Some companies entice investors to invest before an initial public offering (IPO). The companies dangle the carrot of high returns by investing in a start-up at the ground level.
There are qualifications required for investing in pre-IPOs. And investing in a pre-IPO can be risky. Analyzing an investment opportunity for a pre-IPO is imperative. That's because not all pre-IPO offerings are legal. But how do you invest, and how can you tell the legitimate ones from the frauds?
How a Pre-IPO WorksPre-IPO companies have yet to go public. The pre-IPO provides private placements that take place before an IPO is scheduled.
Shareholders of these companies seeking liquidity sell their shares to accredited investors.
Once these investments are made, the investors typically hold shares in a fund until there’s an exit event. Investors often hold the fund for two to seven years. Pre-IPO investments are usually made in later-stage companies that are valued in excess of $500 million.
One advantage of purchasing pre-IPO shares is that if you wait, you may not receive an allotment if an IPO is oversubscribed. Often, before going public, some companies opt for pre-IPO. The companies can gather capital and limit stock availability by reaching out to investors.
Accredited Investor Needed for Pre-IPOAccredited investors are the potential investors that a company must turn to for capital. The accredited investor is eligible to invest in many early-stage companies.
According to the U.S. Securities and Exchange Commission (SEC), accredited investors qualify based on wealth and income thresholds. They also must have other measures of financial sophistication.
There is a financial requirement to become an accredited investor. You must have a net worth of over $1 million, excluding your primary residence.
You must also have income over $200,000 per year as an individual or $300,000 with a spouse. This income must be stable over the prior two years with the expectation it will remain the same for the current year. There is also a professional criterion.
How Are Pre-IPOs Sold?There are three ways that companies sell pre-IPOs. The first of these (collectively) are: venture capital, private equity, and angel investors.
A second method is stock options that are granted to employees. And third, there are pre-IPO placements. Immediately before an IPO, the underwriter makes a stock available at a discounted rate.
If you want to purchase a company's pre-IPO shares, you'll want to go through a broker or financial advisor who participates in pre-IPO trading. They may represent sellers. Ask your financial advisor if they know a broker or if they can help you.
Reason for Investing in a Pre-IPOPre-IPO placements usually cost less than IPO. But there is a “lock-in” period during which an investor cannot sell their shares. This lock-in period often lasts a year.
By investing in pre-IPO companies, you're first in line for profit. Once the company goes public and begins trading, you can cash out with a profit.
Pre-IPO AdvantagesStability is one pro. Pre-IPO placements guarantee price stability. This deters an excessive number of shares available to be sold during the IPO.
Often, when too many shares are sold during a public offering, companies experience high levels of volatility as investors buy and then quickly sell stock. The result is falsely lowering the company's valuation.
A pre-IPO stabilizes share prices by regulating supply.
Pre-IPOs are a way for investors to exit a business. For example, private equity firms and venture capitalists that are heavily invested in a company may wish to sell their investment. But if they do so during an IPO, their stock will be deflated.
A pre-IPO offers a way out for the current investors and helps new investors who want to retain shares for a long time.
Risks with Pre-IPOsThere are risks involved with purchasing shares through a pre-IPO.
It may be illegal. All companies that want to sell securities to the public must register with the Securities and Exchange Commission or meet an exemption. If they don’t, the offering is illegal and you may lose your money.
The internet is riddled with fake websites of companies offering a pre-IPO. You also may receive an email from a fake company asking if you're interested in investing in a pre-IPO. Talk to a legitimate broker or financial advisor before transferring those funds.
There's always the risk that the company may never go public. In many cases, fraudsters have touted an alleged IPO's predicted value and imminence. The goal is to lure and pressure investors. Do your due diligence. And keep in mind there’s no guarantee of big returns after an IPO or that the company will ever go public. Either way, you’ll lose money.
Analyzing a Pre-IPO CompanyIt's essential to gather the details when investing in a pre-IPO.
First, you should know the company. What are their services or products, and who are their customers? Check to see if they have physical plants, contracts or inventory. The SEC claims "that the most successful frauds start out with plausible lies". Ensure you have independently verified everything you were told.
Know the management's background. You'll especially want to know if the management has run a profitable business or if they have violated the law.
The business should have retained an investment banking firm to underwrite the offering. Find out what firm they are working with.
And think about how you found out about the offering. Did you hear about it from a stranger? If you received an email or saw an online advertisement, beware.
Buyer Beware With a Pre-IPOThere are many advantages to a pre-IPO. Buying low and selling high is always a good thing. But many nefarious people are waiting to take your money.
The best course of action is only dealing with a reputable broker and financial advisor.
The Epoch Times copyright © 2023. The views and opinions expressed are those of the authors. They are meant for general informational purposes only and should not be construed or interpreted as a recommendation or solicitation. The Epoch Times does not provide investment, tax, legal, financial planning, estate planning, or any other personal finance advice. The Epoch Times holds no liability for the accuracy or timeliness of the information provided.