Guide to Investing in Pre-IPO Secondaries for Advisors

Brianne Lynch
Apr 13th

Overview

Private technology companies that have matured from being “startups” have fewer reasons to go public quickly today than they did a decade ago. With the abundance of private capital available, these venture-backed companies are increasingly reaching valuations of $1 billion and even $10 billion before they go public. While these companies may still have upside in public markets, the magnitude of growth that pre-IPO investors experience can be substantial. Public market investors are missing out on this value creation, which has created a need for advisors to tap the pre-IPO secondary market to help generate meaningful returns for their clients.

The graph above displays how value creation from 1986 through 2018 has shifted from the public markets (green) to the private markets (gray). Roku's private valuation multiple based on Series B to IPO. Companies shown may not be actual portfolio investments of any EquityZen fund.

In the pre-IPO secondary market, shareholders of private, venture-backed companies transfer the ownership of their shares to an investor as a means of getting liquidity before a company-wide exit event. The investor exchanges cash for shares of the private company and the proceeds of the sale go to the selling shareholder.  If the company goes public, investors typically receive shares after a lockup period. If the company gets acquired for cash, investors receive cash for their shares.

The pre-IPO market spans industries including: enterprise software, cloud computing, big data, cybersecurity, health tech, food services, artificial intelligence, gaming, and more. Private companies within these industries include household names like Robinhood, Bytedance, and Impossible Foods. According to CB Insights, over 515 companies globally have a private-market valuation above $1 billion. These “unicorns” represent a tremendous amount of value locked up in the pre-IPO market - over $1.6T.

Over the last 25 years, top-quartile VC firms generated returns of 18.9% to 25.1%, while the public markets returned less than 13%.1 The secondary market is unlocking this return potential for investors who had previously been shut out due to high investment minimums and limited access. Through the secondary market, advisors can invest in companies backed by top-tier venture companies and drive returns on behalf of their clients.

How Advisors Allocate to the Pre-IPO Market

Late-stage private companies like Robinhood are certainly different from early-stage investments with high market and execution risk. These companies have proven business models with many generating hundreds of millions of dollars of revenue and employing thousands of workers. Ten years ago, when companies went public earlier in their life cycle, these companies would already be publicly traded. For this reason, many advisors consider late-stage private companies as part of their growth equity allocation. Especially for advisors who maintain a sizable allocation to the technology sector, many of these companies round out their public market technology allocation.  

It is important to note that pre-IPO investments don’t typically offer near-term liquidity. Because of this, advisors should only allocate assets to private investments that will not be needed in the near-term (at least 1 year from investment, and typically longer). Private company investments are typically held until there is an exit event for a given company, which can take years, though products like EquityZen’s Express Deals can provide earlier liquidity. Given this liquidity consideration, pre-IPO investments should also be considered in the context of a client’s overall illiquid or long-term investment allocation. 

Ultimately, advisers allocate to the pre-IPO market with the goal of driving attractive returns for their clients. Venture Capital strategies outperformed the S&P 500 by 2-3x over 20-25 years and investments on EquityZen’s platform have generated a 26% annualized returns for investors.2,3  While there are risks involved, including loss of investment, advisers are keen to offer diversification beyond public equities while offering potentially higher returns through pre-IPO investments.

Diversification

Depending on a client’s overall portfolio, advisors may look to invest in single private companies or access the pre-IPO market via a diversified fund. Advisors with clients who already invest in single company stocks may choose to invest in individual private companies. Secondary investment platforms can provide individual company research to aid advisors in analyzing potential investments.  However, it should be noted that private companies typically disclose less information than you’d find for a public company because they don’t have the same regulatory reporting requirements.  This potential lack of information can make pre-IPO investments riskier.

Managed funds can provide exposure to the broader pre-IPO market or may target a specific sector or theme (e.g. Artificial Intelligence and Machine Learning or Fintech). EquityZen’s Thematic and Global Opportunity Funds serve this purpose.  Some advisors find that these diversified products help mitigate some of the risks of single-company investments, similar to an ETF. This investment approach makes sense for advisors and their clients who typically don’t invest in individual public companies and instead seek broader market exposure.

The Future of the IPO Market

2020 proved that the IPO market is alive and well.  Despite COVID-19, IPOs were well received by investors, raising record-breaking levels of capital.  We expect the robust 2021 IPO pipeline to continue, bolstered by rising equity markets, the growth of SPACs and the pent up liquidity needs of shareholders in the private markets.  However, with the abundance of venture capital available, the trend of companies staying private longer is unlikely to change. It’s an exciting time for pre-IPO investors as reputable secondary platforms, like EquityZen, give access to these investment opportunities and offer solutions that advisors need. As the pre-IPO market grows, this will become an increasingly important area for any advisor to consider to drive meaningful returns and a well-balanced portfolio for their clients.

Sources:

  1. Alumni Ventures Group, December 2019
  2. As of 06/30/2019, Cambridge Associates 
  3. Please see https://equityzen.com/investment-returns/ for more information

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