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Buying stocks in startups early on can see great returns, and that typically means buying at the IPO (Initial Public Offering) stage. But there is a way to get in on the ground floor even earlier, buying pre-IPO stocks, which can mean even better returns in a shorter span of time.
As with any investment, there are no guarantees. Pre-IPO stocks are a gamble and have some special considerations for investors to be aware of, including a lack of liquidity and available information. But if you have some money you’re willing to risk for a potentially high and fast return, pre-IPO stocks are something you may want to consider. In this article, we’ll explain how to buy pre-IPO stocks in 2023.
Understanding Pre-IPO Stocks
Pre-IPO stocks are shares of privately held companies. When a company has an IPO, its shares start to be traded publicly on stock exchanges like the NYSE or NASDAQ. In some cases, pre-IPO stocks are sold for companies that are on the verge of going public and may have even filed to go public, but the IPO date hasn’t yet happened.
Pre-IPO stocks can also refer to privately owned startups that are privately owned without any specific plans to IPO in the future.
IPO is a way for companies to raise capital by allowing them to trade shares on the stock exchange. Pre-IPO placements enable a company to raise capital before it goes public. Once public, share prices can be impacted by a number of factors. The IPO may not meet expectations if investors aren’t buying, meaning the company can’t raise the needed capital. Pre-IPO shares aren’t subject to the volatility of the market, so the company can sell large blocks of shares at a set price and raise a predictable amount of capital.
Pre-IPO stocks do not have a prospectus, and there is no guarantee that a pre-IPO placement will eventually lead to an IPO. Pre-IPO stocks are typically sold to private investors, generally private equity firms and hedge funds. They can also be acquired on the secondary market, and employees of a company may be offered stock options are part of their compensation package.
Pre-IPO stocks are offered at a discounted price than will be quoted for the IPO as a way to compensate inventors for risking an uncertain investment.
Researching Pre-IPO Stocks
Startup directories are a good way to find potential pre-IPO stocks. These directories are also a useful way to see how early customers feel about these startups’ products and services. Is there a demand, and how are the products and services being received? Crunchbase and ProductHunt are two good resources for finding information on pre-IPO stocks.
Be sure that any startup you’re considering investing in has the necessary documents required for them to operate. For example, in placements and securities pre-IPO, startups either have to be registered or exempt under SEC rules or your state securities regulator.
Pre-IPO, startups usually disclose their projected revenue growth, and as a prospective investor, it’s a good idea to evaluate the information. Return on investment (ROI) is one measure most investors use because the data will give you an indication of the startup’s continued viability.
A business valuation of a potential pre-IPO investment might include analyzing the company’s management, capital structure, future earning prospects, or the market value of its assets. Commonly, an approach to a business valuation will include reviewing financial statements, discounting cash flow models, and comparing similar companies.
Private companies that plan to go public will provide a Private Placement Memorandum (PPM) to their investors. A PPM typically contains information about the company, its management team, the products and services offered, the intended customer base, past performance, financial resources, and potential risks investors should consider.
Analysts often create reports about pre-IPO companies that investors can use to help determine a company’s potential. The reports are available via news sources, investment journals, online, and company publications.
Accessing Pre-IPO Stocks
Angel investors and venture capital firms are one option for investing in pre-IPO stocks, as they often acquire large blocks of shares.
Some companies offer stock options as a way to attract and retain talent. Often, the employees are willing to take a lower salary for the chance of a big future payout if the company is successful.
Employees and former employees of startups may wish to sell their stock options, and there are secondary markets where they can do so. As pre-IPO stocks have increased in value in recent years, secondary markets have become more popular. Two such marketplaces are EquityZen and Forge Global. Sellers set the prices for their shares, and a broker manages the offers and gets permission from the company that issued the shares.
Pricing is tricky on secondary markets. On exchanges, stock prices are known, and the companies listed have to share certain financial data. Those things don’t apply to the secondary markets.
There are also crowdfunding platforms like AngelList, OurCrowd, and Trendscout that are making pre-IPO placements more accessible for potential investors.
Working with Brokerages and Financial Institutions
In the past, it’s been hard for regular investors to have access to pre-IPO stocks, but that has begun to change, and the market is opening up.
There are specialized brokerages that allow for pre-IPO investing. Each platform has specific requirements investors must meet to invest in pre-IPO stocks, including being a platform member and having minimum investment capital. You must be sure you understand and meet the requirements before investing, and not all platforms will have access to a specific stock you may want to invest in.
Angel investing is another potential avenue to pre-IPO investing. Angel investors typically contribute capital to startups looking for quick funding in exchange for an ownership stake. Those who provide such early-stage financing may purchase a startup’s stock at a reduced price in the pre-IPO stage if they’ve provided funding in the company’s early stage.
Only accredited investors can invest in pre-IPO companies as angel investors. Accredited investors are those who have an income of at least $200,000 in each of the preceding two years or more than $1 million in net worth, excluding their primary residence.
Some well-known brokers that offer access to pre-IPO stocks include TD Ameritrade, E*Trade, Fidelity, and Robinhood.
Many platforms offer just a small selection of pre-IPO stocks, and in some cases, orders are limited, so there is no guarantee your order will be filled.
Evaluating Pre-IPO Stock Options
Stock options are offered to employees as part of their equity compensation plans. They give the employee the right to buy company stock at a specific price for a set period of time.
The value of pre-IPO stocks is typically determined by the company’s most recent assessed fair value rather than by a fair market price, as is the case with publicly traded stocks. Selling the stocks pre-IPO may be prohibited depending on the plan’s guidelines. Exercising pre-IPO shares is a taxable event, and if the company never has an IPO or the shares don’t appreciate as much as expected, this can mean a significant financial loss.
Once the IPO happens, you may face a lockup period that can restrict your ability to sell your stock. During this time, usually six months post IPO, you may not be allowed to sell shares according to the agreement your company has with the investment bank helping take the company public.
Risks and Considerations
Like any investment, buying pre-IPO stocks has its risks, but there are some unique risks to be aware of. All investments are speculative, but pre-IPO is the most speculative time in a company’s history.
According to the U.S. Bureau of Labor and Statistics, 20% of privately owned companies fail in their first year. And as many as 90% of startups fail within five years.
If the company never goes public, the shares can be hard to sell, so pre-IPOs are an ill-liquid investment. An IPO could be delayed, causing a cash flow issue for investors.
The lock-up period can, again, cause a cash flow issue, again making the investment an ill-liquid option. Because startups tend to lean heavily into the tech sector, pre-IPO stocks can cause you to be overexposed in one area, meaning your portfolio isn’t properly diversified.
If it’s your first time investing in pre-IPO stocks, start small so you can learn the process without risking a lot of money. It can take months or even years for a company in the pre-IPO stage to go public. Even if the IPO does happen, there is no guarantee that the stock price will increase right away.
Pre-IPO stocks can see investors reap significant gains but have some risks that many other types of investment do not. Pre-IPO investing requires all of the research and due diligence of any investment, and then some and not all of the usual information investors typically use to evaluate an investment is available. Investors have to make their decisions based on very limited information.
Depending on the platform, you may be required to have a relationship with an investment bank or venture capital firm, and that can mean being an accredited investor, a threshold the average investor doesn’t meet.
Buying pre-IPO stocks should fit into your overall investment strategy, including your timeline and risk tolerance.
Pre-IPO stocks are stocks in privately held companies.
Investors have the opportunity to get in on the ground floor of new, up-and-coming companies that could see a massive increase in stock price when they go public.
Pre-IPO stocks are ill-liquid due to being sold on a secondary market and potential lock-up periods.
If you have the resources and meet the eligibility requirements, finding the right pre-IPO investment can be a great opportunity but also comes with significant risk.
Yes, but there are barriers; in many cases, you will need to be an accredited investor with a significant net worth.
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