The Pros and Cons of pre-IPO Placements

Just as the name implies, pre-IPO placements are private sales of large quantities of a company’s shares just before it goes public. Also, it is a relatively new asset class that companies, especially new ones, employ to raise capital before becoming a publicly-traded company. The prices are usually lower than an IPO.

Typically, the buyers of pre-IPOs are private investors, equity firms, hedge funds, and other large institutions desiring to own stakes in the company. In recent years, pre-IPO placements are becoming more popular among issuing companies and investors alike. This is because of some of the significant prospects it promises.

One of the pros of this type of investment is the opportunity to make significant and quick returns on investment (ROI). As an investor buying pre-IPO shares at discounted rates, you stand the chance of making instant returns when the company finally launches the IPO at a higher rate.

The discrepancy between the company’s quoted IPO price and the price you paid during the pre-IPO becomes your profit. For example, you bought 100,000 pre-IPO shares at $30 per share, which equals $3 million worth of investment, and on the first day of public trading, it closes at $50 per share. Multiplying your initial input by the current share price would amount to $5 million, which means that between the time you bought the pre-IPO shares and the opening day of public trading, your returns jumped by 83.33 percent.

Aside from raising extra capital, pre-IPO can help firms maintain price stability for stocks upon listing. Share price volatility is one of the problems companies usually face after listing their stocks on a stock exchange. This problem arises from investors who rush to sell their IPO shares after the end of the IPO. In cases where the investors sell a mass number of shares, the company’s valuation can plummet significantly.

However, by offering large chunks of pre-IPO shares before going public, companies can have a sizable number of shares intact, which aren’t for sale. This would help protect them against such unwanted scenarios, control share supply, and ultimately stabilize their prices.

Even with its significant promises, pre-IPO placements also come with some constraints worth considering. These constraints are mainly on the side of investors.

One such constraint is that delays in IPO launches can cause liquidity problems. In finance, liquidity refers to how easily and fast investors or companies can convert assets or securities into cash without affecting their market price.

As an investor, after buying pre-IPO shares of a company, you have to wait till they go public before taking further steps. This signifies that, if for some reason, the issuing company decides to delay the launch of their IPO, you have to hold the shares as long as possible. A situation like that can tie down significant portions of your finances since buying the pre-IPO shares in the first place requires huge financial commitments.

Additionally, in more unique cases like the firm canceling the issues, the problem may go beyond lack of liquidity to totally losing your investment. Although, this is unlikely as it would require the company to be bankrupt.

Another downside of pre-IPO placements is that it discourages middle and lower-class participation due to their cost. As already mentioned, investing in pre-IPOs requires massive financial commitments, which you may not be able to afford as a private investor. It is a scheme designed for wealthy corporations, hedge funds, and investors.