Some private companies that intend to go public through an initial public offering decide to set aside some shares that investors can purchase in a pre-IPO placement. Private companies might choose to do this to raise capital, and investors that can purchase pre-IPO stock frequently receive a discount on the price at which the stock might be offered in an IPO.

Pre-IPO investments carry a significant amount of risk, but they also offer investors the potential to benefit from substantial returns on their investments before the companies go public. Investing in a pre-IPO company can also help to increase your portfolio’s diversification, but it can be difficult to find pre-IPO stocks. Here are some tips on how to get pre-IPO investments and ensure that you earn a good return on your investment.

The pre-IPO investment process

Many companies that are preparing for an initial public offering that decide to sell pre-IPO stock do so through a process called pre-IPO placement. Through pre-IPO placement, a company can privately sell large numbers of shares before their stock goes public and is listed on an exchange.

Most of the buyers are large, institutional buyers, including hedge funds, investment banks, and private equity funds. Because of the risks and the sizeable investments made during the pre-IPO placement, buyers receive a discounted price from that stated in the company’s IPO prospective.

Few individual investors participate in pre-IPO placements because of the restrictions the Securities and Exchange Commission has in place. To participate in a company’s pre-IPO placement, individual buyers must be accredited section 708 investors. These are people with a great degree of sophistication and experience in the markets who also are of substantial net worth.

Following a pre-IPO placement, there will be a lock-up period to prevent the buyers who purchased blocks of shares during the pre-IPO placement from immediately selling their shares if the market price soars upon the company’s IPO. The lock-up period is attached to the pre-IPO placement so that buyers know that they will be prevented from selling their shares in the short term.

How to find pre-IPO investments

The 2012 Jumpstart our Business Startups Act or JOBS Act made it easier for retail investors to invest in pre-IPO stock. This law allows startups with less than $1 billion in revenue to raise capital through regulation crowdfunding.

Retail investors can thus make pre-IPO investments by pooling their investments with others on crowdfunding sites. In 2015, the SEC expanded Regulation A under the JOBS Act to allow private companies to sell up to $50 million in shares to raise capital without having to register with the SEC.

There are a few ways to find potential pre-IPO investments, including the following:

• Join Urban Capital Network to get access to pre-IPO investment opportunities
• Ask accounting firms, investment brokers, and advisory firms if they know of any pre-IPO startups that are worth investing in.
• Review listings in established startup directories, including Crunchbase and ProductHunt.
• Follow news about startups that are preparing to go public.
• Attend startup pitching competitions.
• Look at crowdfunding sites offering pre-IPO investments, including AngelList and Republic.

What to look for in a company before investing

Once you have identified several pre-IPO startups, it is important for you to carefully review each one before you decide to invest. Companies that are preparing to go public issue private placement memorandums to potential investors. A company’s PPM will include important information about the company, the services or products it offers, its management, the company’s past performance, the company’s finances, and the risks that should be considered before deciding whether or not it is worthwhile to invest in the company.

You should carefully review a PPM before deciding to get pre-IPO investments and assess the risks and finances of the company. If you are unsure, you can ask an investment advisor to review the PPM and tell you what he or she thinks. Ideally, you want to find a startup that has the potential to grow and perform well over the long term.

How do pre-IPO investments affect your portfolio?

When you invest in a private company, your investment will carry a greater level of risk than an investment in an established blue-chip company. However, the potential rewards of a pre-IPO investment can also be significant. You will need to critically think about your ability to tolerate risk and determine whether any of the pre-IPO companies you have identified meet your portfolio’s needs for diversification.

Start small with a modest investment and thoroughly research the company before you leap. Consider your pre-IPO investment as an investment that you are making for the long term. The investment horizon for a pre-IPO company can be much longer than the investment horizon for a blue-chip stock. Make sure that your portfolio is thoroughly diversified so that you can withstand the potential risks of your pre-IPO investments.

What are the different types of pre-IPO investments?

While it is not easy for retail investors to invest in pre-IPO companies, it is still possible. There are several different types of pre-IPO investments that you can make. If you qualify as an accredited investor, you can participate in a company’s pre-IPO placement and purchase a large block of shares.

Another option is to purchase pre-IPO stock through a crowdfunding site that offers pre-IPO stock, including EquityZen, Forge, and others.

If you are unable to directly back a pre-IPO startup, you can gain indirect exposure by investing in a publicly-traded company that invests in private companies. Finally, you might also be able to invest in pre-IPO stock through a third party such as an investment bank or lending institution that specializes in pre-IPO placements.

Best ways to get pre-IPO investments

Choosing to make pre-IPO investments can be a good way to build wealth. If you carefully research pre-IPO startups and invest in the right one at the right time, a pre-IPO investment can provide the potential for exponential returns on your investment.

Like other types of investments, pre-IPO investing carries risks, but the potential benefits can be high. If your risk profile and resources allow you to withstand the risks, pre-IPO investing presents an opportunity that you should not overlook.