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Why Pre-IPO Investing is Growing Rapidly

By: Gridline Team | Published: 09/27/2021
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Est. Reading Time:
3 minutes

Startup companies are spending more time — and raising at larger valuations — in the private markets. At the turn of the century, the median volume of equity raised pre-IPO was just $42 million. In 2020, that number quadrupled to $167 million.

Equity raised by companies before IPO in the U.S. 2000-2020
Equity raised by companies before IPO in the U.S. 2000-2020 (Source: Statista)

Why companies are staying private

Private rounds allow businesses to build up a war chest of retained earnings before going public. Companies choose to stay private longer because they see the advantages of having more time to grow their businesses and raise ever-larger private rounds, almost like aging fine wine. Companies are staying private longer, across sectors including software, marketplaces, subscription, and e-commerce, according to Crunchbase research.

Research by Jeremy Abelson and Ben Narasin showed that between 2012 and 2015, companies that entered public markets with a market cap above $1 billion reached a 60% higher valuation than companies with a market cap under $500 million.

Private businesses also face fewer requirements for reporting. They aren't mandated by the SEC to submit complex annual reporting and third-party auditing, which are costly, time-consuming, and distracting. Private businesses can retain their focus on strategy instead of meeting the expectations of public markets.

IPOs bring risks on every level. Businesses planning an IPO face regulatory risks, shareholder-related risks like alleged listing misstatements, and contemporary risks such as indemnification to the underwriters.

Businesses can avoid these risks by staying private longer while retaining control and amassing capital. If and when a business chooses to go public, it’ll achieve a much higher valuation by having grown privately.

Why invest pre-IPO

Investing pre-IPO gives you access to private companies before they go public. With pre-IPO equity, you tend to get much more for your money. 

When a company goes public, it issues shares and sells them to the general population. In the early days of a company’s life, however, investors interested in getting in on the ground floor can do so by purchasing shares from venture capitalists, private investors, or even employees instead of waiting for the initial public markets valuation.

Pre-IPO investing offers investors a greater opportunity to grow their stake faster early on in the company’s lifecycle than after it goes public and begins to distribute dividends.

Buying into these companies early on gives you an advantage over time as the business grows and distributes returns to shareholders via dividends and share price appreciation.

Countless headlines read something like “If You Invested Right After Facebook's IPO” or “If You Had Invested Right After Tesla's IPO,” showing how you’d be a millionaire today. These returns pale in comparison to what’s possible by investing before these companies went public.

Why this trend will only continue to grow

Pre-IPO fundraising has the advantage of increased control and capital in the long term.

Public companies must distribute profits to shareholders through dividends and share buybacks. But when a company is private, executives can choose whether or not to sell their shares at any time.

This option allows companies to build up enough cash reserves before going public that distributions can be lower once they are listed. Companies that choose not to use this cash reserve benefit by building shareholder value through increased buyouts or acquisitions rather than dividends.

Pre-IPO transactions have been more favorable than IPO transactions for both founders and shareholders.

Recent examples

Affirm, Qualtrics, UiPath, Roblox, Coinbase, and others have gone public in 2021.

Affirm popped nearly 100% in its market debut. Qualtrics priced its IPO at $30 a share, but it only became available to regular investors at around $45 a share. These same shares were worth only around $18 just a couple of years prior.

That exponential gain rarely (if ever) continues after a public debut.

Summary

The pre-IPO equity market is increasingly becoming the place for investors seeking higher returns from their capital. It's growing in parallel with the demand for alternative investments. Gridline makes investing in diverse pre-IPO equity strategies effortless.

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