Investing in Pre-IPO Stocks.
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A Short Guide on How to Make Money in Late-Stage Private Deals.
We are currently facing a combination of investing challenges not seen for decades. Historically, high levels of inflation and rapidly rising interest rates amid a slowing economy have created a tactical opportunity for late-stage technology companies.
As shown in the picture, some of these companies are recession-proven. Just look at the valuations of AirBnB, one of our exits, during the GFC.
Why Later-Stage?
Later-stage companies have emerged successful from the hardships of start-ups, convincing investors, clients, and partners that they can deliver on their missions.
They show an impact on structuring and negotiating deals in their industries. They can acquire competitors and aggregate businesses in their market or go international via acquisitions.
Typically, companies that have existed for 5-7 years are relatively mature companies that have proven product viability, increasing adoption, and revenue growth. These companies are focused on growing marketing and sales.
There is another sub-segment, though, the very late-stage companies that have been around 8-12 years, where Cash flow is abundant and dependable. They are past the initial hyper-growth period, and it is reasonable to expect a sale or IPO within 12 – 24 months. This is the focus of PRE IPO CLUB.
Who are the Sellers?
While not easy, it is more common to contact secondary blocks in unicorns because of their larger and more diverse groups of existing shareholders: founders, current/former management, employees, seed, family, high net worth, early-stage institutional venture, and professional angels.
Each group has different levels of involvement, varying rights and protections tied to equity, and divergent investment objectives. It is key to access these deals with the help of an expert principal and not try to DIY via crowdfunding and other preIPO platforms that do not invest their own money in the deal.
Founders and management may be significantly invested in the company and need to create liquidity for alternative projects or life challenges. Start-ups and seed investors may desire a quicker exit at a lower valuation than an IPO to acquire new, early-stage companies.
What are you getting?
Late-stage equity is typically based on the previous A-D series of preferred stocks; however, it can involve common stock from converted options, which can offer a greater upside, depending on liquidation preferences (e.g., how motivated the sellers are, whether they left the company, and so on).
Sometimes, these companies have arranged secondary transactions to allow their staff to sell some of their holdings, and only professional players in the secondary market are invited to participate in these deals. These deals may take the form of a last round for reasons such as acceleration of growth, existing shareholder liquidity, recapitalization, or postponing exit to secure a higher valuation.
Are these private deals risky?
By their nature, pre-IPO investments may require more extensive and complex due diligence. Investors must evaluate current capitalization, issued/outstanding securities, existing shareholder rights, liabilities like complex credit facilities, IP, common stock versus preferred stock, and control issues.
Calculating the price per share can be a complex process for investors. Commonly, it’s based on pre-money valuation (common equity value of the company before investment): the pre-investment issued and outstanding shares of common stock plus all preferred stock on an “as-converted” basis. But watch out: it may or may not be “fully diluted”! If not, it’s called “Not fully diluted,” it only includes issued and outstanding common stock, excluding all shares underlying outstanding common stock equivalents (i.e., outstanding convertible debt and preferred stock, warrants, and management equity incentives).
At PRE IPO CLUB, we work only with fully diluted share counts, including outstanding equity incentives, issued and outstanding common stock measured on a fully diluted basis, and all shares underlying issued and outstanding common stock equivalents (i.e., stock options issued to management), as if these equivalents have been converted or exercised. Fully diluted also includes the entire equity incentive plan.
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