A guide to buying pre-IPO stocks

Want to trade stocks? You probably know how easy it’s become to open an app, and with a few taps, buy and sell publicly traded companies. Brokerages have even expanded access to initial public offerings (IPOs). But what about how to buy pre-IPO stocks? Before companies announce that they’re going public, obtaining equity in a private company might seem difficult. Being an employee with stock options in a startup or a venture capitalist participating in a funding round might seem like the only ways to buy pre-IPO stock.

The good news, however, is that some individuals can invest in pre-IPO stocks through secondary marketplaces like Forge. If you meet the financial requirements of being an accredited investor, then investing in companies before they go public might be easier than you assumed.

The good news, however, is that some individuals can invest in pre-IPO stocks through secondary marketplaces like Forge. If you meet the financial requirements of being an accredited investor, then investing in companies before they go public might be easier than you assumed.

What are pre-IPO shares?

Pre-IPO shares are simply shares of privately held companies. In contrast, when a company has an IPO or otherwise goes public (for instance, through a special purpose acquisition vehicle, or “SPAC”, transaction or a direct listing), its shares become publicly traded on stock exchanges, like the New York Stock Exchange or NASDAQ

In some cases, pre-IPO shares refer to companies that are on the cusp of going public. Perhaps they’ve even filed to go public but the IPO date hasn’t occurred yet. But pre-IPO shares can also refer to startups that are privately owned, without any specific path toward an IPO. They might have an IPO (or otherwise go public) in the future, or they might never go public.

Who generally buys pre-IPO shares?

Several different types of investors can buy pre-IPO shares. Examples include:

• Institutional investors, e.g., private equity funds, venture capital funds, and hedge funds, who invest in private companies, such as through primary capital raising rounds
• Other companies looking to acquire stakes in new businesses, like a publicly traded automobile company investing in a self-driving car startup
• Individuals buying pre-IPO shares as part of a friends and family round during the early days of a startup. These often involve accredited investors, but there can be some exceptions that allow some unaccredited individual investors to take part.
• Individual investors participating in a crowdfunding campaign to buy private shares
• Accredited individuals buying pre-IPO shares through a secondary marketplace like Forge. In these marketplaces, private shares could come from employees looking to sell some of their company stock before an IPO, or they might come from institutional investors who participated in earlier funding rounds and want to liquidate some of their holdings.

In other words, don’t assume that private markets are closed off to you if you’re not in a founder’s inner circle or aren’t connected to a VC fund. So, how to buy pre-IPO stock?

See if you meet the SEC’s requirements for being an accredited investor, e.g., having an individual annual income of $200,000 (or $300,000 joint) for each of the past two years, with reasonable expectations to have that for the current year too.

If you qualify as an accredited investor, then you might be able to buy (you would generally not be required to be an accredited investor to sell) pre-IPO stocks through a secondary marketplace like Forge.

What are the potential benefits of buying pre-IPO stock?

Buying pre-IPO shares can provide several benefits, such as:

Early access opportunities

While there’s no guarantee that startups will increase in value if they go public (and virtually any investment, including in startups, can lose some or all of its value), you can at least have the opportunity to get in early. If the company grows, you might experience a significant upside over the long term.

Potential for outsized returns

Related to the benefits of getting in early, pre-IPO investment opportunities can provide the potential for outsized returns. Even if the company is well known and has reached unicorn status, for example, that doesn’t mean it's too late to experience growth. Just as publicly traded companies can provide significant returns, such as when they beat earnings estimates, privately held companies can also provide outsized returns, such as if they eventually go public and investor demand drives up the share price.

Diversification

TThe private market could be considered a separate asset class compared with publicly traded stock. So, you can potentially benefit from diversification if you buy some pre-IPO shares, rather than investing entirely in publicly traded stocks.

What are the potential risks of buying pre-IPO stocks?

While buying pre-IPO shares can benefit retail investors in several ways, you should also be aware of potential risks/downsides, such as the following:

Less liquidity

In addition to contributing to higher fees, limited liquidity generally means that trading pre-IPO shares takes more time than it does for publicly traded companies. A private market transaction could take a couple of months up to a year to complete. Liquidity levels can also affect transparency.

More red tape

Pre-IPO shares can also involve more regulatory compliance and company trading rules. In addition to requirements for being an accredited investor, for example, you can also face rules like IPO lockups

These lockup periods are determined by companies, and generally, they require shareholders to hold onto their stock for the first six months following an IPO. So, if you buy pre-IPO shares, know that you might not be able to sell immediately after the company goes public.

Potential loss of investment

As with virtually all investments, investments in pre-IPO stocks carry the risk of decreasing significantly or going to zero, such that an investor not only fails to make a return on the investment, but actually loses some or all of the money originally invested.

While you should consider these risks, buying pre-IPO shares can still be a great way for accredited investors to allocate to startups. Consider speaking with a financial advisor to assess in more detail if/how private company stock fits into your portfolio.

You can also register with Forge to gain more private market insights.