First there was ARM, then came Instacart and Klayvio. Companies started to list publicly this fall, after a historically quiet IPO market. Yet, by the time many of these companies go public at 10 or 15 years old, it’s worth asking how much growth is actually left for public market investors to capture. With venture-backed technology companies staying private longer than ever, how do you invest in pre-IPO companies, and access growth equity investments? The answer is pre-IPO investing, a market where women are drastically under-invested.
When you look at professional investors in the global private market, only 33% of entry-level investing roles are held by women. That number dwindles to 9% once you reach the senior investment committee level. The underrepresentation of women in professional private market investments roles matches what we see on an individual investment level. Women hold a smaller fraction of their financial wealth in the riskiest assets, such as corporate shares. Yet corporate shares in private companies are an increasingly essential part of a diversified portfolio.
Given the cost of going public (which can be substantial in terms of time and resources), the short-termism of the public markets (which can cause public companies to focus on quarterly earnings rather than long term growth), and the abundance of capital available in the private markets, technology companies have fewer reasons to go public than they did a decade ago. In 1999, US technology companies typically went public after 4 years. Today, the median technology company IPOs is almost a teenager, listing publicly after 12 years. As a result, venture-backed technology companies are reaching valuations of $1B, and even $50B, before they go public. This means more value being created pre-IPO, and less potential upside for public market investors. With an estimated $3.8 trillion of market capitalization locked up in private unicorn companies, the private secondary market is unlocking that value for investors who had previously been shut out due to high investment minimums and exclusivity. It’s a market that can create great opportunities for a broader set of investors, especially women. In other words, it’s no surprise that more savvy investors are asking the question: How do you invest in pre-IPO companies?
First of all, what is the private secondary market?
The private secondary market is one in which existing shareholders sell their shares to investors while a company is still private. Typically, these transactions are available to accredited investors. Secondary transactions differ from primary transactions in that the proceeds of a secondary sale go to the selling shareholder instead of the company.
Private secondary marketplaces act as intermediaries between shareholders seeking liquidity, and investors who want exposure to late-stage technology companies before they ultimately go public or get acquired. Once an investment is made, investors hold these shares typically via a fund, until there is an exit event. A holding period of 2-7 years is not unusual. If the company goes public, investors receive shares they can sell after the IPO lockup period. If the company gets acquired for cash, investors receive cash.
Private secondary investments are typically made in later stage firms. They tend to exceed $500M in valuation, generate significant revenue, demonstrate market traction, and are backed by top-tier venture capitalists. These companies aim to prove their business models have staying power, with many generating hundreds of millions of dollars of revenue and employing thousands of workers. Twenty years ago, such firms would already be publicly traded.
Late-stage private companies are different from early-stage companies, which tend to have high market, product, and execution risk. While early stage companies can create outsized rewards for the earliest of investors, they are risky. Therefore, on a risk-adjusted basis, late-stage companies tend to provide a growth-equity style return.
For this reason, many investors consider late-stage private company investments as part of their growth equity allocation.Recent studies have shown that late-stage investing can drive strong returns. In fact according to one study, investing at the price of a company’s Series E, F or G, has generated a mean annualized return of 75%+ 6-months post IPO. Meanwhile, investors who invested after the IPO, measured as the closing price on the first day of trading, achieved a mean return of -1.4% over the same period. If you’re long-term minded, investing before the IPO may be meaningfully more rewarding than investing on the day of the IPO.
Evaluating pre-IPO investment opportunities
Unlike public companies, there are fewer disclosure requirements for private firms, which can mean greater risk. So how do you evaluate a pre-IPO investment opportunity? Here are some important things to think about.
Business Overview: What does the startup do, and how does it generate revenue? What makes this company great?
Market: What is the size of the market that the target company is seeking to capitalize on? What is their go-to-market strategy? Who are their competitors and how do they differentiate themselves?
Team: What gives the company’s leadership an edge?
Investment terms & pricing: What are the terms and what is the price you’ll pay for shares? In the private markets, while primary market pricing is set by the institutional investors who lead a financing event, secondary transactions are typically priced relative to the company’s most recent round of primary funding. The price can also be influenced by factors of supply and demand, as well as the share class of the shares you are purchasing. You can learn more about other factors that impact secondary pricing here.
Risks: What could go wrong and how is the company taking steps to mitigate those risks? These risks will be unique to your target company and could include things like economic risk, competition risk, financial risk & operational risk.
Outcomes: What type of returns could this investment generate? Use the information you gathered above to estimate a base, bull and bear case for your investment.
Highlights: Why makes this a compelling investment opportunity? Each investment will have its own unique highlights, for example:
- Has your target company reached product market fit?
- Is the company profitable? Does it have a strong balance sheet?
- Have top-tier Venture Capital investors invested in the company?
- Do you have the opportunity to purchase shares at a compelling valuation?
- Is the company quickly gaining market share in a large and growing market? Do they have room to grow?
Investment Decision: If you’ve gotten this far, you’re no longer wondering how to invest in pre-IPO companies — you’re ready to make an investment decision. Nice work!
So where do you go to invest in late-stage companies before they go public? Due to the relative recency of the private markets, one additional decision to make is to select the right partner to help you execute the pre-IPO trade. EquityZen, the platform I work at, is one of the leaders in the market and has helped investors make over 47,000 investments in over 450 companies. We provide in depth analysis on private companies, informed by 10-years of trading in the private secondary market.
There is so much more to learn about the exciting innovations happening within private companies, and a massive opportunity for women to participate in this growing market. As companies stay private longer and the private market grows, pre-IPO secondary investments will become increasingly important to drive meaningful returns and a well-balanced portfolio for all investors.
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- First-Time Investing With Vivian Tu
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