How To Buy Ipo Before It Goes Public
An initial public offering, or IPO, is when a private company becomes a public company by offering shares on a securities exchange such as the New York Stock Exchange or NASDAQ. Private companies go public for a variety of reasons: maximizing shareholder value; providing liquidity to investors and employees; raising capital to reinvest and grow business; and using stock as a currency for mergers and acquisitions.
Buying a pre-IPO stock is a tantalizing prospect, no doubt. Imagine investing like Sheryl Sandberg and Peter Thiel, who bought into Facebook before it listed on the NASDAQ in 2012. Consider joining the ranks of Evan Spiegel and Bobby Murphy, whose Snap, Inc. (SnapChat) went public in 2017, raising over $30 billion. One good pick could turn you into a millionaire – or better. But finding companies that are ripe for an IPO (initial public offering) is difficult and risky. It’s also not always glamorous or successful. Here’s what you need to know.
- When a company 'Goes IPO,' employees are often given the opportunity to buy a limited number of shares at the initial offer price. They are sometimes given the opportunity to buy at that price for several months after the IPO in the form of stock options. The reason for this is that it's actually quite difficult to buy a stock on its IPO.
- Firstly, investors in private placement are usually pension fund, mutual funds, large banks, insurance companies. That is, they are usually open to accredited investors by way of options. IPO’s however are open to the general public who have enough funds to purchase shares.
What is a pre-IPO stock?
A pre-IPO stock is a company with the potential to list on the stock market. Investors aim to buy in while it’s relatively small and privately-held. They then cash out when shares in the business are sold on a large stock exchange. The ROI can be huge.
It’s difficult to tell whether a stock is pre-IPO until it’s already been listed. By then it’s too late. But such a company will usually have two characteristics: potential for explosive growth and a great story. You should ask the following questions when determining whether you think a business could one day go public:
- Could this company have thousands, if not millions, of customers?
- Could it become an international firm?
- Is its industry growing rapidly?
- Does it have a story that investors can buy into?
- Could it become a billion dollar business?
- Is there a demand for this kind of investment?
There are a few websites that sell shares in companies that could eventually trade publicly. They includeEquityZen, SharesPost, Equidate,OurCrowdandSeedUps.Note: I haven’t vetted or used any of these sites before.
Pre-IPO stock risks and misconceptions
There are plenty of risks involved with investing in a pre-IPO stock. There are also misconceptions that many aren’t aware of. Here’s a short list.
#1: Any company could be “pre-IPO”
A good promoter can make a case for any company to be a pre-IPO stock. He can entice an investor with the prospect of “getting in now before it goes public.” In theory, he wouldn’t be wrong. Your local corner store could be “pre-IPO.” But it will probably never be more than that.
Be cautious of firms that market themselves as prospective public companies. Many are scams. Going public should be one exit strategy for an investor, but it should never be the sole option.
#2: Listing on a stock market is actually fairly easy
Contrary to the perceived glamour of becoming publicly-traded, it’s actually quite easy to list a business on a stock market. There are several small exchanges across the world that will accept a public listing for a fee. These markets are far less liquid (few trade on them) than ones like the NYSE, TSX, ASX and FTSE. They’re homes for countless defunct penny stocks.
Indeed, simply going public isn’t enough to cash out. You need to go public on a market where people will buy your shares. There’s a big difference between listing on the OTCQX and the New York Stock Exchange.
How To Buy Ipo Before It Goes Public Records
#3: IPOs are not always lucrative
Not all IPOs work out, even if they list on a large market. If there isn’t a demand for the stock, then people may not buy your shares. For example, King Digital Entertainment, the creator of the Candy Crush app, saw its stock price fall by 16% on its first trading day. GT Solar and Rackspace Hosting stocks plummeted on their debut, too, during the economic bloodbath of 2008.
#4: Shares are illiquid until the IPO
Shares in a privately-held firm are difficult, sometimes impossible, to sell. If the company doesn’t go public, your capital could be tied up for a long time, if not forever. Be prepared to make a long term investment.
#5: Regulatory concerns
Pre-IPO stocks are exempt market/private placement securities. There are laws that govern how (and if) these shares can be sold. To invest in one, you’ll likely need to receive an offering or private placement memorandum (OM/PPM) and sign a subscription agreement. Otherwise, you’ll need to be an accredited investor or rely on certain exemptions under the relevant securities act.
Illegally raising money from investors is one of, if not the most, common violations of securities law. If a company gets caught, it could face steep fines that threaten that value of the investment, itself. Ensure that the firm is compliant before buying into it. Many early issuers are unaware of the law.
#6: Unknown share characteristics
If you’re a later investor in a privately-held business, prior shareholders may have certain rights that you don’t. For example, they might be entitled to receive IPO earnings before you. Or their votes could carry more weight than yours. Perhaps their shares will be listed, while yours won’t. Before investing, make sure you know what your counterparts were given. You could find yourself at the back of the line, otherwise.
#7: Some companies go public to survive
Businesses go public because they want more cash. That’s often because they need capital to fuel their expansion, which is generally a positive sign. However, sometimes firms raise capital because they’re struggling. They may need to refinance their debts or restructure altogether. In some cases they need it to survive. An IPO is not always a time to celebrate. It can cause shares to fall in value and become diluted.
Conclusion: should you invest in a pre-IPO stock?
There’s nothing inherently good or bad about a pre-IPO company. But the reality is that the chances of investing in a firm that eventually lists on a major exchange are slim. They also come with their own set of risks. In my view, the potential to liquidate through an IPO should be a bonus. It should not be the reason for your investment. If the only way to redeem your capital is to list on the stock market, then you should probably look elsewhere for opportunities.
Read more:
Companies that once rushed to go public are now putting off the day as long as possible—but employees and investors aren’t waiting.
As the average period for a venture-backed company to IPO has risen from 5.9 years in 2010 to more than eight years today, pressure from shareholders to cash out is fueling the market for secondary shares.
Stock held by founders, employees, and investors before a company goes public is in demand. With 177 private companies valued north of $1 billion, according to CB Insights, plenty of pension, mutual, and sovereign wealth funds, as well as other institutional investors, want a pre-IPO slice of the action since returns elsewhere in the economy are sputtering.
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In a sign this private market is maturing, Nasdaq announced on Oct. 13 it is partnering with the advisory firm Scenic Advisement to provide “end to end” private offerings for companies. Their agreement, which is not exclusive, allows the stock exchange to sell shares in private startups. Already, the stock exchange has a unit called Nasdaq Private Market, which provides the technology for a platform that lets employees cash out their vested stock. The platform lets companies manage who is buying and selling shares as well as accessing information about their financials. It also helps companies ensure employees and investors are complying with regulations.
Michael Sobel, cofounder of Scenic Advisement, says his firm serves a similar role as an investment bank in an IPO: finding buyers, managing auctions, setting a price, and disclosing sensitive information. The sales then funnel cash to the company and employees who sell their vested shares. “It’s now part of the ecosystem for private companies to offer liquidity to their employees before they IPO,” says Sobel in an interview. “We believe this is the the way institutional deals will be done in the future.”
Robert Greifeld, CEO of Nasdaq Private Market, says he wants the exchange to meet with companies that plan to IPO long before they ever offer a share to the public. “We want to be positioned wherever a company is in their lifecycle,” he told CNBC. The Nasdaq unit handled $544 million in secondary deal volume during the first half of 2016, up 136% over the same period last year. The average offering across 12 companies was $45 million, and most sellers were current and former employees.
The secondary market is evolving rapidly. Employees or companies can already sell shares in smaller deals through firms such as SharesPost and EquityZen which match buyers with sellers of private shares. But for larger deals, those more than $100 million, a more structured sales process led by the companies themselves is better, argues Sobel. It gives buyers transparency into company financials and allows startups to carefully choose investors with the best possible terms. Ultimately, he says, employees and startups benefit when early hires can sell some of their stock while they’re still working at their companies—even if an IPO is years away.