Everything You Need to Know - How to Invest in Startups Before IPO | INVESTEDMOM
There has been a growing interest in pre-IPO investment opportunities fueled by technological advancements in the modern industry. Savvy investors know the value of early-stage investing in a private company through initial public offerings (IPO) before a startup becomes available. This investment strategy can entice investors to seek higher returns through their investment dollars. Potential investors should understand the benefits and risks involved in buying pre-IPO tech stocks if they want the best chances of investment success.
Understanding the Basics of Pre-IPO Investing
Early investing, or startup investing in the pre-IPO stage, is when you invest in a company just starting its journey as a business or before the business is open to the general public. The significant risks involved are one key factor that sets pre-IPO stocks apart from other investment strategies. If startups fail, this can pose tremendous investment losses for early investors.
Investing in pre-IPO companies can lead to high-value returns as private investors can invest in 'the next big thing' before it begins trending. More than likely, these pre-IPO shares will be significantly undervalued. When you invest in pre-IPO shares, you can gain back more money as the private companies grow and increase their net worth. These returns are not guaranteed, as these pre-IPO investments are often illiquid or difficult to resell.
A diversified investment portfolio comprising various investment strategies across multiple businesses can increase your chance of success by lowering your investment risks. About 5% to 10 % of your portfolio should consist of pre-IPO shares.
Determine Your Investment Strategy
By determining your investment portfolio plan, you will better understand your goals and risk tolerance. Understanding various facets of your investments can help you identify what type of pre-IPO investing will most benefit you. Diversifying your portfolio with multiple investment strategies can benefit your private assets.
Crowdfunding Platforms
Equity crowdfunding is a form of startup investing where accredited investors can buy shares online to support private companies. These are excellent investment options for startup companies looking to do minimal capital raising from a large base of investors.
Crowdfunding platforms typically allow businesses to create a profile containing information on their pre-IPO company as a way for investors to gain a general overview of a company and decide whether it is worth investing their money into.
Accredited investors can buy pre-IPO stocks from various private companies to lower their risks and increase their odds of investment success.
Venture Capital Firms
When you invest through venture capital firms, you pool your money with like-minded investors to support private companies. These investments can happen during any stage of a business' development but typically take place during the earlier stages.
These private equity investments are precarious and usually reserved for accredited investors that meet financial regulations. An accredited investor must meet specific criteria, including having the appropriate yearly income.
This type of pre-IPO investing can benefit venture capitalists by giving them an active management role in the company. They will also receive more significant returns and can pull out when they feel right.
Angel Investing
Angel investors are investors that buy pre-IPO shares to support the beginning stages of a company. This financial backing is usually associated with the exchange of ownership equity for the angel investor. These pre-IPO investments are usually single installments to help a project or business or to provide support through rough patches.
Angel investors run several risks and should only represent between 5% and 15% of an investment portfolio. This approach is the opposite of venture capitalism. Both accredited and non-accredited investors can include angel investing in their portfolios.
Do Your Research
Suppose you are looking to buy pre-IPO stock in a private company. In that case, it is necessary to research beforehand to ensure you are finding the best pre-IPO opportunities. You can do this by networking through startup pitch events or looking around on pre-IPO investing platforms. As you begin the decoding process, critically evaluate the businesses to fully understand their business model, check the background of their marketing team, and assess whether the company has a competitive edge.
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Connect with Pre-IPO Companies
By maintaining an open line of connection between you and the team you are investing in, you will build a better relationship with them and enhance your mutual trust. Attending networking events is a great way to meet the founders of private companies and gain a deeper understanding of their startup mission.
Pitch events are a great way to negotiate terms with a team before buying pre-IPO stock in their business. These terms can include the minimum investment requirements, percentage of ownership, and what might happen in the event of stock volatility.
Invest in Pre-IPO Stocks
After a group of investors and founders come to terms with an agreement, they must finalize their deal to legalize it, which typically includes signing legally binding documents, including investment and shareholder agreements. Before any signing can begin, you must be sure you meet the investment criteria for a particular type of pre-IPO investing. Measures can include suitability for the platform or having accreditation.
If you buy pre-IPO stocks, remain transparent and keep a record of all of your investment communications. Having a record of your pre-IPO investments can help during potential legal complications.
There are various ways you can buy pre-IPO stock. One of the most popular methods is wire-transferring money straight from your mobile device. This payment type is connected securely to your bank account to ensure a seamless transaction. Unfortunately, these transfers can take time and come with percentage fees. Similarly, you could pay online using a credit or debit card, though these limits are lower than wire transfers.
You can also pay with checks for pre-IPO investing. Checks are less secure than other options, as they risk getting lost or stolen during the mailing process. Travel and processing time can drag out the private investing operation. Another method is contacting various accounting firms or consulting an accredited investor for further guidance.
Monitoring the progress of your investment can help you see if your assets are feasible. You can review the financial statements of your initial public offering investment to grasp their financial position better. You can get a closer look at how your assets are coming along by speaking directly to the management team or attending meetings for shareholders of publicly traded stock. Doing this will help you become more involved with pre-IPO companies.
Risks and Rewards of Startup Investing
Investing in pre-IPO companies can be highly rewarding while posing many risks. Understanding the benefits and potential drawbacks can help determine if pre-IPO placements suit you before buying pre-IPO shares.
Rewards
Increased Liquidity
With a private company, a few investors often hold the shares, making it challenging to sell pre-IPO shares. After a company's IPO, the shares are available in marketplaces like the New York Stock Exchange or Nasdaq. Trading in a marketplace increases liquidity and makes dealing with and selling your shares easier. Public investors may be more stable and less likely to seek alternative investments.
Chance of Higher Returns
Pre-IPO companies are an excellent opportunity for investors to purchase pre-IPO stock at a significantly lower value than its worth later on. The limited availability associated with pre-IPO stocks make higher returns more likely for investors lucky enough to get their hands on these assets. These returns are not guaranteed, as pre-IPO companies can underperform.
Diversification
Investing in pre-IPO stock or an industry in which you have yet to invest can help mix up your portfolio. Buying pre-IPO shares gives you access to new business models that you may not have been able to see otherwise. You can talk to an investment adviser for assistance in diversifying your portfolio.
Transparency
The Securities and Exchanges Commission (SEC) requires businesses to file regular financial paperwork and adhere to accounting requirements and practices set by the Generally Accepted Accounting Principles (GAAP). High transparency can help an investor make better-informed decisions based on a business' likelihood of success or growth, reducing their overall risk of investing in pre-IPO stocks.
Risks
Insider Selling
When shareholders quickly sell their pre-IPO shares after the initial public offering, it can signal to other investors that others do not have high hopes and they should sell as well. This pain can decrease the value of shares, making you lose investment dollars rather than gain them. Understanding why insiders might be selling is essential, as it could stem from personal reasons.
Underperformance
Success is no guarantee, and if a business is underperforming, it can be concerning even for accredited investors. A company can underperform from a lack of business or from performing less than what the public values it to. Furthermore, the market's current condition can significantly influence business success.
Volatility
Volatility refers to the ability of an investment to fluctuate rapidly in value. The inherited volatility of pre-IPO stocks makes them a riskier choice for investors of all backgrounds, including retail and institutional investors. These fluctuations can be for many reasons. One of these reasons is the effect broader stock market conditions might have on IPOs. When pre-IPO shares have high volatility, knowing when the best time to sell or buy pre-IPO can be challenging.
Lack of Data
Early-stage companies generally have little historical data, making it hard to know what you are getting into during the investment process. You need to know the financial health of a business to be more inclined to invest in it through pre-IPO shares. You might only know if a company's goals are realistic if they have vital data to support their claims.
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Investing in startups before IPOs can be a fantastic moneymaking option for individuals hoping to gain high financial returns and diversify their portfolios through the private market.
If you need help in the investing world, Invested Mom's course is here to help! Work with me to better understand your finances and learn the many risks and rewards associated with investing. With the proper knowledge, you can make significant strides through your investments.
Meet the Author:
Inge was born and raised in Cape Town, South Africa, and moved to Canada in 2010 looking for a better life. She always had an entrepreneurial spirit and started her first side hustle when she was 9 years old – selling fudge at school during lunch breaks.
It wasn’t until much later that she realized that saving isn’t enough to get ahead. She was always very interested in real estate, but saving up for a down payment was grueling and slow, and the demands of life kept getting in the way.
She started investing in herself and upgrading her skills while learning how to invest. She quickly became debt free and compounded her money at a staggering rate.
It wasn’t until she became a coach that she realized how significant an impact she can make in people’s lives by sharing her journey, learnings, and processes.
So here she is, advocating for everyone who is invested and wants to build their wealth, especially the mommas!