4 October 2022
If done right and with the correct mindset, pre-IPO trading can be immensely advantageous and satisfying. However, as with every other venture that promises good returns, a great deal of risk is involved, and there is a bit of a learning curve.
This post provides a simplified but thorough explanation of pre-IPO investing, answering all the questions a new investor or trader could have. The aim is to give you the confidence to trade or invest in pre-IPO shares legally and help you appreciate the advantages and disadvantages of this approach to investing.
Pre-IPO trading is buying and selling private shares or equity of private companies at the later stages of funding or growth and those likely to initiate an initial public offering in the near term. The pre-IPO market has grown quite a bit in the past ten years as more and more VC-backed startups take longer to go public for various reasons.
Pre-IPO trading or pre-IPO investing has been a preserve of accredited investors, insiders, institutional investors, or high-net-worth individuals until recently, when it became possible to access pre-IPO placements. You can, today, identify promising startups that are likely to have a successful liquidity event and invest in them by purchasing available pre-IPO equity on a trading platform like Robinhood.
Right off the bat, it is essential to note that the primary motivation behind pre-IPO investing and trading is the promise of an impending IPO. For this reason, investors focus on viable startups that are on what many refer to as late-stage funding and mostly have venture capitalists behind them.
There are several reasons and conditions behind the availability of pre-IPO shares in today’s markets. Here are some of them:
One of the reasons you will find pre-IPO shares in the current market is because angel investors increasingly have to liquidate as companies are taig longer to go public than before. Most angel investors usually come in with clear targets on returns. They are usually more inclined towards liquidating when they hit those targets to invest in seed-stage startups.
Many venture capital firms are pretty conservative when investing in startups. They want to liquidate some of their equity at the right time to give their investors a good return and have money to invest in other promising businesses. Again, the fact that more and more companies are opting to stay private for longer is the reason for the growth of the trading of shares in these desirable secondary private markets.
Though it’s not very common, sometimes employees and founders of private companies may want to want to liquidate small portions of their equity before an initial public offering. Now they can do it through these secondary private markets, albeit at a smaller scale.
Tip: An important point to note here is that many available pre-IPO shares can be a red flag to investors because it shows a lack of confidence in the company.
A -rated investors such as hedge funds, mutual funds, and high-net-worth individuals are always looking for promising companies to invest in and are increasingly going to the pre-IPO private secondary market. The fact that a company is already well-advanced in terms of growth and maturity and likely to have a liquidity event makes it even more attractive to these investors.
An important thing to note is that pre-IPO investing can happen during the IPO process. Underwriters or investment banks managing an IPO tend to invite bids from triple-A investors way before the IPO issue in the public stock market, like the New York Stock exchange. However, pre-IPO trading does not happen in this window, so it’s a different thing altogether happening in the secondary market.
Yes, you can comfortably trade pre-IPO shares in the secondary private market through a brokerage or online trading platform that lists pre-IPO shares from eligible brokerages and companies.
Here is how it works:
You open an account with a trading platform that also acts as a brokerage or open an account with a broker that offers pre-IPO shares.
You can also own pre-IPO shares through a mutual fund, ETF, or hedge fund. These investment entities are increasingly looking into the private pre-IPO market for opportunities. They often allow members to select pre-IPO shares to add to their portfolio or invest independently, depending on their approach to investing and the contract signed with their investors.
Yes, you can get pre-IPO stocks outside the stock market through a pre-IPO broker, ETF, or mutual fund that includes them in their investment portfolio. Many late-stage startups are doing pre-IPO placements in the secondary markets, which are now open to all types of investors. Owning a pre-IPO stock means you have equity in the underlying company. Still, you don’t have voting rights or are entitled to dividends.
Investment banks appointed by companies to manage an IPO also tend to offer pre-IPO stock to a select group of investors early. If you qualify, either because you are an accredited investor or belong to a qualifying investment vehicle, you can enjoy early access to stocks before they are floated in the stock market.
As lucrative as it sounds, pre-IPO trading also comes with significant risks that you must be aware of before you put your hard-earned money on the line. Here are some of them:
Pre-IPO stocks tend to experience higher volatility than ordinary stocks as there is a lot of uncertainty, hype, and activity when a company is nearing a liquidity event like an IPO. As is often the case in the public markets, individual investors always find themselves at the mercy of more prominent, resource-rich investors who can drive the stock price up or down with large trades to their benefit.
Prudent, well-informed, and tactical retail investors can still ride pre-IPO price volatility to make quick gains and even bigger profits once the IPO is listed in the public market. It takes a lot of research and analysis to determine what company will likely have a good IPO and invest in it.
A significant risk associated with pre-IPO trading is the risk of overestimating the value of a late-stage startup and losing money when the underwriters determine the accurate valuation during the IPO process. You’ll lose money if the first-day IPO price is significantly lower than the pre-IPO stock price. Avoid buying large blocks of shares in the pre-IPO markets to avoid significant losses.
There are many dubious companies and startups that turn out to be unicorns in the private pre-IPO markets. Research has shown that a large percentage of startups fail once VC funding runs out and they are forced into a private placement pre-IPO. Some of these unicorns don’t even go public. They may hold your money for longer than anticipated unless you sell them in the secondary markets at a loss.
Due diligence is the only way to avoid dubious companies and unicorns in the pre-IPO market. For instance, you can restrict your pre-IPO trades to companies with upcoming IPOs, as this type of information is usually all over. Also, please find out how the company is doing in terms of sales and whether it has achieved a sustainable competitive advantage.
There are a few benefits associated with trading pre-IPO. Here are some of them:
Retail investors are usually limited to buying a certain number of a company’s shares in the public market during an initial public offering. On the contrary, you can buy as many pre-IPO shares as you want in a private placement depending on your risk appetite and availability of shares
There are many more investment opportunities in the pre-IPO market compared to the public market. Only a few companies go public in a given financial year, but there are thousands, if not millions, of promising companies floating pre-IPO stocks.
The pre-IPO market allows you to make quick, short-term gains on your investments by investing in a company that is about to go public. You are guaranteed profit given that most IPOs are underpriced by design to prevent first-day underperformance and the risk of a fraudulent overvaluation.
Investing in pre-IPOs can be a rewarding experience, provided you understand the risks and know how to separate the wheat from the chaff through due diligence. Start investing in pre-IPO stocks today and realize your financial dreams! There are many brokers and trading platforms out there offering pre-IPO trading opportunities for retail investors like you