Why Pre-IPO Shares Are Hot and Getting Hotter
It’s the dream of many investors to be able to get in on a “unicorn, ”a company that reaches a valuation of $1 billion or more before it’s even gone public. And it makes sense. There are more of these magical companies in existence today than ever before.
As of January 2019, there were more than 300 “unicorns” globally, and more than 20 “decacorns” (those with valuations of $10 billion or more).
One of the reasons for this, of course, is the rate of growth of the global technology sector, which is set to be a $5.2 trillion industry globally in 2020.
But another reason is that companies are choosing to stay private longer. In 1999, the average U.S. tech company went public after four years; today, the average tech company stays private for 11 years or more.
Why? To start, the initial public offering (IPO) market has seen a difficult couple of years. In fact, a recent study by Goldman Sachs found that many companies that IPOed over the last two years would have been better off financially had they stayed private (a historically rare occurrence for the markets).
On top of that, it’s usually extremely time consuming and expensive to take one’s company public. Over 83% of chief financial officers (CFOs) estimated spending more than $1 million on one-time IPO costs for their companies, and two-thirds of CFOs estimate spending $1-1.9 million annually on expenses related to their companies being public. Not to mention everything that goes into IPOing can drag the process out for up to 18 months or more.
Considering all those factors, it’s no wonder so many tech companies are choosing to delay or forego going public.
Of course, that leaves many investors on the outside wondering how to get in. In many cases, one of the only ways is to get a job at the company—unless you’re capable of writing a $10 million check (which, let’s admit it, most of us are not).
And if/when that company does eventually IPO, the high valuation will push the market cap to staggering levels, making it more difficult for the average investor to get in on the name at a reasonable price. Plus, by that time, much of the company’s upside will be priced in, so public investors will lose out on most of the growth potential of their shares.
But just because a company isn’t trading on the public market doesn’t mean that the average investor can’t stake a claim. This is where pre-IPO shares come in.
What are pre-IPO shares?
Pre-IPO shares are exactly what they sound like: shares in a private company that are held by insiders before the company goes public.
Since companies are staying private longer, investors and insiders alike are seeking ways to buy and sell these private shares. And companies are looking for ways to grow without having to go public.
Risk factors and benefits of pre-IPO shares
The obvious risk of buying pre-IPO shares (aside from the same risks that go along with any investment) is that the company may never IPO. In those cases, since the shares never trade on the open market, they are highly illiquid and it becomes more difficult (although not impossible) to sell them for a profit. And if the company does go public, the shares might not have the demand it expected, which could cause prices to sink.
What’s more, it’s possible you could lose your entire investment if the company’s IPO does not go as planned or if it struggles to maintain profitability under the scrutiny of public investors over time.
But, that said, there are numerous benefits to trading pre-IPO shares as well.
For one thing, to counter the risk factors of investing in a private company, pre-IPO shares are usually substantially discounted from the expected share price at the time of IPO, which can make the returns all the more lucrative.
For instance, one recent case study showed investors buying pre-IPO shares at $0.10 four months prior to the company’s IPO. As the time of the IPO, shares were listed for $0.20, and within six months, grew to $0.60 per share. Those investors made six times their money in less than a year.
Plus, by getting into a pre-IPO company that’s on its way up, investors are better able to access the gains that high-growth companies enjoy. After all, the climb from $1 million to unicorn territory is typically far more lucrative for all involved than the road from $1 billion to $1.5 billion for a public company. Pre-IPO is where fortunes are make today.
How do you invest in pre-IPO shares?
Sometimes companies will hold pre-IPO placements, which are the sale of large blocks of shares prior to the IPO, in order to raise capital. However, generally these are limited to funds, institutions, and high-net-worth individuals, so retail investors are left out in the cold.
So, how does the average investor get in on pre-IPO shares?
Since they don’t trade publicly, buying them can be a slightly more complicated process than standard investing through a brokerage. A lot of it depends on whether or not you know a company insider, since many of these transactions are done privately between acquaintances. You don’t have to know someone directly; someone in your network might be able to connect you to one of their own contacts. So reach out to your family, friends, colleagues and acquaintances.
Alternately, you could do your own due diligence into private companies that interest you, and try to connect with someone on the staff through LinkedIn or even a general inbox. You could also join business associations and angel investor forums to expand your network. Relationships are the driving force behind the pre-IPO market.
That said, there are firms that specialize in pre-IPO shares and can help guide you in finding these opportunities.
First off, you’ve probably heard of stock tokenization. This essentially allows stock shares to be converted into tokens that operate on the blockchain (like cryptocurrencies). This not only creates liquidity but opens the door for any investor to buy shares of a private company.
Then, there are online marketplaces like EquityZen, which connect startup insiders who want to sell their shares to private investors with capital to spend. These platforms streamline the entire process and give non-institutional investors access to some of the world’s most magical unicorns.