What is Pre-IPO Investing?

Buying shares in startups early in their development is a proven way to earn exponential returns. Usually, that means buying at the IPO (Initial Public Offering) stage. But if you know how to buy pre-IPO stock, though, you may have the chance to get in even earlier and reap even higher rewards, potentially in a shorter time frame.

There are no guarantees, and pre-IPO investments have genuine risks. Still, if you have money that you’re willing to risk in return for extraordinary potential rewards, pre-IPO investments are worth looking into.

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What Is Pre-IPO Stock Investing?

Pre-IPO stocks are shares that a private company sells to investors before the company goes public (before its IPO). Most companies who sell pre-IPO stock use a process called pre-IPO placement. These shares are often bought by institutional investors like hedge funds and private equity firms, along with a few retail investors.

Why Do Companies Sell Pre-IPO Stock?

There are two key reasons why many private companies offer pre-IPO shares to investors before they go public.

Raising Funds

Pre-IPO placements allow a company to raise funds before it goes public. Once a company goes public, its share price can be affected by a wide range of factors. The IPO may not meet expectations. If investors don’t buy the shares, the company might not be able to raise the funds it needs.

Pre-IPO shares, on the other hand, are not subject to market-related volatilities. The company can sell large blocks of shares at a fixed price and raise a predictable amount of money.

Getting Guidance from Investors

Large investment firms, hedge funds, and other institutional investors who have unmatched resources, expertise, and decades of experience are the ones that buy most pre-IPO shares. They can guide the company’s management, help them make the right decisions, and smoothen the process of transitioning from a private company into a publicly-traded company.

The advice and insights offered by these investors can be invaluable, particularly for startups.

Can Retail Investors Purchase Pre-IPO Shares?

Pre-IPO investing is not easy and has a high entry barrier. A vast majority of pre-IPO shares – which are usually offered in large blocks – are purchased by deep-pocketed institutional investors. Individual investors can participate, but there are significant restrictions in most cases.

Accreditation Requirements

Many countries require individuals to meet specific criteria before being allowed to purchase pre-IPO shares. These criteria usually address the following two questions:

• What is the minimal net-worth and/or income level of investors allowed to participate?
• What proof do investors need to provide to show that they meet these criteria?

In the US, SEC rules restrict many private offerings to “accredited investors,” who must have significant income and net worth and demonstrated experience with investment markets.

📋 The SEC has recently revised the criteria for “accredited investors”. The criteria are still restrictive but they have been significantly relaxed, meaning more investors will be able to invest in these stocks. Check the SEC’s revised accredited investor criteria.

Lock-in Periods

Pre-IPO shares have a lock-in period, during which you are not allowed to sell or trade them. This is usually designed to prevent pre-IPO investors from dumping their shares immediately after an IPO.

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What Are the Advantages of Pre-IPO Investing?

Pre-IPO investing has advantages that are difficult to duplicate in any other investment market. Let’s look at some of them.

The Opportunity to Get Exponential Returns

This is the biggest reason why many seasoned investors choose to invest pre-IPO. If you pick the right company at the right time, you can get enormous returns on your investment.

😃 One of the most commonly cited pre-IPO success stories is that of the Alibaba Group, the Chinese conglomerate which went public in 2014. Before going public, Alibaba offered pre-IPO shares (at less than $60 per share) to investment firms and high net worth investors.

💵 Among the investors who bought Alibaba’s pre-IPO shares was Ozi Amanat – a Singapore-based venture capitalist. He bought a block of shares worth $35 million. A few months later, Alibaba went public in the largest global IPO to date, and its share price reached $90 on the very first day. It allowed Ozi Amanat and other investors to earn a 50% return on their investment in a span of just a few months.

Pre-IPO Stocks Are Available at a Discounted Price

When you invest in pre-IPO stock, you don’t know how the company will actually perform once it goes public. To offset this risk, private companies usually offer pre-IPO stocks at a discounted price.

👉 For example:

If a company sets its IPO price at $20 per share, it might offer pre-IPO shares at $10 per share. That lets you buy in at a lower price that’s likely to yield profit even if the IPO is not highly successful.

📉 Let’s assume that the company’s share price declines from $20 per share to $15 per share, due to a political crisis or a pandemic. Investors who bought the company’s shares at $20 apiece will suffer losses. It might take them several weeks or even months to recover their losses. You will be less affected by the dip in the share price since you only paid $10 per share.

📈 If the company performs well and if its share price increases significantly, you stand to earn substantially higher returns on your investment than someone who invested in the company’s IPO. It can help you build enormous wealth over a period of time as well as allow you to earn passive income through dividends.

A Chance to Build Long-Term Wealth

One of the biggest benefits of pre-IPO investing is that you are investing in a company that is on its way up.

If the company performs well, you can benefit enormously from its growth in the long term. It is not uncommon for million-dollar startups to turn into billion-dollar public companies, especially in the tech industry. So, your investment in a company at the pre-IPO stage could pay off massive returns in the future and help you build long-term wealth.

Things to Keep in Mind While Investing in Pre-IPO Stocks

Do Your Research Before Investing

Do your research and find out as much as possible about the company you are about to invest in. Is there a genuine demand for the product or service the company offers? Is their projected rate of growth realistic and achievable? Are the shares reasonably priced? These are things you need to find out before you make a decision.

Be Aware of the Risks Involved

Understand the risks involved in pre-IPO investments. Not all pre-IPO investments succeed. Some make big money. Others never go public at all. Be careful about what you invest in and how much you invest.

Start Small

Do not make a large investment straight away – especially if this is the first time you are investing in pre-IPO stocks. It is advisable to start small and increase your investments gradually over a period of time. As they say – dip your toe in, don’t dive.

Be Patient

Pre-IPO investing is not a get-rich-quick scheme. It can take several months – or in some cases, even years – for a company in the pre-IPO stage to go public. Moreover, even after the company goes public, its share price might not increase right away. So, it’s paramount for you to be patient and focus on long-term wealth generation rather than expecting quick returns on your investment.

Be Realistic in Your Expectations

Not every company you invest in will turn into a Google or Amazon. Do not be swayed by stories of people who invested a few thousand in Apple or Amazon when they were fledgling startups and then made millions. It does not happen every day!

Instead of looking for the next big thing to invest in, look for companies that have the potential to perform well over a period of time. Aim for good returns on your investments, not a single grand slam.

Should You Consider Pre-IPO Investing?

Investing in pre-IPO stock can be a strategic way to build wealth in the long term. If you manage to invest in the right company at the right time, you can get tremendous returns on your investment. There are risks in pre-IPO investing – as is the case with any other investment – but the upsides can be tremendous. If you have the resources and a suitable risk profile, it is an investment opportunity you should not miss out on.