How to Invest in Pre IPO Companies

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Contributor, Benzinga
October 20, 2022

If you've heard that investing in startups early in their development is a proven way to earn exponential ROI, that's because it's a fact. All the world's mega-corporations with over $1 trillion in market valuation began as startups. And investors who staked high on these corporations at the earliest stage reaped the rewards afterward. Pre-IPO investing offers you the best means to lock in your investment before the company goes public. 

Pre-IPO companies are firms whose stock is not yet listed on a public exchange. A company's lifecycle involves six phases — startup, growth, pre-IPO (maturity), IPO, post-IPO growth and public maturity. A pre-IPO company has grown past the high-risk startup phase, is generating revenue and is planning the next step — an IPO. However, to scale up substantially and offset a potential risk that may arise if the IPO is overly optimistic and fails to rise when listed, the firm must have sufficient capital before the IPO.

And as such, these companies often issue their stock (pre-IPO stocks) at a highly discounted price to investors willing to stake high in the company. Pre-IPO investing was typically available for wealthy retail investors, accredited investors, hedge funds, institutional investors and private equity firms. However, thanks to the 2012 JOBS Act, average investors can now invest in these companies. Investing in a pre-IPO company doesn't just offer you an opportunity to maximize profits above what's obtainable in the equity market; you also become a stakeholder in the company. 

However, like other investment strategies, nothing is guaranteed. Investing in pre-IPO companies comes with its own risk. Nevertheless, it is an excellent strategy for diversification and long or even short-term wealth building since it means you're adding high-potential, high-growth stocks of a startup in your portfolio mix. Benzinga looks into a pre-IPO investment, providing deeper insights into its benefits and risks.

How to Invest in Pre-IPO Companies

Investing in the pre-IPO stock of companies comes with a few hassles, unlike buying stock in a publicly traded company. However, adopting the right investment strategies can help you smooth out the processes. Here’s a look at some ways you can invest in pre-IPO companies.

Using Pre-IPO Investing Platforms

Pre-IPO investing platforms are specialized brokerages and financial institutions that typically participate in or facilitate pre-IPO trades. They may represent sellers seeking buyers or have previously acquired pre-IPO stocks they want to sell. An increasing number of these brokers are readily available to help streamline pre-IPO investing. Some popular ones include EquityZen, Raison FinTechnologies, LinTO, Forge Global, MarketX, Nasdaq Private Market, SecFi and EquityBee, to name a few.

Each of these platforms differs in its core service offerings, account minimums and specific requirements you must fulfill to invest in pre-IPO stocks. For instance, to invest through EquityZen, you must be a platform member and have minimum investment capital of $10,000. LinTO also requires a $10,000 minimum. Raison leverages blockchain technology, so you can invest in some of the latest global innovative startups without being accredited investors. It also offers fractional shares, allowing investors to invest as low as 10 cents. However, it's not a U.S. company.

Some specialized brokers have more stringent restrictions, with stock offerings only available to qualified buyers. Therefore, you must carry out due diligence to ensure you meet the requirements specified by your chosen broker. Additionally, there is no guarantee that your broker will have access to stocks in a specific company of choice. 

Therefore, these platforms might not be the best option if you're looking to invest in a specific company's pre-IPO stocks. Regardless, they are an excellent way to invest in potentially lucrative private equities, as most listed equities are above-average pre-IPO stocks with strong potential for long-term growth.

Angel Investing

Angel investing presents another excellent opportunity for you to invest in pre-IPO companies. Angel investors are typically wealthy, business-minded individuals who contribute capital to startup companies that need fast funding in exchange for an ownership stake or convertible debt. You can easily purchase a startup's stock at a reduced price during the pre-IPO stage if you provide early-stage funding.

There is no set investment minimum or size for angel investing — it could be $5,000 or millions of dollars. It usually depends on the opportunity that presents itself. However, only accredited investors can invest in pre-IPO companies as angel investors. And as such, you must meet the definition of an accredited investor according to the U.S. Securities and Exchange Commission (SEC). The qualifying financial criteria is an individual income of at least $200,000 ($300,000 with spouse or partner) in each of the prior two years or over $1 million in net worth excluding primary residence.

These restrictive criteria are in place because of the high risk associated with angel investments. Accredited investors are considered more grounded financially and thus better able to absorb a loss if one occurs. Nevertheless, while some startups may only accept accredited investors for funding, others may accept non-accredited investors. So, depending on your financial situation, you should do your due diligence and properly sort out your options.

Leveraging Crowdfunding Platforms

Retail investors lacking substantial capital to invest in pre-IPO companies via specialized brokerages or angel investing may find a more accessible way to invest in pre-IPO stocks through online crowdfunding platforms. Secondary market and online crowdfunding platforms (such as AngelList, OurCrowd, FundersClub and Trendscout) make pre-IPO placements' inner workings and processes more accessible and visible to potential investors.

Crowdfunding platforms operate by soliciting small amounts of capital from various people to fund a new business venture. Extending the pool of investors beyond the conventional circle of owners, relatives, angel investors and venture capitalists can positively drive entrepreneurship. 

Entrepreneurs, business owners and startup founders frequently pitch their service or product philosophies on crowdfunding platforms. You'll be able to directly invest in a startup you believe has the potential to grow over the long term by using these pitches and some comprehensive personal research as a road map.

Buy Pre-IPO Stocks Directly From Companies

Suppose you prefer a more hands-on approach to investing in pre-IPO companies. In that case, you can buy the pre-IPO stocks directly from the startup companies. 

To begin, you can reach out to banks, non-banking financial institutions and accounting firms to see if they know any private companies planning to issue pre-IPO stocks to retail investors. Typically, these banks, lending institutions and accounting firms have a pre-clientele of early-stage startups looking for investors and may be able to help you find potential investment opportunities.

Alternatively, you can start attending startup pitch events and competitions to look for promising companies that you can invest in. You can directly contact aspiring entrepreneurs at such events to see if they are willing to sell their pre-IPO stocks. It's also a great way to meet other like-minded investors and expand your network. You can get a brief overview of the business plan, go-to-market strategy, revenue models, risks and an analysis of your target companies in such gatherings.

Another great strategy you can try is setting up email alerts to learn about startups looking for investors or planning to go public. Once you've found a suitable one, you can contact them directly and inquire whether they are willing to sell pre-IPO stocks.

Trading Managed Pre-IPO funds.

Retail investors who believe the risk of investing directly in pre-IPO companies is too high or who do not meet the criteria outlined by specialized brokers or the SEC can consider indirectly investing in pre-IPO companies. An excellent way to do this is by setting up managed pre-IPO funds.

For instance, you can buy into publicly held venture capital firms like Apollo Global Management Inc. (NYSE: APO), Blackstone Inc. (NYSE: BX) and others. These funds allow you to buy stock in a company that holds a portfolio of pre-IPO stocks. Private equity exchange-traded funds (ETFs) like Invesco Global Listed Private Equity ETF (NYSEARCA: PSP) and Morgan Creek-Exos SPAC Originated ETF (NYSEARCA: SPXZ) also provide indirect access to pre-IPO company stocks by pooling investor funds and purchasing a range of private equity shares.

These investments expose you to a wide range of private equity investments. And while it reduces your potential risks, it also reduces your gains significantly. Additionally, you must remember that private equity funds are actively managed and may charge high fees.

Why Should You Invest Pre-IPO?

Pre-IPO investing offers diverse benefits that are difficult to replicate in other investment markets. A look at a few of the benefits.

Avoid Stock Volatility

Because private equity shares do not yet trade publicly, pre-IPO investments are less susceptible to economic pressures arising from pandemics, wars, inflation, recession and other factors influencing stock market swings. For example, despite the stock market's general decline from the coronavirus outbreak in 2020, tech startups such as Instacart, Reddit and Stripe continued to grow.

Savings on Lower Stock Prices

Pre-IPO shares are typically sold at a discount by private companies. By doing so, they hope to help investors minimize the risks associated with investing in private equities, making their pre-IPO offering more appealing to investors. By leveraging the stock’s discounted rates, you can save a significant amount of money compared to when you get in during the IPO or after the company goes public. 

Maximize your Investment Potential 

Buying into pre-IPO stocks allows you to maximize the cost-benefit potential of your investment. Since it is sold at a discounted price, you only need to spend a little to meet your investment goals, unlike after listing.

Considerations With Pre-IPO Investing

Like other investments, pre-IPO investments carry risks that you must consider before making an investment decision. Here’s a look at some of the risks.

The Risk of Low Returns

While the prospects may look promising, you must understand there's no guarantee of a successful IPO. Suppose there's no market demand for the company's stock. In that case, the IPO will be unsuccessful, and you might not receive the returns you anticipate. In fact, if the company's stock performs poorly, its value could plummet quickly, and you risk losing all or most of your investment. So you must consider the potential for losses and make decisions based on your risk tolerance.

The Company Might Not Go Public

You make Pre-IPO investments with the expectation that the company will eventually go public. However, IPOs can be postponed, halted or canceled at the last minute for various reasons. When this happens, your money will potentially be locked up indefinitely, except in the unlikely chance you see a willing investor looking to take the pre-IPO shares off your hands.

Inadequate Financial Information

With pre-IPO companies, you may lack comprehensive information to make informed investment decisions. The law requires publicly traded companies to make their financial information available to the public. However, such requirements do not apply to private companies.

As a result, there is an information imbalance whereby those selling the shares (the company management) are fully aware of the company and its financial situation. Those purchasing the shares (the investors) are not. When investing in or buying pre-IPO stock, you should bear this in mind.

Online Brokers for IPO Investing

Benzinga analyzes, reviews and provides valuable insights on investing in pre-IPO stocks and individual stocks of companies, including technology, insurance, finance, cannabis and virtual payment platforms.

Frequently Asked Questions

Q

Is investing pre-IPO a good idea?

A

Yes, investing in pre-IPO stock can be a strategic way to build wealth over time. While there are significant risks associated, the benefits can be overwhelming.

Q

What happens when you invest in a company before its IPO?

A

When you invest in a company before its IPO, you acquire its shares at a discounted price, thereby providing the company funds needed to scale up and launch. You’ll only be able to earn ROI once the company goes public, if it ever does.

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