Until recently, investment opportunities in private companies were only open to large institutional investors. With high demand for exposure to well-known private companies and scope to generate higher alpha, the investor landscape is now changing to include a broader audience in the pre-IPO investment universe.
Investing in private markets is significantly different and complex than investing in public markets. Pre-IPO investments come with their own pros and cons. The long-term average return of private markets is significantly higher than that of traditional asset classes. Investing in alternatives is also gaining traction because of the diversification factor. Adding a portion of alternatives to the portfolio helps reduce overall risk due to volatility in public markets.
While the opportunity to own a stake in a promising company may seem quite lucrative, it comes with significant risk. Here is a list of some of the important risks of investing in a pre-IPO company.
Private companies are not required to make financial statements public; this makes it difficult to get clarity about the company. There’s also no way to validate how well the company is doing.
There are many layers between the investor and the company you invest in, and it is often difficult to understand what the investment process can look like from an investor’s perspective. For example, it can be difficult for an individual to understand the process of investing in a company directly versus investing through a single-layer or dual-layer special purpose vehicle (SPV). Different assets are located in different jurisdictions and are therefore subject to different laws; It is important to understand this as these laws affect your exit.
Since the shares of private companies are not publicly traded, it is difficult to find sellers and relevant information about them. Because private markets investing is generally seller-driven, stocks trade at different prices with different sellers. This makes it difficult to determine the right price or value the investee company. Therefore, extensive research is required before finalizing a deal.
Investment duration and liquidity deadlines
An investor must also be aware of the liquidity aspect before investing in the private market space. Exit options with such asset classes are not as easy as with public market investments. Typically, exit options are available for IPOs (either through a SPAC [Special Purpose Acquisition Company] or an IPO ) or when a large investor comes in, or through secondary liquidity via an asset management platform.
Larger check size
The investment volume required to qualify for this type of investment was quite high and previously only available to institutional investors. Investment size may not be a big issue if you want to invest via unlisted stocks from an unlisted stockbroker before going public. Most brokers offer the investment opportunity for a few thousand rupees. However, if you choose an asset management company that facilitates pre-IPO investments, be aware that only accredited investors under financial regulation laws can participate in such investments. Minimum ticket size varies from one to another (it’s $10,000 – $25,000 on Kristal.Ai for single asset deals).
The key is to have a good understanding of the asset class before making an investment decision. The risk/reward trade-off may be higher when investing in private markets. This also strengthens the case for extensive research.
When investing in unlisted stocks through a broker, make sure you research all of the above thoroughly. When investing through a wealth management platform, ensure that the platform you choose conducts extensive research, gathering additional information about the company and ensuring a due diligence process, typically followed by internal investment committee approval Asset review to follow.
Manmohan Mall is the Head of Private Markets, Kristal.AI.
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