Robinhood IPO: How The Platform Became a $35 Billion Bid to Silence its Critics

Robinhood has undoubtedly been the most newsworthy name in the world of investing since the beginning of the Covid-19 pandemic. Following on from a prosperous 2020 and a rocketing user base, the company is now launching an IPO with the aim of achieving a $35 billion valuation. However, with growing discontent from within Wall Street and the wider world of finance regarding how the app attracts its customers, Robinhood’s debut may be just as much a bid to silence its critics as it is to scale its product. 

“The $30 billion cockroach of fintech,” writes Forbes contributor Ron Shevlin ahead of Robinhood’s much-anticipated IPO. Shevlin goes on to explain that “cockroaches are indestructible - and so is Robinhood,” before noting that, due to the sheer volume of funding that the app has received from venture capital firms, “there’s no way a few nuisance fines and lawsuits is going to slow this cockroach down.”

Shevlin’s analogy is scathing of Robinhood, and particularly of the platform’s payment for order flow business model as its method of generating revenue. 

Shevlin’s anger is echoed by Wall Street stalwart and Berkshire Hathaway CEO Warren Buffett, who said that Robinhood has “become a very significant part of the casino aspect, the casino group, that has joined into the stock market in the last year or year and a half.” 

“American corporations have turned out to be a wonderful place for people to put their money and save but they also make terrific gambling chips,” Buffett elaborated. “If you cater to those gambling chips when people have money in their pocket for the first time and you tell them they can make 30 or 40 or 50 trades a day and you’re not charging them any commission but you’re selling their order flow or whatever…I hope we don’t have more of it.”

2021 has been punctuated by Robinhood news stories, with the investing platform rarely straying from the headlines for all the wrong reasons. In January, Robinhood was at the centre of the GameStop short squeeze that dumbfounded hedge funds as retail investors used the app to invest in the meme stock before a lack of liquidity prevented users from buying more shares - leading to many investors losing out as the stock fell back down to earth. 

(Image: Nasdaq)

Despite its controversies, Nasdaq data shows that the gulf in monthly unique visitors between Robinhood and its competitors has been widening since mid-2020 indicating that users are increasingly happy to use the app despite attracting plenty of criticism. 

In such a tumultuous year, it’s likely that Robinhood will be hoping that a successful floatation will help to silence critics whilst demonstrating its strength among investors, but are these $35 billion ambitions too steep to achieve? 

Before I jump into the nitty-gritty of their valuation, let's see how retail investors can take part in Robinhood's IPO. 

How to participate in Robinhood IPO?

Robinhood announced that it’s reserving 20% to 35% of its pre-IPO shares for its customers. 

The first way to participate in Robinhood's IPO is through their IPO feature - IPO Access. As Robinhood only allows US applications, retail investors from the EU and other countries won't be able to participate. Hence, you'd have to find an alternative. 

Luckily, another platform that's offering to participate in Robinhood's IPO is Freedom24, which works on a very similar principle as IPO Access. 

On the contrary, Freedom24 isn't available for US applications but is available for European retail investors. 

Basically, depending on where you're located, you can still take part in the IPO. 

Is Robinhood’s Criticism Warranted? 

In his scathing article, Shevlin takes aim at the retail investors using Robinhood. He highlights the “hypocrisy” of younger users who ‘supposedly’ want authenticity from the customers they do business with. 

“Really? Is there any fintech company less “authentic” than Robinhood? Its claim to “democratize finance for all” is total nonsense,” Shevlin says. “Because Robinhood makes money by selling order flow, it will always place the needs and priorities of the companies that pay for that order flow over the needs and wants of its users.”

Shevlin’s argument is based on the conflict of interest that exists between Robinhood’s payment for order flow business model and the wellbeing of the users the app has. But what is payment for order flow? And does it really undermine Robinhood’s goal to ‘democratise finance for all’?

Firstly, let’s look at how payment for order flow works: Brokers send commission-free retail trades to a wholesaler or market maker. This is done rather than sending trades to the respective stock exchanges because market makers claim to provide better prices for users. 

Market makers then match buyers and sellers - or more more commonly buys or sells the shares itself in order to later buy or sell them to match orders. 

However, it’s worth questioning who really benefits from this model. There’s no real regulation of this split, and a broker could seek out a market maker that promises higher payment for an order but delivers less price improvement. Provided the market maker and broker are still offering investors NBBO pricing, it’s still an act that complies with regulations.  

This means that payment for order flow can become a conflict of interests between the broker’s duty to provide a service to customers and its obligation to shareholders in order to maximise profits, according to advocacy group Better Markets. 

Generally speaking, this business model incentivises more active trading on brokerages, which may not be good for traders. With this in mind, it’s perhaps no surprise that Robinhood decided to pull the confetti animation it displayed once new investors made their first trade amid criticisms of the company gamifying the investing experience. 

Are Robinhood’s Critics Guilty of Elitism?

As Warren Buffett expressed his concern over Robinhood’s ‘casino-like’ business model, his right-hand man, Charlie Munger also attacked the company. 

“I think it’s just God awful that something like that brought investments from civilized men and decent citizens. It’s deeply wrong. We don’t want to make our money selling things that are bad for people,” Munger said. 

However, some of these criticisms appear to be built on the assumption that retail investors are incapable of understanding how Robinhood makes money, and that they’re too ill-educated to make intelligent investments.

Evidence suggests that retail investors have consistently been making smart decisions on Robinhood over recent years. “Ivo Welch, a professor at the University of California (LA), published an article where he studied the behavior of thousands of traders during the bearish trend in March 2020; he came to a conclusion that Robinhood traders tend to make wise moves. During 2018-2020, they earned good profits, which means beginners are not that weak players, after all,” noted Maxim Manturov, head of investment research at online brokerage Freedom Finance Europe. 

Robinhood also released a statement in response to Munger’s comments that appeared to leap to the defence of its users: "In one fell swoop an entire new generation of investors was criticized and this commentary overlooks the cultural shift that is taking place in our nation today," the company said on Twitter. 

(Image: Business of Apps)

Robinhood has a particular interest in protecting the growing number of retail investors arriving onto the investment landscape, after all, the app’s average account size shows that it stands alone in catering to more casual users who intend to invest smaller sums of their money. 

In a financial landscape that’s traditionally been a closed shop to retail investors, it’s fair to say that Robinhood is at least attempting to crack open investing for everybody, regardless of their pre-existing wealth. 

Recently, the platform launched its IPO Access feature, which was designed to enable retail investors to participate in IPOs without the need for a minimum account balance to qualify - an unprecedented move that opens another door to smaller investors. 

Robinhood’s rise in popularity and controversial business model has won the company plenty of enemies across the world of finance. Now, its massive and long awaited arrival on the public market will show the true level of confidence investors have in the company’s sustainability. For fintech’s ‘casino’, this IPO represents a big roll of the dice.