Every investor wants buy shares of small companies before they become household names.
Investors also dream of buying into companies before the rest of the market discovers them.
This makes investing in companies pre-IPO seem particularly alluring as once a company makes its major-market debut, a lot of the money has already been made.
Investing in private companies seems like an attractive opportunity for investors looking for a high-risk, high-return bet. Despite the interest in investing in a company early on, this isn't an opportunity that is available to most retail investors. Before an IPO, only a group called "Accredited Investors" can buy the stock.
Accredited investors are people or entities that are allowed to invest in companies that are not registered with the SEC. Investors do not need to pass an exam or have their credentials reviewed to become an accredited investor.
The definition of accredited investor was recently expanded, but still applies to a pretty small number of people. Individuals whose income has exceeded $200,000 over the past two years are automatically qualified, or $300,000 when combined with a spouse. Additionally, you automatically qualify if you have a net worth that exceeds $1 million, not including the value of your primary residence.
If you qualify as an accredited investor and want to invest in a private company, you can sign up for sites such as EquityZen to browse a market of private companies which includes everything from Rivian, to SpaceX and Barstool Sports. This marketplace connects employees and owners of the private companies with accredited investors who otherwise wouldn’t be able to own shares in the company before it’s public offering.
Because of the high income and net worth standards, investing in private companies is not attainable for most individual investors.
One way to get exposure to some pre-IPO companies is through mutual funds. These vehicles are often early investors in companies and so buying shares of a mutual fund with a stake in a pre-IPO company allows you to share some of the gains.
Despite not being able to invest in private companies, investors can still capture enormous ROIs by investing in companies immediately after their IPO.
When considering that EquityZen and other private equity marketplaces rely on connecting investors with employees who own shares in the company, perhaps through an employee incentive program, one wonders how long an investor will have to wait before the company holds its IPO, and whether or not they're really getting a good deal on the stock.
Larger, private companies that are growing fast tend to have these programs. This means that a lot of the growth has already occurred, meaning these "early" accredited investors don’t actually beat the retail investors by much. So they may be getting into a company at the tail end of their tenure as a private company, and if the stock falls at or soon after the IPO, for one reason or another, then they become the first loser from the company after rushing to be its first winner.
This is why even if you can qualify as an accredited investor, you may not want to buy shares through one of these exchanges. The IPO process gives the public investors a better look at the company's financial statements and other disclosures than you may be allowed through these programs.
