Pre-IPO Investing: The Pros and Cons

By Reuben Buchanan, Managing Director – Axstra Capital Pty Ltd

This article takes a look at the pros and cons of investing into what is called Pre-IPO capital.

What is Pre-IPO capital? Well it’s exactly that – capital that is raised prior to an IPO.

So to make things clear, an IPO, or Initial Public Offer, refers to the time when a company is about to list (i.e. float) on a stock exchange, and they have issued a prospectus in order to attract investor’s funds – both retail and wholesale. The amounts sought vary greatly depending of the size of the company and the need for capital. So if you invest into an IPO, you get the prospectus via a broker or online, fill in the application form and post it in along with a cheque or EFT payment. About 3 to 4 weeks later the company lists and you get your shares which you can immediately sell if you want to.

You are usually limited by the maximum number of shares you can subscribe to. It may be $10,000 for example. There will also be a minimum subscription. This varies but is usually $2,000.

Another aspect that is common with an IPO offering is that there is a defined time period in which you must respond – usually about 3 weeks. This allows the company and their broker to coordinate the float with the exchange. It also creates urgency for the investor by giving you a deadline in which to make a decision by.

Pre-IPO capital raising is different to this, although it sounds similar. Pre-IPO capital is raised anywhere from 3 months to 18 months prior to the company listing, or floating, onto a stock exchange. It is mostly done without a prospectus and in most cases, is done at a time when there is no stock-broker representing the company or underwriting the float.

At the pre-IPO level, there is no guarantee that the company will make it to the actual IPO, what the IPO share price will be, or which broker will do it. Also, because it may take up to 2 years before the company floats, you money is pretty much tied up until then.

As you can see, there is higher risk involved. To reflect this, pre-IPOs are usually offered at a considerable discount to the anticipated IPO price. For example, if company X believed that they will IPO for $1 per share, they may offer shares in a pre-IPO capital raising at $0.25. Should they end up listing for $1, they you make 4 times on your money at the IPO.

Most investors have not even heard of pre-IPO investment opportunities. This is because pre-IPO’s are only usually made available to wholesale investors, high net worth individuals, professional investors or investment funds. So to gain exposure to these, you do need to know the right people. Even some high net worth individuals do not get exposed to pre-IPO opportunities simply because they are not connected to the company or the corporate advisor managing the raising.

Most opportunities are restricted to “wholesale” investors however limited opportunities are sometimes available to some “retail” investors. Click here to learn more about Wholesale Investor requirements.

There is no safe way to invest into pre-IPO opportunities. Simply because there are many factors that may prevent the company from reaching the IPO. So the key is to invest into companies that are fairly close to listing. Some of the indicators for this are:

  • Estimated listing timetable stated in Information Memorandum document (ideally within 12 months)
  • Board of Directors in place
  • CEO in place
  • Key management and staff in place
  • Lead broker in place (or at least shortlisted)
  • Legal team in place (for IPO)
  • Accountant in place (for IPO)
  • Advisor in place (for IPO)
  • Financial projections completed
  • Revenue positive or profitable
  • Market opportunity clearly defined
  • Share capital structure in place
  • Value entry level established

It’s not necessary to have all the above criteria ticked, but the more the better as each criteria lowers the risk for you, the investor.

How do you know the company is going to list? The short answer is you don’t. Even some IPO’s have been pulled at the last minute. The bottom line is that investing into Pre-IPO is risky, so be sure to only invest what you can afford to lose. And as a rule-of-thumb, only invest a maximum of say 10% of your investment portfolio.

On the other hand, when pre-IPOs work, the returns can be quite staggering. I know of a recent float where the pre-IPO investors bought in at $0.10 per share, less than 4 months before the IPO. The company floated at $0.20 and within 6 months, the shares rose to over $0.60. That’s 6 times their money within a year. However bear in mind that this was relatively speculative, and the pre-IPO investors could just have easily been left holding the stock for a couple of years.

In terms of Due Diligence, it is wise to spend about 20 min on the phone to the CEO or better still, meet with them. Get them to answer any questions you have about the company and its ability to deliver on its promises. If you are investing $50,000 or more, it’s time well spent. If you were to spend a similar amount on a car, I’m sure you would take it around the block a couple of times, so make sure you do some homework when looking at a pre-IPO investment.

So how do you gain access to pre-IPO opportunities? Speak to your broker or get to know an advisory firm who specialises in pre-IPO capital raisings. From time to time, you will also see them advertised in the Australia Financial Review. It’s free to enquire and even if you don’t invest, it’s good to get a feel for this type of investment prior to writing a cheque.

IMPORTANT: This information is general and should not be taken as specific advice. Readers should always seek their own professional advice. For more information, please email enquiries@axstra.com.au

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