How to take safe steps while investing in an Pre-IPO?

Pre-IPO investing is emerging as a great way to be a part of the initial growth phase of a company before it goes to the stock market. While this avenue can give huge returns it can be equally risky. Hence one should do a thorough research before investing in the shares.

Why Pre-IPO?

1. Go In Early and Make Profits: A pre-IPO is an avenue to enter the race early. Some companies allow their investors to buy the pre-IPO shares even 1.5 years before they get listed. The pre-IPO shares are sold at a substantial discount to the investors to compensate for the risks involved in investing in them. If the IPO prices increase substantially from the pre-IPO levels the investors can sell the shares after the lock-in period and make an exponential return on investment. Especially in the case of tech start-ups investing in the pre-IPO stage can help to reap numerous rewards.
2. Avoid Stock Market Volatility: Pre-IPO shares are not as much affected by global events causing stock market volatility as the shares listed on the stock exchange.
3. Pre-investing in companies with a successful track record de-risks positions.

Pitfalls of investing in Pre-IPOs

1. Pre-IPO is a risky business. Since unregistered shares are being bought in pre-IPOs the risk is extremely high. The offering may turn out to be illegal or fraudulent. One must be especially very sceptical about companies that promise huge returns or those having fancy websites and make unfounded claims.
2. Capital Loss: If a company gets a low valuation on listing, Investors run the risk of losing money.
3. Usually the success of start-ups coming out with pre-IPOs hinges on the success of an idea or a strategy. Any change in the economic or market conditions could hamper this success. Also the start-ups have limited financial resources and are so much more vulnerable to changes in the economic conditions.
4. Sometimes companies may delay going public or even cancel it. If the company delays its plan to go public and get listed, the investor’s funds get locked and he even might not make any profits in the deal. In case of project failure or bankruptcy, the company may be forced to altogether cancel the deal. The investor will lose all his money. Also, he will be stuck with shares which he cannot sell.
5. Companies raising funds by pre-IPO are not always in a position to pay dividends. This is because investors expect the funds to be reinvested in the company. Hence pre-ipos are not ideal for investors who expect recurring revenue like dividends.
6. Dilution: The investment share could be diluted if the company raises additional funds at a later stage

How to Avoid the Pitfalls and Make a Safe Investment

1. Details about the offering: One must obtain complete information on the company- its products, services, customers and financial results, background of the management and the history of the promoters. One must also check if the company has identified any investment banking firm to underwrite its offering. One must also understand the business completely, i.e., its business model, operations, financials and then only invest.
2. Read the documents of the companies completely before subscribing to their pre-IPOs. Examine the legal documents. Also especially one should completely read and understand the “Risk Factors” section which lists the general and specific risk factors that is company is exposed to.
3. Never invest more than 5-10% of the portfolio. That is one must diversify one’s portfolio. In case the investment does not go as planned one must be ready. Hence an investor must invest in a diversified portfolio like in bonds, preference shares. This will ensure that one can get returns even if things do not turn out as expected.
4. One must completely understand the advantages and risks associated with the investment that is being made in the pre-IPO.

Pre-IPO investing is risky. But they also have a potential to bring in huge returns to the investors. These kind of gains cannot be made in the stock markets. Hence one should be very careful before making a pre-IPO investment.

Team up with an expert

Though IPO investment requires a lot of complexities, it can get easier when teamed up with an expert. Want to be a part of a successful investment journey? Talk to our investment expert now!