There have been many initial public offerings (IPOs) so far in 2021 -- but few have gotten as much attention as Robinhood Markets' July 29 IPO. Since HOOD shares went public at the lower edge of its pricing range and then fell 8.4% on the first day of trading, the IPO was considered a bust. The Wall Street Journal attributes the drop to giving 25 percent of the pre-IPO allocation -- rather than the typical 10 percent -- to individual investor customers who sold shares fast.
This raises questions for business leaders: What mistakes did Robinhood make? What lessons can leaders take from those mistakes? With a $29 billion stock market capitalization, is this busted IPO really so terrible?
The answer to the third question is 'No.' I am guessing that co-founders Vladimir Tenet and Baiju Bhatt must be thrilled that the company went from no revenues in April 2013 to 2020 revenue of $796 million. They are both billionaires and are probably now thinking about how they can keep the company growing fast.
What drove down its shares on the first day of trading? I think Robinhood violated three basic business principles. Springing from my book, Value Leadership, here are the principles, how Robinhood violated them, and lessons for leaders.
1. Fulfill your commitments.
If you make a commitment, you should fulfill it. Otherwise, your business will eventually disappear as people realize you can't be trusted.
This comes to mind in considering Robinhood's business model. The promise of the company is to democratize finance and never sacrifice the safety of its customers' money. That premise attracted many users -- Robinhood estimates it opened about half of new U.S. brokerage accounts in the last five years.
Sadly, Robinhood makes money in a way that strikes me as being inconsistent with that commitment. It charges no commissions for its users' trades and makes 81 percent of its revenue by selling its order flow to so-called market makers who profit from its users' trades.
Simply put, Robinhood makes money by enriching wealthy financial institutions who may not always choose to give traders the best price. To be sure, I have struggled to find evidence of how much this costs individual investors -- but it's clear that the SEC is investigating the practice and considers it a potential conflict of interest.
The implication of this for business leaders is clear -- don't make nice-sounding promises unless you act on them.
2. Respect your customers.
A corollary to the first principle is that you should treat your customers with respect. If you violate this principle -- especially in an industry where you face capable competitors -- you will lose customers to rivals who treat them better.
Robinhood violated this principle -- paying about $70 million in fines to the Financial Industry Regulatory Authority (FINRA).
How so? According to Robinhood's website, "... FINRA found in its investigation that, despite Robinhood's self-described mission to 'de-mystify finance for all,' during certain periods since September 2016, the firm has negligently communicated false and misleading information to its customers."
If I were a customer or investor, this would leave me with questions: Is this mistreatment of customers something that has been permanently eliminated after Robinhood paid its FINRA fine? Or will it continue? If it does continue, could it cause Robinhood customers to switch their accounts to brokerage firms that treat them better?
The obvious takeaway: you can get many customers by making nice-sounding promises but you will lose them if you do the opposite of what you promise.
3. Have a credible plan for sustaining rapid growth.
Ultimately, people invest in companies because they expect the stock price to go up. And the way that happens is if the company can grow faster than investors expect. So if you expect your stock to rise after your IPO, you must have a credible plan to grow faster.
Robinhood's very rapid growth is slowing down. The 796 percent growth in 2020, fell to a still high -- but slower 311 percent growth rate in the first quarter of 2021. For the second quarter, Robinhood expects to report even slower growth -- 130 percent.
Robinhood's growth plan is to convince its customers to buy other financial services. This is easier said than done since the average Robinhood account has "play money" of $240. An expert interviewed by Barron's doubts that "customers will change their financial behavior to integrate a lot of their financial life with a company that has been mired in scandal for a long time."
The takeaway: If you don't have a plan for using IPO proceeds to propel your revenue growth rate, don't take investors' money.