Pre IPO Insights
Pre IPO Investing

10 November 2021

Pre IPO Investing:Definition,Risks,How to Sell and More

Pre IPO investing can be a verified way of building your revenue on a long-term basis. Once you invest in a suitable startup Pre-IPO company at the right time, you can earn a high ROI. Interested parties experienced in purchasing pre-IPO stock usually have higher chances of acquiring attractive rewards within a short time. While the public markets are susceptible to numerous risks, the benefits can be immense. This article covers the following.

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Table of Contents

The Basics of Pre IPO Investing

Private companies sell pre-IPO shares to willing investors before a company’s IPO. Many companies that engage in pre-IPO stock exchanges leverage the Pre-IPO placement process. Hedge funds, institutional investors, investment banks, private equity firms, and some retail investors often buy these shares.

Why Private Companies Trade Pre IPO Stock

Usually, private companies sell Pre-IPO shares to investors and the secondary market due to:

Raise Finances

Private companies can raise finances through a Pre IPO placement before the company finally goes public. After a company goes public, various factors can affect its share price, barring the IPO from meeting its expectations. Suppose no investor purchases the shares; the Company will not raise its required funds.

Pre IPO shares are not susceptible to market-oriented changes. In this case, the Company can trade large share blocks at a defined stock price and generate a specific amount of funds.

Benefit from Third-Party (Investors) Mentorship

Institutional investors like hedge funds and large investment organizations with unmatched expertise, resources, and tremendous experience often purchase the most pre-IPO shares. They can mentor the private Company’s management, enable them to make informed decisions, and make the process of evolving from a private to a public company smooth. The insights and recommendations experienced investors offer are invaluable, especially for startups.

Can an Individual Investor Buy Pre-IPO Shares?

Investing in pre IPO can be a problematic task marred by numerous risks. Institutional investors usually purchase a significant percentage of pre IPO shares, offered in considerable chunks. While individual investors can still engage in a pre IPO investment drive, numerous restrictions may discourage them from pursuing it further. These are:

Lock-In Duration

Pre-IPO shares come with lock-in duration where early investors are restricted from trading or selling them. This duration ensures the investors do not dispose of the shares shortly after the initial public offering.

Credentials Requirements

In many countries, investors will need to meet laid down criteria before buying pre-IPO shares. For example, a private company will want to determine the investor’s net worth or income level. Investors will also need to provide tangible proof to show that they meet the laid down criteria.

The Securities and Exchange Commission’s (SEC) regulations in the US restrict a significant percentage of pre-IPOs to accredited investors. These investors must have a considerable and stable income and proven experience with the investment markets. The SEC revised the accredited investor’s criteria in recent years, allowing more potential investors to invest in private offerings.

Should I Consider Pre IPO Investing? 

Investing in Pre IPOs comes with various advantages, as we shall see below.

If you have the resources and a suitable risk profile, it is an investment opportunity you should not miss.

An Opportunity to Grow Your Returns

Many experienced investors opt to invest in Pre-IPO to grow their revenue exponentially. However, to enjoy profits, you have to invest in a suitable company at the appropriate time. Some of the most successful Pre-IPO companies include the Alibaba Group and Amazon.

Before its initial public offering, the Company traded pre IPO shares to investment organizations and high net level investors at overly minimal prices of less than $60 each share. Ozi Amanat, a venture capitalist based in Singapore, is one of the investors who purchased the shares.

Alibaba, an e-commerce giant, would later go public in one of the most extensive international initial public offerings ever. Its share price hit $90 on the first day, which saw investors earn a 50% ROI within a few months. Another company that had a successful IPO despite the pandemic is Robinhood.

Investors can Purchase Pre IPO Shares at Reduced Prices

Just like any other form of investment, pre IPO investing is unpredictable. Investors have no way of predicting the Company’s performance after going public. To counter that risk, many private companies offer pre-IPO shares at highly discounted prices.

For example, assuming a company’s planned initial public offering price is $20, the pre-IPO share price could be $10 each. That way, should the share price drop from $20 to $15 due to various factors, investors that bought shares at the IPO will suffer losses. However, pre-IPO investors will make a small profit margin.

An Opportunity to Generate Long-Term Revenue

By investing in a pre-IPO, you are banking on a company with a robust foundation. Should it perform well, you can earn tremendous benefits from the grown on a long-term basis. Often, small startups transform into successful companies after going public. Investing in a company at its early stage can earn you great returns, in the long run, allowing you to accumulate long-term revenue.

What are some of the Risks of Investing in Pre IPOs? 

Investors should beware of the following risks before purchasing pre-IPO shares.

Low Return Risks

Low returns are some of the most significant risks of investing in a pre-IPO. Investors have no guarantee that the stock price performance will be attractive. What happens when the initial public offering fails?

What if the company stock lacks demand? In this case, investors may not get the returns they anticipated for. Remember, when the Company you have invested in doesn’t perform well, the shares will lose value, and you could lose your entire investment.

There is no guarantee that the Company will go Public

When you participate in a pre-IPO, you expect the firm to launch its IPO as soon as possible. However, you have no way of verifying whether the company will go public or even gauging its risk tolerance levels. Sometimes IPOs are halted, postponed, and even canceled when you least expect it.

Inadequate Financial Information

Often, pre-IPO investors may not get sufficient data to help them make informed decisions. The law requires publicly traded firms to reveal their financial standing to the public, but private companies are not. Such a situation causes information imbalance where the management of the private company knows its financial information, but pre-IPO investors don’t.

Can Individuals Invest in Pre IPO?

Unlike in the past when pre IPOs were only available in large blocks to highly profitable firms like SpaceX, individuals can now invest through pooled investments and brokerages. Always read the prospectus before investing in a pre IPO.

Today, investors can work with brokerages smoothly thanks to FINRA, a body that seeks to protect investors by facilitating smooth operations between the two parties (broker and dealer).

The Jobs Act was structured to encourage startup companies with less than $1billion to invest in pre-IPOs. Retail investors can participate in pre-IPOs by:

  • Raising funds through crowdfunding. Today, firms can raise money via regulation crowdfunding. Further, they have also been exempted from listing with the SEC after meeting some laid down conditions.
  • Expanding directive A. Today, the SEC permits firms to offer investors up to $50 million worth of shares annually without listing with the organization.

The Jobs Act triggered an equity crowdfunding explosion which hit over $438 million by 2020. Due to that, many crowdfunding equity platforms have become popular for non-authorized investors seeking to invest in rapidly growing startups in the early stage.

Retail investors participate in pre IPO investing indirectly by purchasing shares from firms that invest in the growth-phase businesses. One of the famous companies, in this case, is Sutter Rock Capital.

The venture capital organization is registered on Nasdaq, and it invests in firms a year or even two before their initial public offering. Their pre-IPO investments include Dropbox, Apple, and Spotify. Some firms allow investors to access the private market investment opportunities to access a diverse collection of venture-oriented late-stage private firms.

Selecting the most suitable stocks and assessing the market conditions and investment valuation can be a difficult task. Worth noting is that the average investor will hardly counter inflation if they choose to invest individually. Investing in pre-IPO can be overly risky, with some studies suggesting that up to 90% of startups fail.

How do Firms Sell Pre IPOs?

Companies often sell pre-IPOs through one of the following methods.

Venture Capital Firms or Angel Investors

Venture capital firms utilize funds collected from investment organizations, pension funds, and large corporations to invest in small companies. Venture capitalists don’t invest using their own money.

An angel is a verified investor who invests in small businesses using their own funds. Their net worth should be at least $1million with a minimum of $200,000 income annually to qualify as accredited investors.

Angel investors can be friends and family or small business owners. Small business angels strive to assist startup founders in growing their business plans and earning profits. Angel investors have more reasonable terms compared to venture capitalists’ terms.

Pre-IPO Placements

Pre-IPO placements take place when a private company’s underwriters offer stocks at reduced prices to designated investors before an initial public offering.

Stock Options

Often, stock options are given to employees who may want to resell their shares while adhering to the laid down regulations.

Can an Investor Dispose of their Pre-IPO Shares?

Many firms restrict the selling of pre-IPOs on secondary markets. If you have invested in a private company’s pre-IPO, waiting for the initial public offering could be longer than expected. Often, you may start wondering whether or not to dispose of the pre-IPO shares and earn some money instead.

Pre IPO shareholders can list their shares in secondary markets where interested parties can purchase them. Selling on the secondary market can be an ideal strategy if you need funds immediately. However, there are various disadvantages of selling.

You surrender any interests in your shares by selling your shares on the secondary market, and you may have to pay high tax amounts. Instead of selling their shares, startup employees can opt for non-recourse financing, especially if they want to leverage other options’ liquidity without ignoring them.

Employees who believe that the value of their firms will increase of those who need assistance financing the value of utilizing their options may opt for non-recourse financing. Some firms allow their employees to sell their shares back to the firm in a tender offer even though this strategy is not common.

Selling a Private Company’s Shares on the Secondary Market

Here is how to go about disposing of your pre-IPOs on the secondary market.

  • Select your preferred online platform
  • Define the number of shares you want to dispose of and include the price
  • You will be assigned a broker who will match you with a suitable buyer
  • After identifying a buyer, you should seek consent from your organization
  • Once your organization approves the move, you can close the deal.

The share disposal process will proceed fast if there is a high demand for the shares. However, the process often takes weeks and sometimes months. Different platforms offer varying services, but the general process remains the same.

Understanding Secondary Markets 

In the investor and venture capitalist world, an employee’s stock market options and shares are primary. Your firm developed them for you specifically. The exact process happens when a venture capital organization invests in startups or raises funds in an initial public offering.

In that case, new shares are generated explicitly for those transactions, also known as primary transactions. When pre-IPO shareholders dispose of their shares to an external investor, no new shares will be generated, and that becomes a secondary transaction.

When Should Holders of Private Company Pre-IPOs Sell their Stock? 

You can choose to sell your stocks if:

  • You require colossal sums of funds immediately.
  • You are not confident the firm’s value will increase
  • You are ready to pay off the highest tax rate on your earnings.

You are not patient enough to wait for the IPO.

How to Sell Your Pre-IPO Shares on the Stock Market

  • Choose your preferred online platform.
  • Define the number of shares you want to dispose of and include the price
  • You will be assigned a broker who will match you with a suitable buyer
  • After identifying a buyer, you should seek consent from your organization
  • Once your organization approves the move, you can close the deal.

The share disposal process will proceed fast if there is a high demand for the shares. However, the process often takes weeks and sometimes months. Different platforms offer varying services, but the general process remains the same.

When Should an Investor Avoid Selling on the Secondary Market 

Don’t sell on the secondary market if:

  • You need some liquidity without losing interest in your shares
  • You want to achieve long term value from your options and are patient enough to wait for an initial public offering
  • You no longer work with the Company but still want to utilize the 90-days time span to experiment with your options
  • You cannot meet the least sale amount the secondary market medium needs

Pros and Cons of Selling Your Pre-IPOs on the Secondary Market 

The secondary market allows you to maximize the total funds you can earn immediately from your shares. That would be ideal for a startup employee who wants to get the most liquidity without waiting for an opportunity to exit. Still selling on a secondary market comes with the following drawbacks.

Investors Lose 100% of their Equity’s Upside

Disposing of your pre-IPO investment will earn you instant cash, but you will be surrendering any opportunity to earn colossal amounts from an IPO. If you think the Company’s future is shaky, the secondary markets can be an ideal alternative. However, some studies suggest that employees that disposed of their pre-IPO shares before the IPO earned up to 47% less than the average IPO value. Had they waited for the initial public offering, their earnings would be an extra 47%.

Your Need Consent from Your Company

As we have learned before, many companies restrict the sale of pre-IPOs on the secondary markets. Remember, the board of directors will need to approve your intention to sell before proceeding with the plan. Often, many companies will not consent to have their private shares disposed of on the secondary markets.

You Will Incur the Highest Tax Rates Possible

Once you manage to sell your shares, you will need to pay taxes on your earnings. Often you will be taxed at the highest tax rate available. That means you will not gain from the discounted long-term capital earnings rate, where you would have saved at least 31% on taxes.

You Could Sell at a Loss

Buyers rule the secondary markets, and often the best you can get out of your sale is approximately 80% of the overall value. Based on our first disadvantage of selling pre-IPOs and the final IPO price, employees would end up earning approximately 53% of the estimated value on average.

The Company Reserves the Right of First Refusal (ROFR)

Your Company reserves the right to purchase the shares first before allowing you to sell them on the secondary market. Should you identify a buyer and your Company chooses the ROFR, you will still need to pay the regular 5% platform charge for any done deals.

You will Need to Sell a Minimum Equity Amount of $100,000

Every secondary market platform has a minimum share amount that investors can sell. Often, it is approximately $100,000 worth of equity but can also be higher. Some platforms allow investors to combine shares with other shareholders but others do not.

The Process Could Take Longer

Due to a company’s approval procedure, finalizing a deal on the secondary market could take longer than expected. Whether you are working on a timeline or not, there are no guarantees that you will beat the deadline.

Alternatives to the Secondary Markets

Investors can use any of the following alternatives to disposing of their pre-IPO shares on the secondary markets.

Tender Offers

A tender offer is the process where a company opts to re-purchase pre-IPO shares or stock options from their employees. It can also be when a firm chooses external investors to purchase employee equity systematically. While the latter is a secondary sale, your employer organized and approved of it.

Some notable companies like Airbnb in New York and Pinterest execute this process for their employees now and again. Tender offers come with various restrictions. However,  their key advantage is that employees get the total value of their shares based on the prevailing price. While tender offers can be a great deal, only a few companies offer them.

Non-Recourse Financing

Non-recourse financing is a fund advance that covers the following:

  • Any potential tax burden
  • Your strike price
  • Extra liquidity that you can use as you like

Employees will only pay back the non-recourse financing amount when a successful exit occurs. When the exit does not happen, or should the Company go bankrupt, the employees do not owe anything. Your shares will act as collateral for the financed amount, meaning that your assets will be safe. Non-recourse financing comes with various advantages, as seen below.

Employees Keep their Equity’s Upside

Seeing that the financing firm will not be selling or buying your shares, you will reserve the ownership and rights to the shares. Suppose the Company’s share value rises and a successful initial public offering occurs, employees can participate.

Employees Earn Liquidity before the IPO

As you finance your exercise, you will earn a cash advance in addition to your exercise costs. As a result, you won’t need to wait for the IPO to utilize your equity value.


  • Pre-IPO investing can be both profitable and risky. However, the advantages outweigh the risks.
  • By choosing the right pre-IPO Company at the right time, you are bound to make massive profits.
  • Unlike in the past, when only large institutional firms would invest in pre-IPOs, individual retailers can participate in a pre-IPO. However, they should meet laid down regulations.
  • Employees can sell their Pre-IPO shares before the IPO, but they have to get approval from the Company’s board of directors.
  • Selling pre-IPOs on the secondary market can be convenient, but it comes with various drawbacks. Existing secondary market alternatives can be ideal for employees.

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