Pre-IPO Investing: Risks, Rewards and How to Invest in Startups (2024)

Pre-IPO investing is where the money is at. It used to be for millionaires. And the average investor could invest only in publicly traded companies. But times have changed.

Startups are risky. However, they also have the potential to bring in massive gains. Gains you don’t see on the stock market. That’s why you should consider investing in pre-IPO companies. Let’s look at the details of how to invest in startups before their IPOs…

What Is Pre-IPO Investing?

Pre-IPO investing iswhen youinvest in a private company before its initial public offering (IPO). An IPO is when a company’s sharestrade on a public market for the first time.Pre-IPO shares are not available to everyone. In the past, pre-IPOinvesting was limited to accredited investors, private equity firms, hedge funds and a few other groups.

But that’s no longer true. In 2012, Barack Obama signed the Jumpstart Our Business Startups Act, or JOBS Act.The bill makes it easier for companies to go public or to raise private capital and stay private longer. There are a few more additional benefitsfor private companies:

• The bill increases to 2,000 the number of shareholders a company can have before it’s required to register common stock with the SEC.
• It allows up to 500 unaccredited shareholders.
• It allows different forms of equity crowdfunding.
• The bill also raises the limit for securities offerings under Regulation A from $5 million to $50 million.

In 2015, the SEC adopted all titles under the JOBS Act. The rules went into effect in May 2016. Since then, unaccredited investors have been able to invest in companies before they go public with as little as $100.

So now that you know what it is, the next question is…

Should You Invest in Pre-IPO Companies?

Investing in a company pre-IPO can score you some huge returns. However, it’s important to do your research on the company beforehand. Every investment opportunity comes with a fair amount of risk, but startups in particular can carry a lot of risk.

This is where your research can make all the difference. However, private companies aren’t required to disclose certain information to the public. So, the information you can gather on one of these companies may be limited.

Additionally, your pre-IPO investment is only as strong as the company you’re investing in. You can never be sure that the startup you invest in will succeed. Fortunately, companies recognize these risks. That’s why many offer discounted prices for early-stage investors. This brings in investors, but it also protects the company. If it goes public and the IPO isn’t successful, the company still has funds raised from private investing.

Having outlined some of the risks, let’s consider what the benefits are…

Benefits of Pre-IPO Investing

Private equity firms and savvy investors flock to invest in startups pre-IPO for a few reasons…

Exponential Return on Investment

The first and biggest reason for pre-IPO investing is the gains. Pre-IPO investments can lead to tremendous returns for investors. Let’s look at how pre-IPO returns compare with the average stock market return.

Since the start of the stock market, it’s historically returned an average of 10% annually. That’s before inflation.

For example, let’s take a look at Snapchat (NYSE: SNAP). The company went public in 2017. Let’s say you invested $100 in the early days before it went public. Your $100 would have turned into $22,000. That’s a 21,900% gain!

Snapchat and other technology stocks have great potential in the stock market. Although you can see that early investors make some of the biggest gains before they go public. You can now get in on those gains as well.

Avoiding Stock Volatility

Another benefit is avoiding stock market volatility. Events such as the 2008 financial crisis or the COVID-19 pandemic can have a huge impact on the economy. Shares in public companies generally plunge as a result.

However, these events don’t impact investments in private companies nearly as much. They’re less likely to be affected by societal and economic events that trigger stock market shifts. On the other hand, these events can still impact companies. And that will impact your investment.

So, if you’re thinking pre-IPO investing might be right for you, the next step is…

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