Unlocking The Potential Of IPO And Pre-IPO: Opportunities And Pitfalls For Investors

When the rates in the USA were low, a surge in initial public offerings (IPOs) could be observed; in 2021 the US witnessed 1 035 IPOs. However, because of the geopolitics and pandemic outcomes, many companies delayed their IPO plans out of concern that they wouldn't attract sufficient investment. That’s why in 2022 and 2023, IPOs declined significantly, reaching 181 and 154, respectively.

Even as the pandemic receded, interest rates remained high. This presents a dilemma: launching an IPO under current market conditions would be costly. And in the near future, along with the rate cuts, IPOs are anticipated to attract investors again. That’s true. Among the recent examples of IPO is Reddit. It became a public company on March 21st and the first major social media site to launch an IPO since Pinterest back in 2019. 

In this regard, examining the main features of an IPO process and what a qualified investor should pay attention to when investing in it becomes crucial.

How Can Companies And Investors Benefit From An IPO?

In the perception of many investors, an IPO is the starting point for investing in a company. In fact, this is far from being the truth. There are five main stages on the company’s path to IPO: pre-seed funding, seed funding, series A,B,C, fundings, Pre-IPO and finally, IPO. Successfully passing through them, companies intensively increase their capital, capture a rapidly growing market share and eventually conduct IPOs worth billions. 

Investors may be interested in allocating their funds at stages far before an IPO to profit from the company's growth. At the seed funding stage, they can buy 10 percent of the company for a ridiculous 50, 30 or even 10 thousand dollars. Can you imagine how much they will earn when the company goes public with a billion-dollar capitalization? However, in investing before an IPO, not only are the stakes high, but the risks are also elevated, especially the fact that a company may shut down before an IPO. Thus, buying stocks from an IPO at least guarantees that the company will not disappear from the market and lowers the risks. 

What Else To Watch Out For When Investing in an IPO?

Nevertheless, even with low risks, an IPO has its pitfalls to be attentive to when investing. Since the share price at the initial public offering is valued fairly, the yield from the IPO is usually lower. Moreover, most companies introduce a lock-up period during which shares purchased at the IPO cannot be sold. And in the future, when the opportunity to sell appears, the shares may significantly decrease in price. 

Another challenge in IPO investing is allocation. Typically, the initial offering dates are publicly known, attracting many investors. Each broker is likely to receive limited shares to distribute to their clients. In the end, you may get fewer shares than planned, or even worse  – do not get them at all. Any excess funds beyond the shares you eventually acquire won't be lost. However, from the time you apply to the broker until you receive confirmation of your share allocation, the funds you reserve for the investment will be inaccessible.

Pre-IPO As A Way To Minimize Risks While Investing

From the point of view of the risk/return balance, it is worth considering the penultimate stage in the chain of steps of venture investment – a Pre-IPO. Pre-IPO is an unofficial name for the stage when the company's object of investment is firmly on its feet and has stable financial flows. At the same time, it is a period when a public offering is seen on the horizon, and probably the company has even made an announcement regarding it.

The Pre-IPO stage will bring greater returns than buying shares from an initial public offering. Usually, you can earn 2-3 times more than what you have invested in a late-stage transaction. In many cases, there is also no lock-up period, and even before going public, an investor has the opportunity to make a profit selling his stocks even on the secondary over-the-counter market.

Beyond elevated risks, there are also other disadvantages. Legal registration particularities and other subtleties of this stage can delay the investment period up to one or two years and considerably reduce the benefits of the transaction, so each case should be evaluated individually.

Summing up, if you are not a professional venture capitalist and even more so a business angel, then it is recommended that you limit yourself to the Pre-IPO stages and the actual public offering. This will help you both eliminate the risks and diversify your portfolio. 2024 will likely be the year of the IPO so that you can try it out in practice. 

This article is from an unpaid external contributor. It does not represent Benzinga's reporting and has not been edited for content or accuracy.