Pre IPO Investing: Meaning, Benefits & How to Get Started

What Are Pre-IPO Stocks?

Pre-IPO stocks are stocks of companies that are yet to go public. You will be one of the company's important shareholders and a part of its growth as a pre-IPO investor. It is also possible to earn a huge profit when the company goes public.

You might not get an allotment if an IPO is oversubscribed. This is one reason why some investors choose to invest in pre-IPO companies. Before going public, many companies opt for pre-IPOs to reach out to investors and gather capital.

How Does Pre-IPO Investing Work?

Interested investors can invest in the company's growth before it goes public. However, a lack of awareness makes pre-IPOs less accessible to everyone. Previously, pre-IPO shares were only available to banks, hedge funds, private equity firms, and a few other entities.

You can now invest in pre-IPOs if you have a bank account and a demat account. Additionally, a company can now dematerialise its shares, allowing everyone to invest in them and conveniently transfer them between accounts.

Share brokers handle the majority of pre-IPOs as investing in a pre-IPO requires their help. Pre-IPO companies and their details, such as brokerage fees and share prices, are disclosed by your broker.

If you wish to invest in the pre-IPO, you must send the investment amount to the broker, who will transfer the amount to the company's account. Shares will be delivered to your demat account by T+0 evening or T+1 morning. The transaction is complete once you see the ISIN number of the shares in your demat account.

Fund houses are another way to invest in pre-IPOs. AMCs often offer limited-subscription pre-IPO mutual funds. In this way, as an investor, you can invest in companies at the end of their development stages.

Why to Invest in Pre-IPO Companies?

You can benefit from investing in Pre-IPO companies for a variety of reasons. Some of them are:

• Pre-IPO is launched by top players

On paper, a startup may look good, but it's more likely to succeed if an experienced entrepreneur leads it. These leaders have already mastered the art of running a business and have a good sense of what works and what doesn't. Investing in Pre-IPO companies allows investors to get in early with someone who has done it before.

Investors who put| money into Pre-IPO companies are betting on both the team behind them and their reputations. Your investment will likely yield better returns if you invest in an established company with an experienced founder than if you invest in an upstart without knowing their success factors.

• Business models of pre-IPO companies are profitable

Often, pre-IPO companies have been around for at least a year and have shown they are profitable. In other words, it means their business model is working. A company's valuation skyrockets when it goes public, and it has to compete with much larger companies.

These challenges don't exist in pre-IPO companies - yet - which is why you can purchase solid companies at a low price. If you invest in pre-IPO companies, you get dibs on profit. You can cash out as soon as the stock begins trading when you're first to invest (and profit).

One of the benefits of investing in pre-IPO companies is being able to do so early enough to gain when they go public. When you invest in pre-IPO companies, you can benefit from big upsides without having to wait for an IPO. Moreover, compared to IPOs, pre-IPO investments are subject to less regulation.

• Pre-IPO companies have detailed plans

Pre-IPO companies often have more information available than their post-IPO counterparts. Since these startups do not need to raise additional capital, they have more time to develop detailed business plans for investors.

Getting involved with a pre-IPO company now remains advantageous, even if you do not intend to buy equity right away. The relationship you establish will be important when shares are offered to other investors and sold on the public market. It is better to invest now than to wait later if you want to build a relationship.

In pre-IPO businesses, failure is taken very seriously. Comparatively, private companies have less incentive to do anything but prioritise success over failure than publicly traded companies with quarterly earnings reports. This means even higher standards and better products from startup founders who haven't thought about liquidity yet.

Pre-IPO opportunities can be a great way to increase your risk/reward ratio. It is a networking opportunity to invest in a pre-IPO company. Thus, making connections with pre-IPO startups is an effective way to build those networks now rather than later.

• Pre-IPO stocks offer better value for money

With pre-IPO stocks, you can invest in a company at a fraction of its market value, resulting in higher returns. As compared to IPOs, they are more accessible due to the low prices, only if the investment makes it through the initial hurdles.

Even though some companies quote low IPO price values to woo investors, most stock markets correct post-IPO, resulting in greater losses than investing in pre-IPO companies. Many financial experts recommend buying shares on the primary market rather than the secondary market, as post-IPO corrections are common.

Investing in private funds early also allows you to spot valuable trends ahead of time and set yourself up with valuable investments before others. In the primary market, there are no 'corrections' because the markets do not shift once stocks are listed on secondary platforms. As a result, you have more control over your holdings and can decide which companies succeed or fail.

A high-net-worth individual (HNI) generally invests a huge amount in a single deal when investing in these types of stocks. They also tend to know about companies long before they launch publicly, allowing them to act first rather than react later, again giving them greater control over which startups succeed and which fail. Because of their low market value, pre-IPO stocks offer you a wider selection of stocks and safer returns. It is possible to diversify your investment portfolio by purchasing pre-IPO stock if you are looking for ways to do so.

• Pre-IPO stocks are less risky investments

Investing in companies before they go public can seem like a safer bet because these companies are usually not making much money yet or maybe not making any at all. So, there's less risk because there aren't a lot of people buying and selling their shares like in the stock market.

But remember, there's always some risk because businesses can fail, just like how some new ideas can suddenly become super successful. Whether a company does well or not also depends on whether more people invest in it. So, it's important to see how much money is being put into certain types of businesses.

It would be helpful to clarify that pre-IPO investments are subject to risks but can offer high returns. For example: While there are risks associated with investing in pre-IPO companies, it's important to note that these investments offer a good chance of earning high returns. As many investors actively seek pre-IPO stock opportunities, there's little chance that such opportunities will go unnoticed for long.

Benefits of Pre-IPO Investing

Pre-IPO investing provides early access to high-growth companies before they enter the public market, increasing the chances of long-term returns.

1. Invest Early in Promising Companies
Pre-IPO investing gives access to companies at an early growth stage, often before their business potential is fully recognised by the broader market.

2. Higher Potential Returns
Since valuations are typically lower before listing, successful IPOs can deliver strong capital appreciation once the company goes public.

3. Diversification
Including the pre-IPO investments in your portfolio will also be able to diversify your portfolio, giving you an opportunity to be exposed to the private companies that are not listed equities.

Risks of Pre-IPO Investing

Some of the risks associated with pre-IPO listing are as follows:

1. Liquidity Risks
It is difficult to sell pre-IPO shares, and you might have to wait till the time the company is listed in the market or in the secondary market.

2. Valuation Uncertainty
In the absence of a publicly available market offer, valuations can be subjective and not the real value of the company.

3. Lock-in Period Post Listing
You are often restricted from selling shares immediately after IPO listing due to mandatory lock-in periods.

4. High Minimum Investment Amount
Pre-IPO deals are also often capital-intensive and therefore not accessible to retail investors.

5. Regulatory Risk
Changes in the regulations, listing approvals, or compliance requirements can delay or even derail IPO plans.

How to Evaluate Pre-IPO Investment Opportunities

Some of the ways to evaluate a pre-IPO investment opportunity include: Financial Performance

1. Management Team
A capable and experienced leadership team increases the likelihood of effective execution and long-term success.

2. Market Potential
Evaluate the size of the market, industry growth, and the company's competitive positioning.

3. Exit Strategy
Understand how and when returns can be realised, whether through the IPO, acquisition, or secondary market.

4. Due Diligence
Conduct thorough legal, financial, and operational checks to identify hidden risks and red flags.

Factors to Consider Before Investing in Pre-IPO Stocks

While pre-IPO shares can offer significant upside potential, they also come with inherent risks. Here are some key factors to consider before deciding to invest in pre-IPO stock.

1. Company valuation

Before purchasing pre-IPO shares, it is crucial to evaluate the current valuation of the company. A company’s valuation before the IPO can determine the price at which its shares are offered to early investors. If the valuation is too high, there may be limited upside potential once the shares are publicly traded. Conversely, a low valuation could indicate room for growth. As an investor, you should carefully examine the company’s financials, business model, and competitive landscape to assess whether the valuation is justified.

2. Growth potential

You should consider the growth potential of the company when deciding whether to buy pre-IPO shares. Companies that are in rapidly expanding sectors or have innovative business models may be well-positioned for substantial growth. However, you should also assess the company's scalability, market size, and ability to capture market share. Investing in pre-IPO companies with high growth potential can lead to significant returns, but it's essential to have a clear understanding of the company's business plan and its ability to execute on that plan.

3. Liquidity risk

One of the significant risks with pre-IPO investing is the lack of liquidity. Unlike publicly traded stocks, pre-IPO shares are not easily bought or sold. You may need to wait several years for the company to go public or for another liquidity event, such as a merger or acquisition, before you can sell your shares. This illiquidity can be particularly challenging for individual investors who may need access to their capital. Before investing, it's essential to be comfortable with the potential for a long holding period.

4. Regulatory and market risks

The regulatory environment can have a significant impact on pre-IPO companies. Changes in regulation, especially in highly regulated industries such as healthcare or financial services, can affect a company's ability to grow and succeed. You should also consider broader market conditions. If the market is experiencing volatility or an economic downturn, it may affect the timing of the IPO or the company’s post-IPO performance.

How Can Pre-IPO Investors Monetise Their Holdings?

After investing in pre-IPO stock, there are several ways in which you can monetise your holdings.

1. IPO listing

The most common way for pre-IPO investors to monetise their holdings is by selling their shares once the company goes public. After the IPO, shares are listed on a public exchange, and early investors can sell their shares through standard stock market transactions. However, as mentioned earlier, as an early investor, you may be subject to a lock-up period, during which you cannot sell your shares.

2. Secondary market sales

In some cases, you may not have to wait for the IPO to sell your shares. There are secondary markets where investors like you can trade pre-IPO shares with other interested buyers. These markets provide a platform for early investors to sell their shares before the company goes public. However, liquidity in these markets can be limited, and the prices may not be as favourable as the post-IPO price.

3. Mergers and Acquisitions (M&A)

Sometimes, a pre-IPO company may be acquired by another company before it goes public. In such cases, you can often sell your shares as part of the acquisition deal. Depending on the terms of the acquisition, you may receive cash or shares in the acquiring company.

4. Private equity buyouts

Private equity firms often buy stakes in pre-IPO companies and may offer to purchase shares from early investors. This can provide an opportunity for investors like you to cash out before the IPO or another liquidity event.

Conclusion

Due to the fact that they are not listed yet, pre-IPO investments offer substantial return potential at low investment costs. It might be helpful to mention that as an investor, you should conduct thorough due diligence and consider seeking advice from financial experts or professionals before investing in pre-IPO companies. This is where experts at Kotak Neo can help you with your investments. When a company is still in its early stages of growth, you can make money investing in its stock.

Read more Process of IPO in India: A Step-by-Step Guide for Investors