Pros and Cons and Factors to Consider Before Investing in a pre-IPO Company

6 min read • Published 11 January 2023
Written by Krishna Deshmukh

Investors choose to subscribe to IPOs to get an early mover advantage and make considerable profits as the stock price increases upon its listing. But, with a pre-apply in IPO, investors can apply for the same even before it is made available to the general public.

Previously, the option to pre-apply in IPO shares was available only for a few handpicked investors like banks, hedge funds, and other well-established entities. Now, the average investor can participate in it. 

Definition of Pre-application in IPOs

As the name suggests, in a pre-IPO placement, people can invest in shares of an organisation before the company decides to go public. This method is used by private organisations to survey the market and also gain capital before getting listed.

An  investor in pre-IPO companies experiences the entire journey of the startup right from its inception to its booming stage. Thus, they become a prominent part of an unlisted organisation’s growth and can also generate massive profits once the company gets listed.

Investing in startup companies that are not listed may turn out to be very risky, but investing in the right one can reap huge profits. For that, you need to do adequate research, analyse growth trends and then put your money into it, taking into account your risk appetite and investment goals..

Method of Investing in Pre-IPO 

Investors can purchase unlisted shares from intermediaries that deal with the sourcing and placement of unlisted shares. Such transactions do not occur on exchanges and are off-market transactions. You only need a Demat account to hold unlisted shares. 

If you want to invest in pre-IPOs, you need to approach these brokers, who will tell you about the share price and brokerage fees for the transaction. If you agree, the shares will be transferred to your Demat account. Alternatively, you can invest in mutual funds that invest in late-stage unlisted companies. 

It is important to remember that these shares may have a lock-in period within which you can neither buy nor sell the shares.

Things to Consider Before Investing in Pre-IPOs

With higher returns also come higher risks. As mentioned before, investments in pre-IPO companies can be very risky. Therefore, you should keep in mind the following factors before investing:

  1. Information Available on the Company

Although an unlisted company may not provide much information regarding its operations, you should still gather as much data as possible to evaluate the firm’s financial situation and future growth potential. The official website of the Ministry of Corporate Affairs (MCA) has important data about registered businesses.

The websites of companies are other useful sources of information. You can browse newspapers and media websites to check any accessible news on a company. Investors can also get a Private Placement Memorandum (PPM) from private enterprises planning to go public. 

It is a document that contains the details you require to determine whether the business is investment-worthy or not. Be sure to carefully study the PPM before purchasing pre-IPO stocks. You can also ask your stockbroker or investment advisor to review the PPM and give their opinion.

  1. Investment Period

Pre-IPO shares are generally long-term investments. To enjoy the benefits, you have to be patient and bear with the ups and downs of the market. Moreover, there is also a period where you can neither sell nor buy these shares. 

It can take months, at times even years, before the organisation decides to move from its pre-IPO stage to IPO. So, investors cannot expect immediate gains when investing in these shares.

  1. Risks Involved

An organisation that is at a late stage has a higher probability of going public. A private entity may also decide not to go public even after applying for pre-IPO. Moreover, it’s difficult to buy and sell shares of unlisted companies as only a few handpicked investors may want to trade. So there can be low liquidity. Eventually, dependency on brokers increases while completing these transactions.

Pros and Cons of Investing in Pre-IPOs

There are several pros and cons of investing in pre-IPOs. These are:

  1. Pros

In addition to potentially growing their money substantially, many investors buy pre-IPO shares to have some influence over the company’s policies. 

Unlisted organisations that have established a name in the market have a strong business model and serious intentions of making money. So it is likely that your investment at the pre-IPO stage will generate large profits once the shares are listed, allowing you to make an early exit. You can also stay invested over the long term to grow your profits.

  1. Cons

There is little certainty regarding the fact that a private organisation will become public in the near future. The returns may also be affected as it might be difficult to find buyers of these unlisted shares, if someone decides to sell them. There is also little guarantee that the IPO share prices will be higher than its pre-IPO ones.

Final Words:

To conclude, pre-IPO shares are ideal for highly aggressive investors looking to make large profits from investing in private companies with high growth potential. However, before you start investing, you should learn about the risks involved and make sure to thoroughly research the company’s fundamentals and future prospects. 

Frequently Asked Questions

Is there any benefit of pre-applying for IPOs?

Yes, the share prices are available at a much lower price at the pre-IPO stage. Moreover, if the IPO has huge demand in the market, it provides an option for a profitable early exit.

What happens to pre-IPO shares after an IPO?

Once a private organization with pre-IPO goes public, the existing shareholders can sell off their shares immediately, if they want to.

How long is the lock-in period of a pre-IPO?

The lock-in period for pre-IPO shares is usually one year. During this time, investors cannot sell their shares on the open market.

How are pre-IPO shares valued?

In contrast to publicly traded shares, the value of your pre-IPO equities is determined by the most current estimate of your company’s value rather than by the fair market price. Because of this, the company value can change drastically with the change in market sentiments.

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Krishna Deshmukh

Investment Principal
Krishna is an investment professional with a demonstrated history of working in Debt Capital Markets. He has completed his B.E. (Hons) in Computer Science Engineering from BITS Pilani and MBA (Finance) from JBIMS, Mumbai. He is currently working as Investments Principal at Wint Wealth. Previously he worked at Kotak Mahindra Bank at their DCM desk and Northern Arc Capital at their Structured Finance desk. learn more

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