10 November 2021
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.
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.
Usually, private companies sell Pre-IPO shares to investors and the secondary market due to:
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.
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.
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:
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.
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.
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.
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.
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.
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.
Investors should beware of the following risks before purchasing pre-IPO shares.
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.
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.
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.
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:
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.
Companies often sell pre-IPOs through one of the following methods.
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 take place when a private company’s underwriters offer stocks at reduced prices to designated investors before an initial public offering.
Often, stock options are given to employees who may want to resell their shares while adhering to the laid down regulations.
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.
Here is how to go about disposing of your pre-IPOs on the secondary market.
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.
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.
You can choose to sell your stocks if:
You are not patient enough to wait for the IPO.
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.
Don’t sell on the secondary market if:
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.
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%.
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.
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.
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.
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.
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.
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.
Investors can use any of the following alternatives to disposing of their pre-IPO shares on the secondary markets.
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 is a fund advance that covers the following:
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.
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.
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.
