but not limited to, unproven management, significant debt, and lack of operating history. For a comprehensive discussion of these risks please refer to SoFi Securities’ IPO Risk Disclosure Statement. IPOs offered through SoFi Securities are not a recommendation and investors should carefully read the offering prospectus to determine whether an offering is consistent with their investment objectives, risk tolerance, and financial situation.

New offerings generally have high demand and there are a limited number of shares available for distribution to participants. Many customers may not be allocated shares and share allocations may be significantly smaller than the shares requested in the customer’s initial offer (Indication of Interest). For SoFi’s allocation procedures please refer to IPO Allocation Procedures.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

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