What is Pre IPO Risk Involved Who sells Pre IPO Shares?,Advantages, Disadvantages By Virendra bodele

Pre IPO can be defined as a tool used by companies to acquire capital by selling large amounts of shares/stocks before being publicly traded in some markets to private investors, hedge funds, HNIs, etc. A pre-IPO placement method happens when private investors buy a firm's shares before the IPO goes live on the market. These private investors are usually private equity firms, hedge funds, etc. that are in a position to buy a big stake in the firm.  When there is a steady market demand for an upcoming IPO release, the company generally issues a pre-IPO first. The firm first issues the share at a discounted price to private investors than the price it will quote during IPO.  This is done primarily to mitigate the risk of any possible outcome during the launch of the IPO, and to focus on the expected volume of trade. Any risk that arises on the basis of the above two factors may to some extent be covered with the capital raised by pre-IPO investments.

Risk Involved in Pre IPO Investment

1-Loss of capital Investing in companies where the IPO has not been tried and tested can sometimes result in total washout of capital. The expected return here is also coupled with the risk of a complete or partial washing out of the amount invested in such non-listed companies. In the future, the company could go bankrupt due to organizational failure or lack of potential financing and result in a loss to pre-IPO invested money.  2-Liquidity shortage When we invest in an unlisted company the future chances of selling the share are grim as there is a lack of interested buyers if the company fails to generate a positive pulse on the market. Thus, due to the difficulty of selling or trading the liquidity crunch of the shares may tend to develop.  3-Payout shortfall Few businesses that refuse to pay dividends from Pre IPO placements because the majority of shareholders opt for reinvesting the money generated in the business itself. Thus it will be difficult for companies raising capital by Pre IPO to yield returns in the form of dividends.  4 – Freezing If the company plans to accumulate new funds by issuing newly subscribed shares at a later stage through additional funding, the value of holding previously held by pre-IPO investors who fail to subscribe to this new additive capital will eventually decrease.

Who sells Pre IPO Shares?

An increase in Pre IPO dealings means that the company's founders, employees holding Employee stock option plan(ESOPS) and private investors are gaining liquidity in a shorter span of time compared to previous company life cycles. The liquidity crunch is frequently faced by start-ups and private-owned companies due to the absence of the market that allows them to sell shares and/or transfer obligations that may hinder the sale.  Thus investments in the Pre IPO are a response to the above problem. Private investors looking for fruitful businesses make a profit based on the issuing company's discounted issue of shares. Companies are still using this collected capital as a buffer for unpredictable situations like IPO problems or an excessive amount of trade with the IPO.

Process of Selling Shares in Pre IPO

• Private investors usually pledge their interest in buying pre-IPO shares 

• The issuing company offers the bank account for the transfer of the sum to be made. 

• The buyer or private owner receives details of its DEMAT account. 

• On clear settlement date, the issuing company will pass the shares to the private investor's DEMAT account while the private investor will move the transaction balance to the issuing company's bank account information.

Advantages

Sometimes it is investing that can be considered a more profitable investment than IPO.  This will fund a fantastic product/service and the person that spends this offers seed capital for that incredible venture. One becomes the early subscribers to a company's shares even before they reach out to the public. 

The acquired share is purchased at a discounted rate that immediately triggers profit-making in the mode of difference between the amount of share purchased at the pre-IPO stage and the price quoted by the company during the IPO 

It helps avoid the trading stampede on the market where the share prices go aggressively high or low and offer an opportunity to make the trading or investment before others do so. 

Disadvantages

Investments are done primarily without a prospectus being made available. The lack of a stockbroker or other underwriter always makes the transaction more costly for the long run.

  There is no guarantee as we agree to pre-initial public offering that it will proceed to an IPO, or what the eventual share price will be. It is simply because the amount of time taken between a company being pre-IPO and attaining an IPO point will range from 2-3 years, which means that the money invested would be trapped during this time period. 

It is not common among other investors as it can be managed only through institutional buyers or HNI customers. Only these are common to private equity firms or to qualified investors. Therefore we need to link to the right group of people to get an overview of these

Investing in a Pre IPO? 

Compared with the IPO process, Pre-IPO operates more in an unorganized one. In such shares, one can invest by: 

• The shift in shares from current owners or workers who still own those stock. Before this, a thorough analysis of whether these shares are further tradable needs to be undertaken. 

• By being an angel investor, but that requires a great deal of capital and only HNIs can handle that. 

• Try to invest in a particular hedge fund depending on its portfolio and has some exposure to the pre IPO. 

• With the help of some advisory firms or fund management companies, a retail investor can find access to that.