Pre-IPO Stocks: What They Are and How To Get Them

W ondering how to get pre-IPO shares? You’re not alone. These intriguing investment opportunities can be hard to come by if you’re not connected with a company about to go public. However, there are some ways you can get in on the action. Just keep in mind that along with the potential for huge and quick profits, pre-IPO stocks come with significant risks.

Key Takeaways:

  • An IPO happens when a company first goes public and shares stock in the open market. Pre-IPO stocks are shares that certain investors hold before the IPO happens.
  • It can be difficult to buy pre-IPO shares unless you’re closely connected to a company, but some methods exist for investors who want to look for ways to buy pre-IPO stocks.
  • The big advantage of pre-IPO stocks is the potential for the ‘first-day pop,’ which happens when a stock makes huge gains on its first day of trading.
  • Buying shares pre-IPO comes with considerable risks. In addition to a general lack of information before a company goes public, there’s no guarantee that stocks will continue performing well — even if they do experience that initial ‘pop.’

What Are Pre-IPO Stocks?

Image via Unsplash by austindistel

An IPO, or initial public offering, is the time when a company first goes public, selling shares from its stock in the open market. Pre-IPO stock, then, is stock that companies offer before going public.

An IPO is underwritten by one of three main sources:

  • An investment bank.
  • A broker-dealer.
  • A group of broker-dealers.

The entity underwriting the IPO purchases shares from a company. Then, that entity sells and distributes shares to investors at the IPO. Up until the moment the IPO happens, a company remains private.

Private companies often offer pre-IPO stock in order to raise extra funds before going public. Since the pre-IPO buyer won’t know how the stock will perform once the IPO happens, there is a risk that the stock underperforms, resulting in potential losses.

What Is Pre-IPO Placement?

If you’re looking into buying shares pre-IPO, keep in mind that a big piece of pre-IPO share selling happens in pre-IPO placement. A portion of IPO stocks are given to private investors just before the IPO is about to hit the market when the IPO is made public.

Most private investors who engage with pre-IPO placement either have private equity or large hedge funds, allowing them to invest in a big stake in the company. Because these private investors take on a big part of the company’s investment, they often pay a lower price for pre-IPO shares than the IPO’s prospective price.

Pre-IPO placements usually happen when there’s a big demand for a pending IPO. This demand can occur because of the IPO placement’s price per share, with risk depending on the company going public with shares. The pre-IPO placement makes up for the risk by offering a lower per-share price than the expected price the IPO will offer. The risk usually comes from the potential for low post-IPO demand, which can decrease the price of the shares.

How to Buy Pre-IPO Shares

It isn’t always easy to buy stock before an IPO. Investing in these shares can often only happen if you know the right people. Investors who have the opportunity to buy shares pre-IPO most often include:

  • Company employees.
  • Company management.
  • Family and friends of the company.
  • Hedge funds.
  • Investment banks.
  • High-net-worth clients.
  • People with huge accounts with the broker that will bring the company public.

Even if you do fall into one of those categories, it’s no guarantee that you’ll be offered the chance to buy pre-IPO shares. The hottest IPOs usually have huge interest (think: LinkedIn’s IPO), and unless you’re very closely linked to the company, it can be really tough to get in.

That said, buying pre-IPO stock is not impossible. A few methods for getting the chance to invest in pre-IPO shares exist, including:

  • Developing business connections: You can make connections at events like business incubators or venture forums. You can also establish relationships in angel investor communities.
  • Monitoring the news and alerts: Look for news about companies that plan to go public or even startups. You can ask about companies looking for investors by speaking with local accountants and bankers as well.
  • Working with a stockbroker or advisory firm: Stockbrokers and advisory firms specializing in capital raisings and pre-IPO shares offer one of the most common ways for investors to get started with buying pre-IPO stocks. They can give instructions about how to invest in pre-IPO stocks before a company goes public.

When Can You Sell Pre-IPO Stocks?

One of the biggest draws of purchasing stocks before an IPO is the potential to make big profits, usually on the first day of trading. If you buy IPO stocks, they’re generally held with a brokerage account. You can sell them at pretty much any time by phone or online. You also can usually place a limit order, setting the price and number of shares you’d like to sell. You should keep in mind that you’ll likely owe your broker commissions.

If you make a profit from shares you hold for less than a year from your date of purchase, those profits are typically taxed as ordinary income. This rate is usually higher than the rate for long-term capital gains.

The Benefit of Buying Pre-IPO Stocks

Investors try to buy pre-IPO shares because they can be incredibly lucrative. The biggest way pre-IPO stocks lure in investors is with the potential for a huge increase on the first day the stocks are traded publicly. You might hear this referred to as the ‘first-day pop.’ For example, when LinkedIn started trading publicly in 2011, the company’s shares rose a whopping 109% on the first day.

Risks When Buying Pre-IPO Stocks

Investing in pre-IPO shares can include risks that go beyond typical investment risks. With a company that has been public for a longer time, you can more easily look at stock charts and analyze the trajectory of the business’s growth. That’s not possible pre-IPO stock.

Risks that come with pre-IPO investments include:

  • Lack of information: When it comes to pre-IPO shares, it can be much more difficult to evaluate a company’s future due to what’s known as information asymmetry. When managers and directors sell their shares as pre-IPO stocks, they know much more about their own company and the situation it’s in than the people who are buying into the company. Managers and directors are not required to disclose information to the public while a company is still private. This automatically limits the amount of information you’ll be able to find on the company.
  • Increased price: Underwriters who complete the sale have an incentive to maximize the price they can secure in the secondary market.
  • Difficulty selling: Shares purchased before an IPO are much harder to sell before stocks start publicly trading.
  • No price guarantee: The first-day pop with an IPO certainly is the stuff of legends. However, even if a stock performs amazingly well on that first day, that’s no guarantee for the stock’s continued performance. Even some of the biggest IPO performances in recent history haven’t completely lived up to expectations after an initial honeymoon period. Consider big names like Spotify, Twitter, and Facebook. Those companies all saw their stocks fall substantially after their debut. Only Facebook manages to consistently surpass its IPO price.

G etting in before an IPO may sound like the ticket to immediate riches. Even if you can get access to one of these events, you’ll want to be wary of the big risks IPOs can pose.