The 60/40 portfolio, comprised of 60% stocks and 40% bonds, has been the bedrock of many investors’ portfolios for decades. Now, it’s on track for its worst year in history. Interest rates have risen at the fastest pace in years, failing to tamper with 40-year highs in inflation. At the same time, stocks are underperforming as companies navigate a 180-degree turn from quantitative easing to tightening.
Many investors are looking for alternatives to the traditional portfolio in this environment. One increasingly popular option is investing in pre-IPO companies. Capital physics is less favorable for an investor when a company is listed on a public exchange. It’s much harder for a multi-billion-dollar firm to provide 10x returns than for a $100 million firm.
Pre-IPO investing offers the potential to get in before a significant liquidity event, and with firms staying private longer, there’s even more runway for returns than before. But there are risks to consider before diving in.
Employee Equity Valuations Are Inflated
A growing number of investors are accessing pre-IPO companies via employee equity. Companies like Equity Bee, Quid, Equity Zen, Forge Global, and others offer accredited investors the opportunity to buy shares from employees of high-growth startups.
But there’s a catch: The shares are often significantly overpriced. In many cases, investors are paying more for employee options than the companies are valuing themselves at.
As one CPA explained for NerdWallet, the investor pays an amount between what the shares are worth and what they might be worth in the future: “Let’s say they’re sitting at $10 a share, and the company expects to IPO at $100. An accredited investor might offer to pay $40 a share.” In other words, even in a bull market, this approach means you’re paying a hefty premium for investing early.
And in a bear market, as we’re currently experiencing, the risk is even higher. Median pre-IPO tech valuations, for instance, fell by 50% in the third quarter of this year. EquityBee explains on its homepage that these platforms let investors come in “at past valuations.” That means you could be massively overpaying for a company already falling in value.
Altogether, buying employee equity is one of the most overpriced, high-risk ways to invest in pre-IPO companies.
The Alternative For Pre-IPO Investing
A better way to invest in pre-IPO companies is through venture capital and private equity funds. These funds are run by experienced professionals who deeply understand the startup ecosystem and can provide mentorship and support to portfolio companies.
Additionally, these funds are much more selective than retail investors in employee equity programs. They carefully consider a company’s business model, competitive landscape, and management team before investing. As a result, they’re much less likely to overpay for a company that turns out to be a dud.
What’s more, these funds avoid the premium that comes with employee equity by investing directly in a company’s funding round. That means you’re getting in on the ground floor rather than paying extra for the privilege.
The Bottom Line
Pre-IPO investing is a risky proposition. Employee equity valuations are inflated, and you’re likely to overpay for the privilege of investing early. A better alternative is to focus on active managers who can provide mentorship and support to help a portfolio of companies move through the value creation lifecycle.
Gridline allows access to these opportunities with lower capital minimums, lower fees, and greater liquidity.