What are Pre-IPO Placements?
What are Pre-IPO placements?
Pre-IPO placement is a private transaction of shares of a non-publicly traded company, which is a fast way for the company to raise capital. Private equity firms, hedge funds, large institutions and ultra-high-net-worth individuals would be the main users of pre-IPO placement.
These investors are subject to a lockup period, which means that investors cannot convert the restricted shares into publicly traded shares immediately after the invested company goes public.
In general, investors can transfer the shares to the public after the company listed on the exchange for six months or more.
Reasons for investment
To compensate for the liquidity issue and offer a return to the investors, the buyers of pre-IPO placement can enter the deal at a discounted price. Private equity investments usually give a higher return compared to equities and fixed income. According to research by Cambridge Associates, private equity produced average annual returns of 10.48% over the 20 years ending on June 30, 2020, while the S&P 500 only returned 5.91% over the same period.
For instance, Alibaba held a pre-IPO and sold its shares with the price per share below $60. After its IPO on the first trading day, the stock price per share is closed at $90.
Apart from the low liquidity yet high internal rate of return features, lower volatility risk is another feature of pre-IPO placement while the publicly traded equities usually are exposed to larger price variation.
Since the restricted shares cannot be traded on a stock exchange, the valuation of the invested company would not be affected by a large daily variation in the market before it goes public.
Limitation for Pre-IPO placement
The entry barrier of PE investments are generally much higher than the publicly traded equities and fixed income. Thus, usually only institutional investors and high net-worth individuals can afford the entry fees.
Although pre-IPO placement has its own limitations such as lower liquidity, limited information and high entry barrier, investors of pre-IPO placement could enjoy a higher expected rate of return and lower volatility risk as mentioned above.
Compared to the risk and return tradeoff, pre-IPO placement is quite popular among ultra-high net worth individuals and different financial institutions.