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What is Pre-IPO Investing?
As an investor, you might have heard of initial public offerings made by the companies. Their primary objective is to raise money from investors to expand their business. In return, investors get numerous benefits from investing in it, like voting rights, bonus shares, rights issues, and interim and final dividends. Everyone wants to avail of these benefits when the company's fundamentals are strong enough to sustain. Investors can primarily sell these shares at a premium price.
When an IPO is oversubscribed, only lucky investors get the shares, and the rest of the funds are returned to the investors. It means only a few investors get allotment. The rest of them don’t get the share to hold. In such a case, you, as an investor, miss out on the opportunity to invest in a good company that might have the potential to give you better returns.
Pre-IPO could be a solution to the problem. You can apply for shares in a potential company even before the opening date of the IPO. To understand the concept of pre-IPO investing, we need to understand what an IPO is.
What is an IPO?
When a private company is willing to raise funds for the purpose of further expansion of the business in a heavy amount, they convert themselves into a public company for which it is required to make public a participative owner of the company.
IPO is a way to accomplish the task. A company offers the public to buy their shares through initial public offerings, IPO. Retail investors apply for their shares after analysing the company's internal management, fundamentals, and financial growth potential, and they invest in it if the company's financial reporting satisfies them.
By holding a company's shares, you, as an investor, will become the proportionate owner of the company. You will have a voting right in general meetings of the company, and your opinions matter to the board's decisions.
What do we mean by pre-IPO investing?
Before a stock is placed on a public exchange, a substantial number of shares are sold privately through a pre-initial public offering (IPO) placement. Due to the size of the investments being made and the significant risks involved, the price mentioned in the prospectus for the IPO is often discounted for the investors of such a placement. Private equity companies, hedge funds, and other institutions eager to purchase sizable interests in the company are frequently the buyers.
Earlier, it was not open to all investors. Only High Net Worth (HNI) individuals could invest through such a route because minimum investment requirements are so high to invest. As it required a deep understanding of the financial system and the current market structure, such types of investment were regarded as complicated. Consequently, only private equity firms, banks, venture capital firms, etc., could invest in enterprises before they went public.
But now, it's accessible to everyone, especially retail investors. Everyone can invest in the pre-IPO phase by choosing the correct company and observing the growth trend of the company. By dematerialising its shares, a firm can now sell them to anyone and make it simple for them to be transferred from one Demat account to another.
How does the profitability of investing in pre-IPO work?
There could be two options available to you when you invest in IPO.
Suppose you bought the shares of the company through pre-IPO for Rs. 1000 per share, and now during the IPO, the company is offering shares to the public at Rs 1500.
You can sell those shares during the IPO only and get the offered price, i.e. Rs 1500.
Now, if you see the potential of a price hike in the company’s shares, you can hold the shares till the IPO process is not completed. Suppose the shares of the company you have invested in through such a way opened at a premium and traded at the stock markets for Rs 2500.
Now, you can sell those shares in the secondary market, and you will get Rs 2500 per share.
This is how investing works from the perspective of investors. It is all about using educated predictions of the market about the company and investing by analysing the company's fundamentals. The previous study is necessary for investing in any market, whether it is primary, secondary, or pre-IPO markets. Adopting the right investment strategy leads you to growth in profitability.
Various reasons validate your investing decision through it. A few of them are as follows:
- It can generate the best returns on investment. The majority of technology stocks on the stock market have significant upside potential. However, it is obvious that before the company goes public, early investors stand to gain the most.
- The market is the least affected by stock market volatility. Depending on the business, events like the 2008 financial crisis or the 2020 pandemic don't impact these investments as much. The occurrences can, however, also have an impact on commercial enterprises. This will affect your savings.
- Like the stock market, this investment also carries some risk. In order to make up for it, companies discount their share prices. This helps to protect the company while also attracting investment. The company will still have the money that private investors have given it if it goes public, but the IPO fails.
- One of the major advantages of investing in it is you can get the shares of fundamentally strong companies at a significantly discounted price. If you are a trader, you can sell those shares to get profits; if you are a long-term investor, it will help you create wealth or accomplish your financial goals.
- The primary disadvantage of investing in a company before its IPO is that you do not know the market behaviour. Negative market trends could affect the business you have invested in. Business losses are ultimately your losses. There can be a great deal of danger. Startup companies aren't always successful. As a result, when an investment fails, there are no rewards.
- You are ultimately looking for an investment that can be sold at a premium price. But before that, companies need to list themselves, which requires SEBI approvals. The IPO might not take place if SEBI does not approve it. Additionally, the business itself might decide against going public.
Things to keep in mind while investing through such a route
Late-stage companies vs initial-stage companies
Before investing in it, you need to consider the company's probability of being listed on the stock exchanges. Generally, late-stage companies that are already well-established companies and operating effectively are likely to get listed easily.
The problem of uncertainty of listing a company after you have applied for such can be resolved if you go for late-stage companies.
Less volume in trading
You might face a lack of liquidity in the market regarding the company as it might not perform well in the IPO, which leads you to the lack of buyers of the shares. You must analyse the market for the company's shares well before investing in it. It will help you identify the appropriate investment strategy to follow.
Best way to invest in pre-IPO
There can be various ways to invest in it. However, you can choose any of them according to your financial situation and requirements.
- You can go for making an investment through financial advisors engaged in such investing. Ensure that your financial advisor has expertise in investing through these routes. You can check that through their record and historical investments.
- If you are very much interested in financial news, you can keep yourselves updated with the latest financial news. You can save the money you spend on advisors and gain knowledge.
Pre-IPO investing is a new way of investing for retail investors and has also opened a new set of opportunities to gain a decent amount of returns. In the case of such types of investing routes, you do not bet on the prices of the shares; you bet on the fundamentals and internal management of the company, which would lead you to true wealth gain in the long term future.
Frequently Asked Questions (FAQs) :
Q. Can retail investors invest in pre-IPO?
Yes, retail investors can also invest in the placements, as earlier only high net worth investors are able to invest in it because of high capital requirements. But now, retail investors can also invest through such a route in a company’s equity.
Q. Is it profitable to invest in pre-IPO?
It has the capacity to produce the best returns on investment. The majority of technology stocks on the stock market have significant upside potential. However, it is obvious that before the company goes public, early investors stand to gain the most.
Q. Can I sell pre-IPO stocks?
Yes, by listing your shares in the stock exchanges through a brokerage firm, you can sell your shares either through primary or secondary stock markets.
Q. Is investing through pre-IPO legal?
Make sure the company you have chosen is legitimate before you purchase the company's shares. Any business that has registered or been exempted is probably legitimate. Avoid the company in all certainty if it is not registered or exempt.
Q. Is there any lock-in period for pre-IPO?
The equity share capital owned by the company before the IPO must be locked in per current regulations for a year following the date of share allocation.