5 Things To Look For When Investing In Pre-IPO Companies

We’ve all heard of people making a killing out of ‘the next big thing.’ Whether it was Uber, Snapchat, Snowflake, or, more recently, Bumble (which closed up 63% on its first day of trading) there has been no shortage of market debuts. One of the best ways to capture as much upside potential as possible is with investing in pre-IPO companies.

‍Pre-IPOs offer exposure to private companies that plan to go public—which then allows anybody to purchase shares in the business on the public stock exchange. Since more and more companies are choosing to stay private for longer, a pre-IPO company offers exclusive benefits and access to a broader range of investment opportunities.

But of course, not all start-ups are wildly successful. In reality, 90% of them fail. Pre-IPOs also carry significant risk. Knowing how to assess pre-IPO companies and their associated investment offers is essential to making sure you make intelligent pre-IPO investment decisions.

Diving deeper: What are pre-IPOs?

Pre-IPOs are investments in private companies with a plan to go public in the foreseeable future. These companies are often in their early development stages, operate in new areas, and have innovative business models. Pre-IPOs are a chance to purchase shares before the public market can, with the expectation that they will eventually go through the IPO process.

Companies offer pre-IPOs to source the funds that they need to grow or to sure up their internal processes and legitimacy before the scrutiny of a public listing.

Weigh up the advantages and the downside risks of pre-IPO investments

It’s critical to understand the advantages pre-IPO opportunities offer relative to other investment vehicles. It’s also essential to determine and account for the additional risk associated with what is essentially a speculative, sometimes unproven, investment.

Advantages

• Purchase shares at a discount. When a company goes public, everyone knows about it and can purchase shares - it’s also far easier to exit the position. Pre-IPOs do not carry these same characteristics, and are therefore priced lower than they would often be on the public market. Pre-IPOs often carry higher return expectations than the public equity markets.
• Diversify your portfolio. The value of pre-IPO investments are private and therefore ‘mark-to-market’ whenever a liquidity event occurs. They are not subject to the same second-by-second fluctuations in valuation as public shares. They are also not significantly correlated to traditional assets, offering diversity to a well-balanced portfolio.
• Access a wider range of opportunities. Pre-IPOs simply offer additional choice. There are thousands of private companies that the public cannot typically invest in. Pre-IPOs allow investors to back a wider range of business than they would usually have access to.

Downside risks

• Lower liquidity. You can’t sell your pre-IPO holdings on the public market, typically making it extremely difficult to exit your position, especially when things aren’t going well.
• Less regulatory scrutiny. Pre-IPO investments are not subject to the same SEC regulations and requirements of an IPO. This means they’re less transparent than public companies, making it more difficult to ascertain their true financial position and risk profile.
• No guaranteed exit. There’s no certainty that pre-IPO companies will ever go public. The process might be held up, delayed or cancelled, such as what happened to ANT Group earlier this year. Without this public liquidity event, the upside potential is heavily limited.

Key factors to evaluate when assessing a pre-IPO company

The scope of security analysis is far too vast and complicated to adequately cover here. However, when it comes to evaluating pre-IPO investment opportunities, there are a few key components that you should always at least consider. Here are four:

• Understanding. Do you know what the company does? If you do not understand what the company does, the market it serves, and its strategy to grow, it will be tough to come to an investment conviction. Take the time to evaluate how the company generates revenue, or if they have yet to do so, how feasible their path to sales is. What differentiates them from their competitors?
• Addressable market. There are very few monopolies globally, so in a competitive market landscape, you need to assess how large the company’s potential customer base is and how much of that they can realistically capture. Many pre-IPOs are disruptive technologies that are doing something different. If this is the case, how well have they demonstrated their customer acquisition model so far?
• Management. Most organizations, and particularly those in the early stages, are highly dependent on the quality of their management team. Have a look at the executives—what have they worked on previously, and how well do they know their current market? Have any of them had experience taking a company to IPO before? Ideally, you’d like to see an experienced team that has a history of success.
• Overall market. A company with sound fundamentals is a good place to start, but it’s important to take a macro approach as well. Is the company’s industry booming right now (like tech) or is it suffering a decline (like brick and mortar retail)? Is it a relatively blue ocean market with limited competition or are you fighting for survival against the best of the best? It’s important to know where the world (not just your company) is headed.
• Identifiable risks. It’s easy to focus on the positives, although successful investing is arguably more dependent on navigating risk. Every company has risks, and innovative organizations looking to challenge the status quo carry a lot more. Think about what could go wrong; what if the product or service does not resonate with consumers as much as anticipated? It’s also critical to remember that pre-IPO investments are risky in their very structure - they may never go public or be acquired.

Pre-IPO investing may seem complicated. Even when you do understand an investment opportunity, you may not have the tools as a retail investor to participate. HUDSONPOINT Capital provides both retail and institutional investors with the platform and advice needed to access a range of alternative investments, including attractive pre-IPO investment opportunities. By pooling investor’s funds, HUDSONPOINT Capital’s alternative and pre-IPO investment platform offers unique investment solutions with risk-adjusted return profiles designed to meet your financial goals.

If you’re interested in adding pre-IPOs to your portfolio, please schedule a call to learn more about the pre-IPO shares we have available right now.