Seasoned investors are on the lookout for upcoming tech startup pre-IPOs. And for good reason.
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The world’s top businesses with current market valuations above $1 trillion all have one thing in common: They’re all tech startups.
Considering the ever-changing nature of technology and its strong case for substantial financial gain, it isn’t surprising that tech startups are popping up left and right during this time.
These high potential companies are great investment opportunities for those very reasons, and investing in tech startup pre-IPO is an even smarter move that may reap numerous rewards.
What is a pre-IPO?
Table of Contents
Why investing in tech startup pre-IPO makes senseBest Practices when investing in tech startup Pre IPO
Before we can go into learning how you can invest in tech startups pre-IPO, we first have to understand what it is.
Pre-IPO stands for “pre-initial public offering.” This is the stage when founders would sell shares to their tech startup before it’s included in a public exchange listing.
Investing during a startup’s early stages helps its founders gain enough funding to launch and scale.
If early-stage investing sounds too risky, more conservative investors can still get in on the pre-IPO action by choosing to invest during the second or third rounds of funding.
This way, investors are afforded better insight into whether or not a small business is marketable for other, more aggressive investors as well as for their intended customer base.
This setup is favorable for investors who want to engage with most new companies in any industry, but especially with the more sophisticated tech space.
Why investing in tech startup pre-IPO makes sense
Large private equity firms and savvy investors jump on the chance to invest in a tech startup pre-IPO because of the following benefits.
Investors can sell their shares for a much higher rate once the tech company goes public. Venture capitalists, for example, can expect a modest ROI of 10x within 4-5 years.
What’s more, these investors continue to earn passive income through dividends over time. A humble expectation of over 15x in ROI growth is reasonable for most investors.
Avoid stock volatility
Events like the COVID-19 pandemic can have a significant impact on the economy, causing the share prices in publicly traded companies to plummet.
Pre-IPO investments are less likely to be affected by societal events that trigger shifts within the stock market, as shares are not yet made public.
For instance, while the stock market experienced a general downturn due to the coronavirus epidemic, tech startups like Netflix and Amazon continued to grow substantially.
Even tech giants like Apple and Facebook that experienced losses during the first quarter of 2020, their losses are still above S&P 500’s negative median of 12.20%.
For an investor, this is still good news. That’s because even though they suffered losses in their portfolio, it would not take long for them to recover this.
But if you invested with these tech startups pre-IPO, you’ve already earned a substantial return on your investment. In effect, the losses you incurred resulting from the COVID-19 pandemic on your investment were towards your profits, and not on the initial amount you’ve invested.
Shorter holding times
Another benefit of investing in pre-IPO tech startups is the shorter holding period.
If you choose to invest with a tech startup pre-IPO, you’re only required to hold on to your shares anywhere between three months and two years.
On the other hand, those that choose to wait for the startups’ secondary offering before they invest would have to wait longer.
That’s because they’ll first have to wait for the tech startup to go public. That alone can take up to 10 years to happen. Then, you’ll have to wait for the tech startup to announce their secondary offering. Only then would they be able to invest.
By the time that happens, the share prices would have already gone up. So while those that invested in the tech startup pre-IPO stage are already earning dividends, you’re just starting.
While a higher ROI can be expected from long-term investments in the pre-IPO sense, it has also been proven that some tech businesses were still able to deliver positive returns in the small window between the last round of private funding and declaring the IPO like in the case with startups Zoom and Pinterest.
Proven success rate
Tech startups have a positive track record when it comes to growing in stock value. Just in the last decade, it has been recorded that tech stocks have increased in dividend value by about 25% per year.
All this said, it must be noted that there are financial risks are imminent in the investment practice.
For pre-IPO investing in particular, investors run the risk of losing money once the company goes public with a low valuation. In 2019, only 24% of IPOs were reported by Goldman Sachs to have been profitable in the first year of trading.
There is also the possibility that private companies and startups may delay going public due to issues in corporate governance or fear of the stock market.
While there is risk in investing pre-IPO tech startups – much like investing in the stock market, no less – the demonstrated benefits such as outweigh the potential costs, especially in the industry that dominates the business world.
That said, here are tips on how to choose the right pre-IPO tech startups to invest in so that you can avoid experiencing these mishaps.
1. Ask Around
Banks, accounting firms, and other loaning establishments often have a working directory of private client companies who are looking for investors.
If you’ve invested in the past, get in touch with your stockbroker or investment adviser so you can find pre-IPO tech startups worth investing in.
On the other hand, if you don’t have any experience in investing and trading stocks, there are advisory firms and investment brokers who specialize in pre-IPO placements.
2. Build Your Business Network
Smart business connections are integral if you plan on investing in tech startups pre-IPO. These relationships can connect you with industry leaders and profitable investment opportunities that’ll open up in the near future.
Startup incubators and accelerators are fantastic platforms to join and participate in if you are looking to invest your coins in high potential tech businesses.
Established startup programs from leading firms such as Y Combinator and Quest Ventures have paved the paths to success for some of the biggest names in tech today, like Airbnb and Dropbox.
For new tech startup pre-IPO investors such as yourself, these programs and ensuing events can help you not only meet fellow investors but also learn more about up-and-coming tech startups and their products and services.
3. Check Tech Startup Directories
Looking at startup directories is a worthwhile endeavor when deciding to invest in pre-IPO tech startups.
Aside from the chance to discover innovative companies, these business directories also allow you to see how well early consumers receive certain products and services.
Of course, it has to be said that some startup directories are less respectable than others and that by association, individual tech startups become less vendible and less trustworthy.
Thankfully, Google already makes an excellent job distinguishing between legitimate pages and low-quality ones by grouping internet sites into backlink-heavy neighborhoods and giving negative rankings to spammy pages.
That said, budding investors still have to do their due research to pick tech startups that have listed themselves in well-established directory websites such as Crunchbase or ProductHunt.
Crunchbase is the leading platform for information on startups, industry trends, and investing spaces – making this site perfect for traditionalists who want to invest in a variety of industries (including tech.)
On the other hand, ProductHunt is the go-to directory for digital products offered by tech startups.
4. Utilize Secondary Market and Crowdfunding Platforms
Secondary market and crowdfunding platforms such as AngelList, Webull, and Republic make the inner workings and processes behind pre-IPO placements more accessible and more transparent to potential investors.
Tech startup pre-IPO investors can also monitor the news and relevant information regarding startups that are planning to go public.
You can then reach out to these startup founders and offer your financial support. In exchange, you can receive shares in their startup.
5. Lay the Groundwork to Become an Angel Investor
Angel investors are men and women that invest in tech startups using their own financial resources (Think Shark Tank). They also help build a company’s capital in exchange for shares in the company.
With the right tools and a penchant for planning, becoming an angel investor is a much less daunting task than it is made to be.
At the same time, becoming a tech startup angel investor could be extremely rewarding once investments are made before these tech startups go public.
If you meet accredited investor standards, then you are one step closer to beginning your journey as an angel investor.
This is crucial since only accredited angel investors are allowed to participate in pre-IPO and other securities offerings.
Of course, becoming an angel investor and establishing oneself in the angel community does not end in accreditation.
You also need to determine how much of your investment portfolio you’d want to dedicate to angel investments.
Ideally, you should only allocate between 5% and 10% of your entire portfolio to it.
That’s because angel investments’ liquidity is very low, so it’ll take time for you to cash in on your investment.
6. Attend Tech Startup Pitch Events
Pitching competitions are critical opportunities for founders to get their startup in front of seasoned investors and industry leaders to secure the funds they need to scale.
Startup pitch competitions give you the chance to learn more about the startup you are planning to invest in. They’re also great avenues to meet other fellow investors.
More important, you develop a more profound knowledge of the audience of the tech startup you intend to fund.
You can choose to reach out to young entrepreneurs in these events and mentoring them. In turn, you increase their chances for their startup (and your investment) to be successful.
Some examples of reputable startup pitch competitions to attend are Web Summit and Y Combinator Demo Day.
Web Summit is considered one of the largest tech conferences in the world in terms of scope and influence. It’s also one of the most inclusive when it comes to its attendees and participants.
Y Combinator Demo Day, on the other hand, employs a more intimate setup and boasts exclusivity among highly respected investors and the most promising startups.
7. Join a Syndicated Angel List
A syndicated angel list is a practical funding avenue where investors can meet like-minded angels and raise the necessary capital needed to propel a specific tech startup pre-IPO.
Unlike venture capitalist (VC) firms who spend upwards to millions in exchange for a higher ROI, syndicates and angel groups often cap their investments in the thousands, making the latter a more sensible option for the startup market.
One of the benefits of joining a syndicated angel list is that you’re not coming in as an individual investor. So, the amount of paperwork you need to complete is lesser.
Through a Special Purpose Vehicle (SPV), a group of up to 99 investors can invest in tech startups as one entity. Doing this minimizes the number of applications and forms to process.
Another benefit of joining syndicated angel groups that you can build a business ecosystem of pre-IPO tech startups.
Building relationships with tech startup founders increases the exposure of other companies you’ve invested in as an angel investor.
In turn, these startup founders can introduce you to other tech startup pre-IPOs that may fit your criteria.
You can also discover those startups that have the highest growth potential.
8. Use a Stock Tokenization Solution
Stock tokenization refers to the process of dispensing an equivalent number of blockchain security tokens to the shares you purchased from a tech startup pre-IPO. These digital tokens can then be traded in the same manner as you would in the stock market.
Through stock tokenization platforms such as Tzero and Tzero, holders of private business shares can convert “tokens” into cash, allowing ease of stock liquidity.
Additionally, investors can easily buy and hold onto asset tokens as stock tokenization employs a peer to peer trading setup. The key to making sure that one enjoys private equity as an investor is to work with reputable wealth managers.
These wealth managers have extensive experience handling assets and shares of legitimate and well-established companies. As a result, they can immediately tell you whether or not a tech startup is worth the investment.
Best Practices when investing in tech startup Pre IPO
1. Understand the Risks Involved
Every business investor will tell you that every investment opportunity comes with a fair amount of risk.
It’s critical that you employ informed decision making when investing in either the pre-IPO space or the stock market.
Most conservative investors will prefer investing in startups and companies that have been public for some time.
It’s because more information about their growth trajectory and overall success is readily available in stock market charts and reports.
Private companies and boards are typically not required to disclose certain information to the public. This is primarily due to the nature of company ownership. Because of this, the information you gather about the tech startup’s performance is limited.
There is also the looming risk that the tech startup you’ve invested in wouldn’t survive.
As someone investing in tech startup pre-IPO, you need to embrace the losses just like with your profits.
Remember that you can lose what you’ve invested in a tech startup pre-IPO because of the current economic environment.
Fortunately, companies already recognize such risk and would often offer discounted prices for shares to entice angel investment and early-stage funding.
Most tech startup product development activities rely on applications and software. As such, they can start operations at a minimal cost. That’s why they can perform positively on smaller capital funds.
Only consider investing in tech startup pre-IPO if you’re comfortable with these risks. That’s because even early-stage tech startups can potentially yield immense profit once it goes public.
2. Examine the Legal Documents
Collecting and analyzing the tech startup pre-IPO’s documents doesn’t end in identifying the risks. Neither does is creating a risk management strategy for your final step in the process.
Make sure that the tech startup you’re planning to invest in has the required documents for them to operate.
For instance, placements and securities by pre-IPO tech startups have to either be registered or exempt under the rules of the SEC or your state securities regulator.
Documents and SEC filings such as the prospectus and the Form 10-K have to indicate the tech startup’s history, standard operations, and financial condition in detail as audited by accredited legal and accounting professionals.
As a prospective investor, you may access a startup’s SEC filings through the EDGAR service or the Electronic Data Gathering, Analysis, and Retrieval System.
The EDGAR system offers public access to around 3,000 terabytes of company data annually; this includes, but is not limited to, securities offered by the startup, their maturity dates, and the company’s financing operations.
3. Do the computations to see if you get the same results
Investing in tech startups pre-IPO requires a clear understanding of the investing process and the company’s perceived valuation.
Tech startup pre-IPO usually discloses its projected revenue growth. As an investor, it’s going to be in your best interest to do diligent research and check about it.
Return on investment (ROI) is the most metric investors monitor and review. That’s because the data they’ll get shows you whether the tech startup’s still viable. Expressed as a percentage, you can calculate your ROI by using any of these two formulas:
As for your net return, you can calculate for this by using this formula:
Net Return = The latest value of the investment – Past security price
Consequently, the overall costs cover the purchase price as well as commissions paid throughout the process.
A net return higher than the overall costs renders a positive ROI percentage. On the other hand, a lower net gain means a negative ROI.
4. Start Small
Once you’ve found a tech startup pre-IPO, don’t rush into investing your money. Instead, put in a small amount first. Then see how it performs.
If things work out, you can always invest more money into the tech startup. But if it doesn’t, you won’t lose a lot of money in the process.
Another option is to sign up for angel groups or investing through capital building firms.
5. Familiarize Yourself with the Guidelines
Excitement over a high potential tech startup or the initial investment experience can quickly get the best out of even the most seasoned investor.
Unfortunately, not all startups become successful.
That’s why I highly recommend that you follow set investment guidelines strictly.
Understand the market and diversify your investment portfolio. Market timing is an investment standard that all angels and venture capitalists abide by, so be patient.
Another vital principle in investing is keeping costs low. Get help from a broker with reasonable commissions or investing through a firm with low transaction costs.
Additionally, an important guideline to follow is working with your risk tolerance in mind. Be realistic about investment returns. That way you’ll know how long to keep your money in the market. You can also determine which investments make the most sense for your goals.
In due time, these guidelines will be easier to manage, and pre-IPO investing will almost feel like second nature.
Tech startup pre-IPO investments are worth the risk and money.
Investing in pre-IPO tech startups can be financially rewarding.
But like any other type of investment, is always some form of risk involved.
The tips shared in this article will help you lower that risk.
Take the time to review your options to find the right pre-IPO tech startup to invest in. More importantly, they’ll help you stay level-headed so that you won’t make the mistake of investing too much, too soon.
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Build connections within the tech startup investor ecosystems. These networks will connect you with more seasoned investors. They, in turn, can point you to the right startup pitch events, business meet-ups and conferences, and online angel lists.