Pre-IPO offerings are when a company offers shares to select investors before going public. While it can lead to financial gains, there are risks, including illiquidity and the possibility of the company not going public. The SEC warns against investing in pre-IPOs and recommends investigating the company thoroughly before investing.
A pre-IPO offering is when a company offers shares to an investor or investment group before it goes public and makes the shares publicly available. Such stock offerings are typically offered to large investors, hedge funds, or investors with seats on the company’s board of directors at a price significantly less than the initial public offering (IPO) price for a couple of reasons. When big investors buy a company early, it can encourage buying shares immediately after it goes public. The upside to pre-IPO investors is that significant financial gains will be made if the stock sells for a higher price once it becomes available to the public.
There are several drawbacks to getting involved in a pre-IPO offering. The risk is very high due to the fact that the company is not legally required to go public after making a pre-IPO offering, which means that the shares would have little or no value if the company failed to attract enough interest in participating in an IPO. Pre-IPO shares become illiquid, meaning it’s virtually impossible to sell or hedge for cash. There is also usually a lock-up period with pre-IPO stocks where you can’t sell for a certain period of time after the company goes public. If the share price falls after being offered to the public, the pre-IPO share price could end up being higher than the market price, resulting in a net loss to the investor.
The United States Securities and Exchange Commission (SEC), which enforces federal securities laws, warns against investing by the company before the IPO. Marketing pre-IPOs to the general public is often fraudulent and lures investors by offering a high rate of return from a company that is financially unstable, fictitious, or not legally registered with the SEC. Also, pre-IPO offerings that have been successful in the past typically offer double or even triple-digit returns. This type of performance in a narrow section of the stock market attracts all sorts of scammers who promise the same or better returns.
Whether you choose to invest through a standard initial public offering or a pre-IPO, the SEC recommends that any investor take several concrete steps to investigate the company before doing so. This includes checking to see if the securities are listed with a state securities regulator and how the shares may be restricted by blackout periods. A detailed analysis of the company should also be done, including looking at what products or services it offers, who its primary customer base is, and getting copies of its financial statements available through its investor relations department. It is also important to find out who owns and runs the company, as these managers will be registered with the state securities regulator if they have defrauded the public in the past.
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