Pre IPO

What is Pre IPO?

Pre IPO can be defined as a method used by companies to procure capital by selling a large amount of shares/stocks before it has actually been publicly traded in some exchanges to private investors, hedge funds, HNIs, etc. and also it has no prospectus available when the sale takes place.

Explanations

Pre-IPO

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Source: Pre IPO (wallstreetmojo.com)

Examples

Uber, the well-known app-based taxi service company, had issued pre IPO placement before the launch of its IPO in May 2019. The shares were very limited and were available to only key individuals from the board of directors and also for private investors to raise significant amounts of capital before the actual launch of the IPO.

Who sells Pre IPO Shares?

Process of Selling Shares in Pre IPO

  1. Usually, private investors pitch in for their interest to buy pre-IPO shares
  2. The issuing company provides the bank account for the transfer of the sum to take place.
  3. The buyer or private investor provides it’s DEMAT account details.
  4. On a particular date of settlementDate Of SettlementThe settlement date is the date on which the cash and assets that have been exchanged or traded are settled by netting out a process that happened a few days ago. Commonly for shares, it is two business days after the trade.read more, the issuing company transfers the shares to the DEMAT account of the private investor. In contrast, the private investor transfers the purchase amount to the bank account details of the issuing company.

How to Invest in Pre IPO?

Pre-IPO operates more in an unorganized when compared to the IPO process. One can invest in such shares by:

Risk Involved in Pre IPO Investment

#1 – Capital Loss

Investing in companies where the IPO has not been tried and tested can, at times, lead to total capital washout. Here the expected return is also coupled by the risk of a complete or partial wash out of the sum invested in such unlisted companies. The company may go bankrupt in the future due to operational failure or absence of future funding and lead to a loss to the capital investedCapital InvestedInvested Capital is the total money that a firm raises by issuing debt to bond holders and securities to equity shareholders. Invested Capital Formula = Total Debt (Including Capital lease) + Total Equity & Equivalent Equity Investments + Non-Operating Cash read more by pre IPO.

#2 – Lack of Liquidity

When we invest in an unlisted company, the chances of selling the share in the future are grim as there be a lack of buyers interested if the company fails to generate a positive pulse in the market. Thus on account of the difficulty in selling or trading the shares, a liquidity crunch may tend to arise.

#3 – Scarcity of Dividends

Few companies may fail to pay dividends out of Pre IPO placements because majority shareholders will opt for the money generated to be reinvested in the company itself. Thus companies raising capital by Pre IPO will find it difficult to give returns in the form of dividendsDividendsDividend is that portion of profit which is distributed to the shareholders of the company as the reward for their investment in the company and its distribution amount is decided by the board of the company and thereafter approved by the shareholders of the company.read more.

#4 – Dilution

If the company plans to accumulate new funds at a later stage through additional funding by issuing newly subscribed shares, the value of holding previously held by pre-IPO investors who fail to subscribe to this new additive capital will eventually fall.

Advantages

  • It is investing can sometimes be considered a more profitable investment than IPO.
  • A great product/service can be funded by it and the one investing it, providing seed capital to this amazing investment. One becomes the early subscribers to the shares of a company even before it has reached the public.
  • The share obtained are bought at a discounted rate, which immediately triggers profit-making in the mode of difference in the amount of share bought at the Pre IPO stage and to the price that the company will quote during the IPO.
  • It helps in avoiding the trading stampede in the market where the share prices go aggressively high or low and offer an opportunity to get the trading or investment done before others do.

Disadvantages

Conclusion

  • Pre-IPO is a sale of a chunk of shares to private investors or wholesale investors at a discount from the IPO price. It is done basically to accumulate funding for the initial public offering.
  • The company uses the capital as a hedge to mitigate the risk of the initial public offering failing as what it was hoped for. The buyer utilizes it as profit earned from the discounted share versus the actual share price during the IPO though there is no fixed assurance that the market will pay the expected price per share.
  • The purchase is made without the availability of any kind of prospectus or any kind of guarantee that the pre IPO placement will lead to an IPO. Thus the discounted price is treated as the compensation which the buyer gets for bearing this risk or uncertainty.

This article has been a guide to What is Pre IPO & its Definition. Here we discuss how to invest in pre-IPO along with examples, risks,  advantages, and disadvantages. You can learn more about from the following articles –

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