Investing in pre-IPO companies

Buying pre-IPO secondaries can be a way to gain early exposure to generation-defining companies— imagine having a stake in Airbnb, Uber, or Robinhood before they went public.

Now, picking the right companies is one thing. And it’s not easy. But if you’re confident in your investment criteria, the real problem is access: secondary shares in private companies are not easy to come by.

Historically, if you had your eye on a private company and wanted to get equity, you’d either have to be a well-established institutional investor or VC, or you’d have to deal with a human broker.

With private secondary marketplaces like Hiive, however, you can buy private stock directly from the existing shareholders, provided you meet certain criteria for income, net worth, or financial sophistication, and are willing to take the risk of this asset class (more on all that below). You don't have to be a major private market investor with connections, nor do you have to go through a broker. Just place a bid. And because you can talk directly to the seller, you know you’re getting the price the seller agreed on— no funny business. More on that later, though. 

The rest of this article will discuss navigating the pre-IPO secondary market and how Hiive works.

Why pre-IPO secondaries?

TL;DR: Pre-IPO investing may give you a chance at higher returns than what you’d traditionally see in either public investing or private equity. Also, while pre-IPO secondary market investing is risky, historically, there is a higher probability of you being able to liquidate your investment than if you were to invest in the early Seed or Series A stages. 

Why now is the time

Tech companies these days generally stay private for longer than they used to. That means many of the companies pushing at the frontiers of technological advancement are not in the public markets— and won't be for the foreseeable future.

So if you want to ride the growth trends in AI, Web3, and other frontiers, chances are that you only have a limited range of options within the public markets. And because these sectors are so new, there is a decent chance that the category winner isn't a public company yet. 

Pre-IPO investing provides access to such opportunities before they become widely known to the broader public.

Why not just participate in fundraising rounds?

Making a Seed or Series A investment is a major gamble, and getting in on those fundraising rounds usually requires connections and experience in venture capital.

Investing later on, though, (imagine after a Series E for a company with plans to go public) gives you a unique opportunity: you can get a stake in a company that is more likely to successfully IPO than an early-stage startup.

There’s also potentially a shorter investment horizon. If you provide seed funding to a startup, the IPO might be a decade or more down the line—if it happens at all. But with companies closer to IPO, there’s a better chance that you’ll see liquidity within a few years. (To be clear, you may never see liquidity at all no matter what stage you invest at; pre-IPO investing is risky at any stage and only appropriate for those who understand and can tolerate such risk.)

Considerations when investing in pre-IPO

Eligibility and suitability requirements

Because private markets are less strictly regulated and carry higher risk, you need to be an accredited investor in order to buy private stock. This requirement exists to protect investors—the regulators wants to be sure that people only invest in private stock if they can afford the potential downside.

To qualify as an accredited investor in the US, you need to meet at least one of the following criteria:

• have a net worth of over USD $1 million, not counting your primary residence;

• have income of over USD $200,000 (or $300,000 with spouse or partner) for at least the last two years; or

• be an investment professional in good standing.

The SEC website has more details on who constitutes an accredited investor. Hiive will also require you to pass “know your customer” (KYC), anti-money laundering (AML), and suitability checks. Other countries outside the US may have other rules or thresholds for who can participate in pre-IPO investing.

Understanding your upside

Buying private stock is not as straightforward as investing in the public stock market, so it’s important that you take the time to understand what you’re buying. You’ll want to consider the company’s valuation, the terms that come with the stock you’re purchasing, and what kind of ownership stake you have in that stock.

Valuation

When you’re assessing the potential downside or upside of pre-IPO investments, one of the most important factors is the company’s valuation. While private company valuations are generally not publicly available, and there is limited financial or other information available either, there are four sources of information that you and your professional advisor (if you have one) could use to get an indication of a company’s valuation:

1. comparison to similar publicly-traded companies;

2. the company’s 409A valuation;

3. the valuation of the company’s last capital raise; and

4. real-time trading data on secondary marketplaces.

You can read more about each of these factors in our in-depth piece on common methods of calculating the price of private startup shares.

Ownership structures

When buying private stock, you may or may not have the option for direct ownership, i.e. owning stock of the company you are investing in. There are a few different types of investment structures in pre-IPO secondary market investing, and it’s important to consider which one aligns with your goals. Two of the most common investment structures are:

Direct ownership: Owning shares in the company directly is the most straightforward option, and it gives you direct control over the shares you are buying. But direct ownership may not be an option for some companies that limit access to their cap table, and in most cases requires a much larger minimum investment than other options.

Funds (aka Special Purpose Vehicles): Funds allow you to access unicorns at lower investment minimums, because they effectively pool your capital with other investors. With Funds, you're not buying shares of the company directly. Instead, you're buying membership interest in the Fund— and the Fund, in turn, owns shares of the company (or in some cases the shares of another Fund).  A Fund investment may be less administratively burdensome to hold than a direct investment because the Fund manager manages the Fund on your behalf and provides you with period reporting and necessary tax reporting. What you give up with Fund investing is direct ownership in the underlying company shares. 

Liquidation preferences

When a company experiences a liquidity event— usually via an IPO or acquisition— its shareholders receive their payouts in a predetermined order. 

If you have a liquidation preference, you get your share of the proceeds before common shareholders. If the company doesn’t make enough from its liquidity event to repay all of its shareholders, it can mean the difference between getting your investment back and getting nothing.

When buying shares on a secondary basis, knowing whether you’re getting preferred or common shares is essential. If you buy from an investor, you may be getting preferred shares. You'd typically get common shares if you buy from an employee or founder.

Liquidation preferences occasionally come with a multiplier— a 2x multiplier means that the stockholder will be paid double their initial investment before the shareholders behind them in the queue get anything.

Note that there are multiple classes of preferred shares, so people might be ahead of you in the queue. It’s therefore important to understand not only the terms of your own liquidation preference, if you have one, but also the preferences of the share classes ahead of yours, which could mean you end up with nothing on a liquidity event.

Lockup periods

Often, your stock can’t be sold right when the company goes public. Many private stocks have a lockup period, which is the length of time after IPO that you’re restricted from selling your shares— typically between 90 and 180 days. Lockup periods exist to prevent major changes in stock prices and company ownership right at IPO.

The duration and terms of the lockup period impact the liquidity of your investment since a lockup period means you might not be able to realize returns or losses immediately. But if you're not looking to make a quick return, that may not be an issue for you. 

If you really believe in the future success of the company, you may wish to hold your stock for longer anyway. After all, many successful companies didn’t peak right when they IPOd: depending on when you bought Facebook stock pre-IPO, selling it within the first 180 days after its IPO could have netted you a loss. Today, however, those shares are worth more than 10x what they were at IPO.

When investing via a Fund, the Fund Manager will usually distribute your portion of the shares to you as soon as the lockup expires. 

Managing the risk of incomplete information

Private markets come with heightened information asymmetry. When you’re buying pre-IPO stock, the seller may have an information advantage— since sellers are usually employees or early investors, they’re likely to have insider information that isn’t available to you. This puts them in a favourable negotiating position, and you risk paying more for the stock than it’s worth. 

So it’s important that you do your research, engage a professional advisor if you need one, and figure out how much you value the stock, before you decide to buy it. You also need to be in a financial position to tolerate the complete loss of your investment.

But this is easier said than done— while the public stock market always shows you exactly how a stock is valued at any given time, private markets are much less transparent. And since private companies aren’t subject to the same reporting and disclosure requirements as publicly traded companies, they generally publish less information.

So, how can you assess the value of a private company?

If you’re unsure how to value a company based on its limited reporting, you may consider other information as a signal. For example:

• If a reputable fund manager or other existing investor is doubling down on their investment in the company, that may be a positive signal, assuming they have access to information that you don’t. 

• If the securities are held by a fund, and the fund decides to mark them down, that’s a negative signal. If they mark it up, then things may be  improving— but the fund might also do this for other reasons, such as to attract investors or improve their own perceived performance.

• Sometimes the company sponsors its own buy-backs of shares from employees, and the valuations of these purchases are often reported in the press when they happen, especially in the case of high profile companies like SpaceX and OpenAI. Following industry trends and the company’s revenue reports can also be extremely informative. Many crypto companies (eg. Ripple, Chainalysis, Kraken, etc) disclose a significant amount of information publicly. 

Finally, if you’re using a marketplace like Hiive, you can see the price of recent secondary market trades for an indication of what other investors are willing to pay.

Where can I access pre-IPO stock?

Pre-IPO stock can be hard to come by. Traditional brokerage firms or tender offers might make private stock accessible to established investors, but most people will be shut out. Luckily, online secondary marketplaces can connect you with employees or early investors at pre-IPO companies looking to sell, again, provided you meet certain criteria.

Traditional brokers

Traditional brokerage firms can serve as intermediaries for accessing pre-IPO stock. But you may not want an intermediary— if you’re not interacting with the seller directly, settling on a purchase price can become a game of telephone.

These brokerage firms also tend to be hard to find and focus only on institutional investors. Even if they do work with individual investors, traditional brokers often have stringent accreditation requirements and high minimum investment thresholds, making them inaccessible to most people.

Tender offers

Tender offers involve purchasing stock directly from existing shareholders. The company itself often initiates them and third-party firms may facilitate them.

However, tender offers are typically only accessible to major or existing investors in the company. If an individual or family office is able to access a tender offer, it’s typically only via a Fund. 

Tender offers are also point-in-time opportunities— the stocks are only available for a very limited time. It’s unlike the public market, where you can decide to buy into a stock anytime.

Private secondary marketplaces

Private secondary marketplaces have similarities to other marketplaces you use regularly. There are buyers and sellers on the platform. Sellers can list their shares, and buyers can make offers. In some of them, you can see historical transaction data and current bids, which tell you how other investors and sellers perceive the value of the shares.

Of course, private secondary marketplaces can’t magic away all the limitations of the private market. Like with any other venues for buying pre-IPO stock, you will still have to deal with limited availability, regulatory constraints, and information asymmetry.

If you’re interested in exploring a private marketplace, and provided you meet certain criteria, you can access our platform called Hiive. Our investment minimum is $25,000— much lower than most traditional brokers.

How things work on Hiive

Anonymity

On Hiive, you can browse the market and post standing bids anonymously. Your identity is only revealed when you message a seller or when your bid is accepted.

Automated matching + direct to counter party

Hiive automatically matches you with sellers.

While Hiive is a broker, it’s different from traditional brokers because with Hiive you can get direct access to your counterparties. If you work with a traditional broker, they act as the intermediary between you and the seller. On a private marketplace like Hiive, you’ll often get to talk directly with the seller and negotiate with them.

Once you have matched with a seller and settled on a price that works, the next step is to obtain approval from the company.

Company approval

Companies and certain other investors may have a transfer approval or Right of First Refusal (ROFR) over the company’s stock. This means that if you agree to buy shares from an employee of the company, the company can veto the transaction or decide to buy the shares in place of you. 

Hiive takes the lead in seeking the company’s approval. While we can’t make any guarantees, we’ve already had 170+ companies approve deals that we've brought to them.

Hiive also has multiple direct relationships with some companies that work with us as an official venue for trading. For deals with those companies, working through Hiive may facilitate a more efficient approval process.

Finally, if you are buying via a Fund (SPV), the Fund manager will be responsible for obtaining the company’s approval. You would not need to seek approval for yourself since you are not buying the shares directly.

Share and proceeds transfer

Once you’ve agreed in principle to terms of the transaction with a seller, you will usually sign a “share transfer agreement”. This is a contract that includes  relevant details, such as share number and purchase price.

When buying via a Fund, you sign what’s called a “subscription agreement”’ with the Fund. The rest of the process will be relatively straightforward and one that Hiive will guide you through.

Recap

There are various ways to access pre-IPO stock, but private secondary marketplaces like Hiive are a relatively simple way to navigate the process and only require relatively low investment minimums. Provided you meet certain criteria, you can create an account in minutes and start browsing one of the world’s largest marketplaces of secondary deals today.

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