Every beginner, before diving into the article, would like to see some profs. Who is the author?
With a 99,99% probability, I can afford to answer the question from the topic, since for almost 10 years of my life I have been engaged in private /venture transactions in the tech industry.
At the age of 7, I started programming, at the age of 13 I created a super-local forum and social network, which became popular in the Eastern part of Europe. Then I founded and co-founded several startups (Slinky [Acquired by $SOHU in 2013], Teleport [Acquhired by $SNAP in 2018], Stickeroid [Acquired by NAVER Corp. in 2019] that were successful).
Since 2009, I’ve been involved from varying angles, in different roles, in over 80 companies, and over 120 secondaries/venture transactions including such names as Twilio, Robinhood, Chime, Discord, Attentive, DataRobot, DataBricks, Oatly, Coursera, and etc.
At the moment I am still actively working on deals, but I am doing it much more professionally. So, despite the fact that many people leave this industry after the first success, I’ve not lost my appetite for something new.
Let’s start — what is Initial Public Offering (IPO)?
The Initial Public Offering (IPO) market has become increasingly popular over the years, following its share listing credibility and increased transparency. Today, more private start-ups with a valuation of over $1 billion have resorted to public listing through the IPO process. Primarily, most of these start-ups are moving to the public listing for easy trading and raising of new equity capital. While investing in stocks listed in major exchanges comes with plenty of benefits, investors can also gain massive returns by trading shares of a company before its initial public offering. This is popularly known as pre-IPO investing. This article explains what Pre-IPO investing is and how investors can trade shares in Pre-IPO companies.
This refers to the issuance of shares of a private company to the public, including individual or retail traders and institutional investors. This allows private companies to raise sufficient capital from public investors before they can transition to full-fledged public companies. Typically, the private company preparing for an IPO will identify an underwriter for the process. The underwriter is usually an investment bank, which is also mandated to identify the stock exchange in which the shares of the private company will be listed.
Understanding Pre-IPO Trading
Pre-IPO trading refers to the sale or purchase of shares from a private company before the initiation of its IPO process. However, due to the risks and amounts of investments involved, Pre-IPO shares are not for everyone. Pre-IPO shares are issued in large blocks, and they are typically bought by hedge funds, private equity institutions, accredited investors, and a few other investors. The price of each Pre-IPO share may be discounted from the actual value of the shares. The purchase of these shares is said to take place without a prospectus. This means that it is impossible to know the actual price for which the shares will be issued, as well as no guarantee that the company will be listed publicly.
Benefits of Pre-IPO Market Trading
The Pre-IPO market presents investors with a unique trading opportunity that presents plenty of investment benefits. This section outlines some of the key advantages that come with buying shares from Pre-IPO companies.
Access of Shares from Fast-Growing Companies
The popularity of the Pre-IPO market is attributed to the looming growth of tech start-ups, which have the greatest potential for this category of stock market. Tech brands, such as Facebook and Amazon, are examples of small-cap companies that quickly moved into major stock exchanges. Through the Pre-IPO market, investors can access shares from such fast-growing companies.
The Benefit of High Returns
Over the last decade, the number of private companies deciding to make their initial public offerings has grown significantly. The increased demand for this market has seen it offer up to 10% annually based on historical data. Traders who make Pre-IPO investments, therefore, have been known to make tremendous returns. Notably, that Pre-IPO investors make higher returns than those who buy into the company after it has gone public.
Less Stock Volatility
Stocks listed on major exchanges are known to be extremely volatile. The volatility of the stock market is associated with such factors as political events, global financial crisis, or pandemics. However, unlike the typical stocks, Pre-IPO shares are not severely affected by these events, which is advantageous to both the company and the investors.
Generally, Pre-IPO shares are more profitable than the initial public offerings. This is especially because Pre-IPO stocks are issued at a discount. As a result, investors can gain a large profit margin generated by the difference in the price offered at the Pre-IPO stage and the rate issued by the company after a public listing.
How to Trade Pre-IPO Shares
When you decide to invest in the Pre-IPO shares, you will need to understand the trading process to be at an advantage. This section highlights a step by step guide on how to trade Pre-IPO shares.
Step 1: Try to Find SEC-Registred broker
There are two ways through which you can buy Pre-IPO shares. Firstly, you can liaise with a firm whose specialty is capital raisings and Pre-IPO shares. Secondly, you can consider a licensed stockbroker that deals in Pre-IPO shares.
Step 2: Monitor News
Once you have the account and the ideas on how you should trade Pre-IPO shares, you will have to keep track of the news for companies and start-ups that are planning to go public. You must exercise due diligence on the various Pre-IPO companies before investing your money in their stocks. At this point, you might also make enquiries from local accountants and bankers on companies that have the potential of moving to public listings.
Step 3: Pitch in Your Trading Interests
Basically, Pre-IPO trading is a mutual venture, where the involved private companies raise capital from investors as the traders buy into the ownership of the companies. Once you identify the ideal Pre-IPO company, you will need to pitch in your interest to invest in their shares. Consequently, you will be presented with several trading options as far as Pre-IPO shares are concerned.
Step 4: Money Transfer
Once you pitch in your interests in a Pre-IPO company, the next step will be to transfer money to the company in question. The company will provide its bank account through which the investor will transfer the money in a lump sum.
Step 5: Settlement
On the agreed settlement date, the investor and Pre-IPO company will exchange money and shares, respectively. You can then provide your dematerialised (DEMAT) or Carta account through which the transferred shares will be held.
Metrics to Use When Investing in Pre-IPO Shares
When choosing a Pre-IPO company to buy shares from, investors must undertake due diligence on that company. This section identifies some of the metrics that can help you assess the short-term and long-term value of a company in its positioning for IPO.
The outstanding value of the company’s shares is measured by what is commonly known as market capitalisation. However, investors can use a more precise metric known as equity value. This metric reflects the value of the company to its owners and shareholders. Equity value takes into account both common and preferred stocks.
This is a measure of the total value of a company. When investors want to compare Pre-IPO companies with varying capital structures, then enterprise value is the metric to consider.
Enterprise Value to Sales Ratio
This metric establishes how much a company incurs to acquire its sales. The enterprise value to sales ratio compares the company’s total value to its yearly sales. A lower measure of this metric implies that the prospects of the company’s future sales might not be attractive for investors, and the vice versa is also true.
This metric measures the value of a company beyond its forecasting period. The terminal value is the ideal means for investors to predict the future cash flow of a company after the projection period lapses.
Most investors perceive the initial public offering (IPO) of a company as the only way to invest in a fast-growing company. Contrary to this opinion, traders can buy shares in a private company before it is publicly listed in a stock exchange through the IPO process. This is popularly known as Pre-IPO trading, which is coupled with plenty of benefits to investors, including high returns, less stock volatility, and discounted stock prices. However, you must exercise due diligence when trading Pre-IPO shares, as this can expose your investment to substantial risks.
About the Author
Mr. Koch — a serial entrepreneur and late-stage investor specializing in secondary shares.
Previously: Twilio, Xiaomi, iQiyi, PinDuoDuo, Tilray, Livongo, Agora, Bandwidth, Hims.
Currently: Robinhood, Enflame, Grab, Toss, Coursera, Oatly, Epic Games, Chime, and other companies.
The content was collected from various open sources, approved by companies, and does not provide any one-stop recommendation for the purchase of shares. All data was used for only informational purposes and does not contain insider information that may be malicious or refuted by the company and SEC.
This communication does not represent an offer or solicitation to buy or sell securities. Such an offer must be made via definitive legal documentation by the buyer or seller of securities, please check the SEC rules before buying shares from any stock-suppliers.