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How Investment Banks Make Money on IPOs, and Their Built-In Conflict of Interest

Beginner Investing • 6 min

What this lesson is about

Banks get paid a percentage of every IPO they underwrite. Which creates a real conflict when they're also the ones telling you what the stock is worth.

2 parts · a quick check after each · then the quiz

Part 1 of 2

When a company goes public, the investment bank in charge usually takes 3-7% of every dollar raised. For a billion-dollar IPO, that means tens of millions in fees. It's worth understanding these incentives.

The bank's role is to price the IPO and find buyers. They balance the company's goal of raising as much money as possible with institutional investors' desire to buy in cheap. Banks build long-term relationships with major institutional buyers who participate in multiple IPOs. Over time, these relationships matter more than any single IPO outcome.

Insider Angle: This is why investment banks often practice "spinning". They allocate shares of a hot IPO to executives at companies they want as future clients. A first-day "pop" that grabs headlines means the company sold shares for less than the market price. It's great for the institutional buyers who got in at the offering price. But it’s not so great for the company that left money on the table.
The order bookResting orders on both sides. Big orders eat through them.

Quick check

How do investment banks typically get paid for taking a company public (an IPO)?

Part 2 of 2

Try This: Look up a recent IPO's offering price and its first trading day closing price. Calculate the percentage "pop". Think about it. Who gained from that gap, and who lost out?

Quick check

What is 'spinning,' as an IPO-related practice mentioned as a conflict of interest?

Try This - Live Data

Real, recent S-1/424B4 IPO registration filing activity - actual current filings.

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Quiz

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