For many years, initial public offerings (IPOs) were extremely lucrative if you could get in early. Investment banks would reward their best customers and clients by giving them access to coveted IPOs.
Nowadays, IPOs are less common given the economic climate but they can still remain very lucrative opportunities if you can get access.
Today, there are several ways you can buy shares from insiders to get around the investment banks.
It’s important to remember that investing pre-IPO company stock is a very high-risk (but potentially high reward) opportunity.
Here’s what you need to know:
Table of Contents
- What Is Pre-IPO Stock?
- How to Invest In Pre-IPO Company Stock
- How to Invest In Pre-IPO Company Stock
- What Are the Benefits of Investing In Pre-IPO Company Stock?
- What Are the Risks of Investing In Pre-IPO Company Stock?
- Should You Invest In Pre-IPO Company Stock?
What Is Pre-IPO Stock?
“IPO” stands for initial public offering. In simplest terms, the pre-IPO stock is available for purchase before the company officially goes public. Sometimes referred to as pre-IPO placements, they involve private sales of stock before a public exchange lists the company and makes the shares available to the general public.
The purpose of pre-IPO stock is to give the issuing company the ability to raise capital to offset the cost and risks connected with going public. For example, the company could issue the public stock for the first time, expecting to raise $2 billion, but get only $1.7 billion due to a lack of investor interest once the stock hits the market.
With pre-IPO sales, the company has an opportunity to sell shares at a fixed price, guaranteeing a certain minimum amount of capital before the public offering. As an investor, you’ll purchase pre-IPO stock with the expectation that the price will rise upon or shortly after the issue, producing a big profit windfall.
How to Invest In Pre-IPO Company Stock
Since investing in pre-IPO company stock is a high-risk venture, investors must have accredited investor status. That refers to investors who are either high income, high net worth, a combination of both or licensed to sell financial securities.
An accredited investor (defined by the SEC) is one that:
- Have made $200,000 in annual income ($300,000 for joint investors) for the last two years with the expectation that you’ll earn the same or more this year, or,
- Have a net worth over $1,000,000, individually or jointly, excluding their primary residence.
- or, qualify based on defined measures of professional knowledge, experience or certifications. (added on August 26th, 2020)
If you are an accredited investor, you can participate in pre-IPO investments on specific platforms and sites that work with these offerings. There are different ways you can buy pre-IPO stock: through a direct stock sale, through funds, or managed investments that specifically work with pre-IPO stock.
It’s also possible to invest directly in pre-IPO stock as an individual, known as angel investing. But that presupposes you have access to pre-IPO stock sales. If not, the better choice will be to invest through companies specializing in this investing.
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How to Invest In Pre-IPO Company Stock
Below are six companies engaged in the business of pre-IPO investing:
Robinhood is an online brokerage that boasts some of the lowest fees in the industry. In fact, the low fees have made the trading platform very popular in recent years. But in addition to trading stocks, bonds, and ETFs, you can also place orders on pre-IPO stocks. The number of available stocks is small, and Robinhood only accepts limit orders, so there are no guarantees that Robinhood will be able to will fill your order. On their website, Robinhood clarifies that you’re not participating in the IPO itself. Robinhood allows investors to place limit orders before the start of IPO trading, but they cannot execute the order until it’s actively trading on the market. It’s known as IPO Access and they’ve had access to several big name companies in the past.
Through its partnership with ClickIPO, Webull offers investors access to IPOs and Secondary Offerings. Webull is similar to Robinhood in that its target customers are average investors. You can invest in IPOs through the Webull desktop platform and their mobile app. You can access current and previous IPO stocks on the Webull website. For example, there were four recent IPOs listed at the time of writing. On the site, you’ll find company earnings and dividend information, in addition to the offering price and listing date.
AngelList Venture is a platform where you can invest in startup companies on a deal-by-deal basis. The company began operations in 2010 and currently has more than $7 billion in assets under management. They claim to participate in 56% of all top-tier US venture seed deals.
You can participate in rolling funds, managed funds, and syndicates as an investor. The latter is where you can invest in startups on a deal-by-deal basis if you’re looking for individual investments. Syndicate deals require a minimum of $1,000 to invest, but accredited investor status is required.
Based in Israel, OurCrowd offers an opportunity to invest in pre-vetted startups and exclusive venture funds. The platform features 160,000 registered investors in 195 countries, with $1.8 billion in committed funds. OurCrowd has vetted more than 15,000 companies.
You can join the service free of charge, but you must be an accredited investor. Once you have an investor account set up, you’ll be able to browse the many available opportunities. From there, you’ll be able to participate in a portfolio of professionally sourced companies or select from managed investment funds.
FundersClub is an IPO crowdfunding platform, bringing investors together with upstart companies looking for capital. The company has been arranging IPO funding since 2012 and claims it invested in the top 1% to 2% of the companies available for IPO.
The company has participated in funding projects for more than 340 companies, with a portfolio valuation of more than $30 billion – including $170 million invested through FundersClub. You must be an accredited investor to participate on the platform.
What Are the Benefits of Investing In Pre-IPO Company Stock?
When you invest in pre-IPO company stock, you’ll typically be able to purchase the stock at a discount from its pending public price. That will give you the benefit of an immediate return on your investment if you reach the offer price when the stock officially goes public.
But the biggest payoff will come if the stock is well-received by the general investing public once it’s officially launched.
For example, the software company HashiCorp went public on December 9. The initial IPO price was $80, but the stock closed at $85.19 on the first day. Were you to purchase the stock at $80; you would have realized a 6.5% gain on the very first day. Any discount below the initial IPO price would’ve created an even more significant increase.
In some cases, a company’s stock can rise at an even higher premium than was the case with HashiCorp. Some continue to increase for several days or weeks after the initial IPO.
What Are the Risks of Investing In Pre-IPO Company Stock?
The most significant single risk with investing in pre-IPO company stock is that the value of the stock may dive once it officially goes public.
In what might be the most famous recent example of a pre-IPO fall, Robinhood did the exact opposite of HashiCorp. The IPO took place in July 2021, with much fanfare, owing to the popularity of the Robinhood trading app. But that success as a service didn’t translate into victory with the IPO.
The shares opened at $38 but closed down on the day at $34.82 – a drop of 8.4%. If you purchased the stock in a pre-IPO sale without the benefit of a discount, you would’ve taken an immediate hit.
But that’s not the worst of it. As of December 16, Robinhood’s stock is trading at just $18 per share. Had you chosen to hold onto the stock even after the IPO, you would’ve lost more than 50% of the value if you purchased the stock at the pre-IPO price.
The moral of the story is that not all IPOs end happily.
Even with companies you consider to be “can’t miss” prospects, this can be true. Just as is the case with investing in any stock, no one can ever guarantee a successful outcome.
There’s one other risk with pre-IPO stocks, and that’s a lock-up period. This arrangement is typical with pre-IPO company stock sales. Your early access to the stock purchase may restrict you from selling any or all your position for a specified period – typically between 90 and 180 days.
From a company standpoint, the purpose of a lock-up arrangement is to prevent large-scale sales of pre-IPO stock as soon as they hit the market. Since this can have a depressing effect on the stock price, issuers will naturally want to restrict your ability to dispose of the stock for a quick profit.
Should You Invest In Pre-IPO Company Stock?
While the TV version of pre-IPO stock acquisitions is instant millionaire status, that’s a fairly unusual outcome. Under the best circumstances, profits are much more conservative. But losses are at least as likely to occur as gains, especially if there is a lock-up period requirement attached to the presale.
The nightmare scenario is that you purchase a stock pre-IPO, with a 180-day lock-up, during which the stock plummets. That was certainly the case with Robinhood (if the lock-up requirement applied). If you had purchased the stock for anywhere near the initial price of $38, you would’ve suffered a 50% loss within six months.
If you plan to invest in pre-IPO company stock, do so with only a tiny slice of your total portfolio. Though the rewards of pre-IPO investments can be great, there’s an equal likelihood they’ll be disastrous.
For that reason, keep the balance in more predictable investments, like mutual funds, exchange-traded funds.
Finally, even if you invest a small portion of your portfolio in pre-IPO stock, it should be diversified. Rather than loading your entire pre-IPO allocation on one or two companies, spread the money across several upcoming stocks. If you’re investing through one of the pre-IPO specialist platforms listed above, you can even invest in funds that will handle the diversification for you.