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Investing in pre-IPO stocks

Exponential returns are possible if you get in before the next hot public offering, but uncertainties and a possible lock-up period add risk.

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By

Shannon Terrell

Updated

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Investing in a pre-IPO stock isn’t as straightforward as purchasing publicly traded shares. But there are several ways for investors to back startups before they reach the market regardless of their accreditation status, including crowdfunding platforms and pre-IPO brokers.

What is a pre-IPO stock?

Pre-IPO stock is a stock available for purchase before the issuing company goes public in an initial public offering. Also called a pre-IPO placement, this private sale of shares occurs before a company’s official market debut.
This type of pre-IPO investing offers companies the opportunity to raise funds and offset some of the risks associated with the offering. After all, there’s no guarantee a freshly issued stock will do well with the general public, so pre-IPO placements can help counteract the risks of taking a stock public for the first time.

Why should I invest in private companies?

Private investors who invest in a pre-IPO placement get to purchase stock ahead of its official release to the public — typically at a discount. Pre-IPO investors face the same risks as the company issuing the stock, namely that there’s no guarantee the company will do well at market. To reward investors for taking a gamble on pre-IPO stock, many companies offer their pre-IPO placements at a discount.
Beyond the discount, pre-IPO investors have the opportunity to back a company before it’s public and profit from the launch of its stock. These stocks are also better insulated from broad, market-impacting events, which means they tend to be less volatile than those available to the general public.

How the JOBS Act made it easier to invest in pre-IPOs

In 2012, President Barack Obama signed into law the Jumpstart Our Business Startups Act (JOBS Act). The legislation makes it easier for startups to raise capital by loosening Securities and Exchange Commission (SEC) regulations that govern initial public offerings.
The JOBS Act effectively increased the number of shareholders permitted to invest in a company before it must register its stock with the SEC to 2,000. It also opened up pre-IPO investing to up to 500 non-accredited investors, making pre-IPO placements more accessible to retail investors.

What are the risks of investing in private companies?

What should I look for when choosing a pre-IPO investment?
Reduced volatility and potentially exponential returns make pre-IPO companies an attractive investment opportunity. But before you allocate funds, consider the following:

  • Time in business. How long has the company been in business? Review its company history and any available data on its balance sheet to get a more accurate picture of its financials. The younger the company, the bigger the risk.
  • Lock-up period. Find out if the pre-IPO placement you’re interested in plans to impose an investor lock-up period. If so, consider how the stock may perform over the length of time you’d have to hold on to it, and whether you’re willing to weather its trajectory.
  • Diversification. It may be tempting to hop on the bandwagon of the hottest tech startup, but consider whether the company in question will help or hinder your portfolio diversification strategy.

How to invest in a pre-IPO company

Investing in a pre-IPO company isn’t as straightforward as buying publicly traded shares. That said, there are a few avenues of opportunity available to those interested in pre-IPO stock:

  • Crowdfunding platforms. Invest through platforms that offer pre-IPO stocks, like OurCrowd, SharesPost or EquityZen.
  • Indirect exposure. It’s common practice for companies to invest in companies, so if you can’t back a stock directly, consider investing in a publicly-traded company that participates in private fundraising.
  • Pre-IPO placement brokers. Some banks, lending institutions and investment brokers specialize in pre-IPO placements, so you may be able to access pre-IPO stock through a third party.
  • Become an angel investor. While it’s not a viable option for everyone, becoming an angel investor is one way to back private companies. Angel investors are permitted to participate in pre-IPO placements, so if you already qualify as an accredited investor, consider becoming a full-fledged angel investor and joining a syndicated angel list.

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Our expert take

Pre-IPO companies present a potentially lucrative investment opportunity — but a lack of financial data may make it difficult to accurately gauge the risks. Before you buy in, review your platform options across multiple brokers to find the account best suited to your investment goals.

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