Pre-IPO Stocks: What They Are & How They Work

Investors Education
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Pre-IPO investing allows individuals like you to participate in a company's journey before the company is listed on NYSE, NASDAQ or other public stock exchanges, granting access to shares usually reserved for a select group of institutional investors. These shares, offered at a stage when the company is poised for potential growth, provide a unique investment opportunity before the public debut.

This guide aims to demystify how pre-IPO shares work, equipping you with the knowledge and strategies for this unique investment market.


How Do Pre-IPO Stocks Work?


Investing in pre-IPO shares means investing in companies during their growth phase1 before their stock is publicly available after an IPO. It's a strategic move aimed at buying stakes at potentially lower prices, to drive significant returns when the company goes public. However, this potential upside comes with important considerations — legal, regulatory and market-driven — that are important to understand when exploring pre-IPO investments.

Here are the pros and cons of investing in pre-IPO shares: 

Pros

  • High Return Potential: Earlier pre-IPO investments have the potential to yield substantial returns if the company's value increases significantly post-IPO. As companies stay private longer, more of their growth is happening in the private markets leaving less upside for public market investors. Pre-IPO investments help you tap into that growth.
  • Early Bird Advantage: Pre-IPO investors get to support companies that are shaping the future and innovating industries while also participating in the growth that comes with this from an earlier stage.
  • Exclusivity: Get access to companies that aren't available to the general public and offer unique investment potential.
  • Diversification2: Pre-IPO investments add variety to your portfolio, possibly reducing risk through lower correlation to traditional asset classes, with the potential for lower volatility. 


Cons

  • Risk of Loss: As with any investment, there's a potential for loss. Investors must be willing to accept the risk that the company they invest in goes out of business. This risk is less likely at the pre-IPO stage than at earlier stages of investing, but it still is something to keep in mind.
  • Liquidity Issues: Pre-IPO shares are less liquid than public stocks, making them harder to sell quickly. While products like EquityZen’s Express Deals can enable liquidity for pre-IPO investors subject to certain conditions, investors should expect to hold their investment until an IPO or exit, which can take 5 to 7 years.
  • Information Asymmetry: Private companies do not have the same disclosure and reporting requirements that public companies do. Limited information about private companies can make it challenging to make fully informed decision.

 

What’s the Value of Pre-IPO Stocks for Investors?


Pre-IPO stocks offer investors a unique chance to invest in innovative private companies before they hit the broader public market, often at more favorable prices. This early entry can lead to significant growth if the company's value increases with the public listing, translating early support into notable financial returns. Beyond the numbers, there's value in being part of a company's growth journey, witnessing and supporting its success story from earlier on.


Who Can Invest in Pre-IPO Stocks?


Not everyone can invest in pre-IPO shares. Historically, these investments were almost exclusively available to large, institutional investors and the very wealthy. Now, thanks to investment marketplaces like EquityZen, which offer lower investment minimums than private equity funds and broader access through digital tools, these private company investments are now more easily available to accredited investors too. The accredited investor standard is based on regulatory requirements. Accreditation ensures that investors understand and can withstand the investment’s potential ups and downs. Platforms like EquityZen offer guidance and resources to assist potential investors in determining whether or not they are accredited, ensuring they meet the necessary criteria for pre-IPO investing.

Typically, accredited investors have an annual income above $200,000 individually or $300,000 jointly with a partner in two of the last three years, with a reasonable expectation for the same in the upcoming year, or a net worth over $1 million, excluding their primary home. Institutional investors like venture capital and private equity funds often engage in pre-IPO investments, leveraging extensive resources to evaluate potential. More recently, holders of certain professional licenses, like the FINRA Series 7, also qualify as accredited investors. 


How To Evaluate Pre-IPO Stock Investment Opportunities


While the opportunity for significant returns in pre-IPO investing is compelling, it comes with inherent risks. Because of this, when investing in a single company, a keen understanding of the company's trajectory and broader market trends is vital to navigating this market successfully.

Here are some things to look for when evaluating a pre-IPO investment opportunity:

Financial Health Check: Think of this as your way to gauge the company's heartbeat. Are revenues growing? Are they profitable? When did they last raise funding? Understanding these core financial metrics, based on publicly available information, sets a solid foundation for your investment thesis.

Market Potential Exploration: Here, you're sizing up market potential alongside the company's position and competitive edge. How big is the market, and what's the company's role in it? This helps you understand the growth potential of your investment in the context of the broader market opportunity.

Leadership Team Analysis: The driving force behind any successful company is its leadership. Investigate the executives' and board members' experience, history of exits and strategic vision. Also consider checking who is on the company’s board of directors. Companies backed by top-tier venture capitalists may have more resources to grow and succeed.

Terms of the Stock Offering: Dive into the specifics of your investment, detailing the type of shares (common or preferred), pricing and any unique rights like liquidity preferences. Information from the capitalization table can help investors understand the shares outstanding, the potential valuation and where their investment falls in the liquidity waterfall.  Similarly, the investment offering document will spell out all the specific terms about your investment.

Industry and Broader Market Trends: Look at the larger macroeconomic and industry movements to gauge how they might impact the company and your investment. Staying informed on these trends allows you to consider potential shifts and opportunities, ensuring your investment decisions are as forward-thinking as possible, while suited to benefit from, or at least weather, the current macroeconomic environment.


How Buying Pre-IPO Stocks Compares to Other Pre-IPO Investing Options


Opting to buy pre-IPO shares of a single company means taking a more singular route, directly investing in a company's potential before it goes public. This choice contrasts with other pre-IPO investment methods, such as investing in a diversified fund, where your investment is spread across various companies.

Choosing pre-IPO shares in a single company is akin to placing a targeted bet on a specific company's growth story. It requires a keen understanding of that company's vision, market and potential, calling for a thorough analysis. While this means a closer alignment with the company's success or failure, it also calls for an in-depth evaluation and preparedness to shoulder the unique risks and rewards of a concentrated bet, just like in the public markets.

As you consider this path, weigh the desire for targeted exposure against the broader, perhaps more balanced approach of other pre-IPO investment options, like EquityZen’s diversified funds. It's about matching your investment style with the right investment product — ensuring your journey into the pre-IPO market is rewarding and aligned with your investment philosophy and risk appetite.

For investors looking for broad pre-IPO investment exposure, diversified across multiple investments, pre-IPO funds can be the right investment option. These funds have an experienced investment committee that selects the individual investments within the fund, making sure they align with the investment goals and criteria of the given fund’s strategy. This type of product offering can complement a broadly diversified portfolio and may be a good fit for investors who are new to the pre-IPO market or are not sure which companies to invest in. The diversified exposure offered by these funds permits investors to spread their risk across a variety of companies or sectors, thereby mitigating the risk of any one company underperforming and supporting a potentially more stable return on investment. As with any investment, it is important to to understand the full terms of the fund offering to determine if the investment timeline and risk-return potential align with your investment approach. 


How To Get Started Investing in Pre-IPO Stocks


Embarking on your pre-IPO investment journey is an exciting endeavor that requires preparation, insight and a touch of daring. Here's a roadmap to guide you:

Educate Yourself: Begin with a thorough understanding of pre-IPO investing. Utilize resources like EquityZen's blog for foundational knowledge and stay updated with the latest trends and news in the industry.


Determine Eligibility: Ensure you meet the criteria to invest in pre-IPO stocks, typically as an accredited investor. Understand what this entails and whether it aligns with your financial situation.


Platform Selection: Choose a platform specializing in pre-IPO investments that offer comprehensive information, transparency and a track record of success.


Company Evaluation: Utilize the earlier discussed evaluation criteria to select companies. Dive into their financial health, market potential and leadership, among other factors.


Connect with a Community: Engage with communities of investors, perhaps through forums or investment clubs, to exchange insights and experiences. Learning from others' journeys can provide invaluable context and confidence.


Start Small and Learn: Consider starting with a smaller investment amount to familiarize yourself with the process and risks involved. As you gain experience, you can adjust your strategy accordingly.


Investing in pre-IPO stocks is both an art and a science, combining diligent research with instinct honed by experience. As you begin, let knowledge be your guide and curiosity your compass. The path of pre-IPO investing is not just about financial returns; it's a journey of learning, engaging and potentially being part of the next big success story.


Invest in Pre-IPO Stocks With EquityZen Funds


Now that you understand how pre-IPO shares work, you can confidently and clearly embark on your investment journey. With EquityZen, tap into expert guidance and market analysis, informed by over a decade of leadership within the pre-IPO investment market. Our platform brings exclusive opportunities to your fingertips, offering some of the lowest investment minimums available.

Sign up with EquityZen today and be part of the vibrant community shaping the future of investing.

 

Related Resources

Navigating the Private Market Investment Landscape: Venture Capital vs. Private Equity: EquityZen
What is Pre-IPO Investing: EquityZen

 

Sources:

  1. Manhattan Venture Partners, https://www.mvp.vc/research-industry-sector-report/pre-and-post-ipo-returns-analysis
  2. Diversification does not assure a profit or protect against market loss.

Disclaimer: Not all pre-IPO companies will go public or be acquired, and not all IPOs or acquisitions are or will become successful investments. There are inherent risks in pre-IPO investments, including the risk of loss of the entire investment, illiquidity, and fluctuations in value and returns. Investors must be able to afford the loss of their entire investment.  This should not be construed as investment advice.

 

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