Robinhood's decision to democratize its IPO shares could leave the stock trading app exposed to the whims of the very amateur investors it's trying to help. Earlier this month, Robinhood Markets publicly released its prospectus for its debut on the Nasdaq, revealing the free-trading pioneer plans to reserve 20% to 35% of its IPO shares for its own clients. IPO shares have historically been set aside for Wall Street's institutional investors or high-net worth individuals, but Robinhood — a disruptor in retail investing — is moving to lower the barrier to entry for its users. Yet, Robinhood's efforts could ultimately leave the company's newly public stock at risk of the mob mentality associated with the Reddit crowd, at least in the early stages. "There's no doubt that retail traders are much more fickle. The more [Robinhood] sells to retail, the more susceptible they will be to some sort of Reddit super squeeze type of activity," Greg Martin, managing director and co-owner at Rainmaker Securities, told CNBC. Speculative activity exploded this year on Wall Street, partially due to the rise of retail trading. Day traders in online chatrooms managed to create massive short squeezes in names like GameStop and AMC Entertainment , which inflicted huge pain for short sellers and jolted volatility in the overall market. "Given that Robinhood's clients and the Reddit crowd had been responsible for some sharp moves in various stocks - AMC, GameStop - sharp moves that are unrelated to fundamentals, having more people like that as shareholders potentially does expose Robinhood's stock to great volatility," said IPO expert Jay Ritter, a finance professor at the University of Florida. Robinhood's S1 revealed the company has grown its funded accounts, those which have bank accounts linked to them, to 18 million in March of this year from 7.2 million in 2020, an increase of 151%. Assets under custody have ballooned to roughly $80 billion from $19.2 billion last March. Monthly active users total about 17.7 million. "I recognize that the more you give allocations to IPOs to retail investors, it can create more volatility in your stock and of course it can end up hurting those same retail investors," added Martin. Rainmaker Securities provides financing for shares of private companies like Robinhood. Secondary market bids for Robinhood have remained in the $55 per share range since the GameStop trading mania in January, according to Rainmaker. However, the volumes of bids has increased, which Martin said signals "comfort" from investors. "I think Robinhood is a real company that has room for significant growth," Martin added, who is also the founder of Liquid Stock. "They are the leading brand. I think it would be a little scary to be out there putting on a big short." Robinhood, the next meme stock? Robinhood's public debut is already generating tons of activity on chat rooms like Reddit's WallStreetBets. A post about "shorting the Robinhood IPO" has more than 11,000 interactions, while other posts are threatening to just "ignore the IPO entirely." Robinhood seemingly made some jaded ex-customers when it limited trading of certain securities during the GameStop trading mania amid increased capital requirements from clearinghouses. "Just forget Robinhood altogether. Let them go down in lawsuits and loss of customer base," one WallStreetBets post said. "It would be interesting to see the Reddit sphere trying to hurt Robinhood who's really just trying to help the smaller investor get access to the IPOs," added Martin, who assume underwriters will price that risk in and provide downside protection. Thomas Peterffy, chairman and founder of online brokerage Interactive Brokers, told CNBC last week that Robinhood's financials make the company extra exposed to a retail trading takeover. "I think that [Robinhood] is going to be one of the greatest meme stocks of the future because basically they have — I looked at the filing — they have no equity. They have negative equity. They have roughly zero earnings, and they are growing very fast, so it's the kind of thing that the market seems to like lately," Peterffy told CNBC's "Squawk Box" earlier this month. Robinhood was profitable last year , generating a net income of $7.45 million on net revenue of $959 million in 2020, versus a loss of $107 million on $278 million in 2019, according to Robinhood's S-1 filing with the Securities and Exchange Commission. However, the brokerage lost $1.4 billion in the first quarter of 2021 tied to emergency fundraising-related losses during January's GameStop trading mania. In general, though, Peterffy spoke favorably of Robinhood and the fact they're getting young people into the markets. On brand for Robinhood Matt Kennedy, senior strategist at Renaissance Capital, which advises clients on IPOs and runs the Renaissance Capital IPO ETF, said he has never seen a company offer this many shares to the retail audience. "Traditionally companies going public prefer large, sophisticated, institutional investors," said Kennedy. "I think it makes sense for Robinhood, both their philosophy of democratizing investing and finance as well as being a marketing event for the company." Historically, brokerages have shied away from the IPO space for fear of the downside risk of public debuts, he added. "Selling to retail comes with a large risk of pissing off a lot of people, which the company, the underwriters and especially the regulators typically don't want to see," said Kennedy. Tim Welsh, founder and CEO of wealth management consulting firm Nexus Strategy, said allocating IPO shares to retail investors won't change the trajectory of the company. "I don't think this makes [Robinhood] more or less exposed to the Reddit traders. Once they set their mind to it, these people will pay whatever price for a stock, despite its fundamental value," Welsh said. "Whether they buy Robinhood at the IPO price or wherever it ends up trading, if it is in their sights they will bid it up, assuming of course that Robinhood becomes the next meme stock of the day," he added. Rich Repetto, retail investing analyst at Piper Sandler said investors and short sellers "are very leery of shorting anything that might have a big retail component." Improving retail participation in public debuts Retail traders typically don't have a vehicle to buy into newly listed companies until those shares begin trading on an exchange, which is often after the share price has surged. The traditional IPO process has been criticized in recent years as being broken, with investment banks allotting the shares to big clients who reap the instant first-day gains. Meanwhile, the average first-day return for IPOs last year was 41.6%, according to data from Ritter. "A lot of that was because the retail investor wanted to buy shares in a lot of these hot IPOs —Doordash, Airbnb, Snowflake — all these guys who had big pops on the first day," said Martin. "The big underwriters were talking to the big institutions but they were never talking to the people on the Robinhood platform. The market has realized and I think companies have realized that 'I want to be talking to the people that are going to be buying my shares on the public market'," he added. Robinhood — which plans to trade under the symbol "HOOD" on the Nasdaq — ultimately is making a good move by including individual investors in its public debut, according to Welsh. "I actually think that holding aside IPO shares for your customers is a very clever strategy – if you own a company's stock, you are more likely to be loyal to that brand and continue to shop there due to that feeling of ownership, no matter how small," added Welsh. — with reporting from CNBC's Kevin Stankiewicz.
