Pre IPO Shares
How Pre-IPO secondary markets work, how to get started and key risks
👋🏼,
A couple of years ago, I was catching up with a friend over coffee when I casually mentioned that I’d bought shares in a private tech company through something called the “secondary market.”
Their reaction?
A mix of confusion and suspicion, like I’d just admitted to running a black-market side hustle.
“I didn’t even know you could do that,” they said. Honestly, I barely did either when I first started.
But after some digging and a bit of risk-taking, I’d managed to snag shares in what I thought was a promising startup before it went public.
To be honest, the company wasn’t a roaring success when all was said and done.
But I didn’t put much in to begin with, so it was more of a learning experience than anything else and that doesn’t mean to say that investing in this space can’t be lucrative, I know first hand from people I know that it can generate huge returns. However, risk levels are high.
But let’s dive in to find out more.
I’ll cover:
- Pre IPO secondary markets - what are they and why are they needed
- Stripe - a case study
- Types of secondaries
- How can an everyday investor get started
- Risks
Pre-IPO Secondaries (secondary market)
Think of a pre-IPO placement as a backstage pass to a company’s stock before it goes public. It’s when big investors—like private equity firms, hedge funds, or other institutions—buy a chunk of shares behind the scenes, well before they hit the public market.
Why would they do that? For one, they usually get a discount compared to the price regular investors pay when the IPO launches. But it’s not without risk - these buyers are making big bets on the company’s future. It’s a win-win for the company too, since it gets cash upfront to fund its growth or smooth out the IPO process.
Why do Pre IPO secondaries even exist?
You’ve probably noticed that companies are staying private longer these days. Since the IPO boom in early 2021, IPO listings have fallen dramatically, due to a combination of factors including: increased market volatility, rising interest rates and economic uncertainty.
For some companies this is great - they don’t have to deal with the headaches of public markets - but it can be a huge problem for employees.
Why? When employees join a startup, they’re often given ESOPs (employee stock options). The dream? The company eventually goes public, and those options turn into shares they can sell for real money.
What a lot of employees don’t realize, though, is that these options usually come with an expiration date - often just 10 years. If the company doesn’t go public within that window, and the employees can’t exercise their options, those options expire worthless.
Yep, all that potential money? Gone.
It’s a nightmare for early employees who bet big on their company’s success.
That’s where secondaries come in. They allow employees to sell their shares before they expire, giving them a way to cash out without waiting for an IPO. Secondaries also help cover the costs of exercising options and paying the taxes that come with them.
Take Stripe, for example. In one of its recent secondary rounds, the company gave employees a way to sell their expiring 10-year options. It was a lifeline for long-time employees who might have otherwise lost everything they’d worked for.
As startups stay private longer, secondaries aren’t just a nice-to-have - they’re becoming essential.
Types of Secondaries
GP-Led Transactions
GPs (General Partners) manage venture funds and make money through management fees, carried interest, and fund distributions. In a GP-led transaction, shares (or a percentage of shares) in the fund are sold off.
These deals are typically massive. For instance, a large investor might get tired of waiting for a liquidity event - like a company going public or being sold - and decide to offload their position quickly. A good example? The hedge fund giant Tiger Global recently tried selling fund positions through secondaries.
LP-Led Transactions
In LP-led transactions, limited partners (investors in the fund) sell their ownership stakes. Here’s the twist: the fund itself doesn’t sell any shares. Instead, it’s the ownership structure of the fund that shifts as new investors buy out the exiting LP’s position.
Tender Offers
When lots of employees want to sell shares, companies can coordinate a tender offer. This means they match those shares with a buyer (or multiple buyers) at a set price and terms agreed upon by the company. It’s a more organized way to handle employee demand for liquidity.
Direct Secondaries
A direct secondary transaction is probably what comes to mind when you think of secondaries. It’s straightforward: one shareholder sells their stock directly to another person or entity, typically using a Stock Transfer Agreement to formalize the deal.
Forward Contracts
Forward contracts are a bit more complex. These are lengthy (10+ pages) derivative agreements where the seller gets the cash upfront but agrees to deliver the shares to the buyer later, usually after transfer restrictions -like an IPO lockup - have lifted. Think of it as “cash now, shares later.”
How to get started…
It’s tricky but there are ways!
The best route being pre-IPO investing platforms
Unfortunately, mostly are for Accredited investors (which means you have a net worth of at least $1,000,000, excluding the value of your primary residence or have had an income of at least $200,000 each year for the last two years, or $300,000 combined with a spouse) can use platforms like EquityBee, Linqto, and EquityZen to access pre-IPO investment opportunities in private companies, including Stripe.
These platforms facilitate the purchase of pre-IPO shares, allowing investors to gain exposure to promising companies before they trade publicly.
If you’re not an accredited investor, then there are more and more companies cropping up that are allowing a more accessible route e.g. Forge Global
MicroVentures is a platform that allows ‘sophisticated non-accredited investors’ to invest in startups across various industries. They conduct due diligence on prospective companies and provide detailed information for investors to review.
Risks in pre IPO investing
Investing in pre-IPO companies can feel like getting in on a secret opportunity, but it’s definitely not all upside. There are some major risks you need to be aware of before diving in.
First, there’s the liquidity issue. Once you invest, your money is essentially locked up. Pre-IPO shares aren’t traded on public markets, so if you suddenly need that cash, it’s not as simple as hitting the sell button.
You could be stuck holding those shares for years until the company goes public - or worse, if it never does.
Then there’s valuation risk.
Pre-IPO companies are often valued based on projections, not actual profits. It’s easy to get swept up in the hype, but those sky-high valuations can deflate quickly if the company’s performance doesn’t match expectations. Remember, not every startup turns into the next Uber or Airbnb - some just fizzle out.
A prime example of pre-IPO hype leading to a dramatic valuation drop is WeWork. At its peak, WeWork was valued at nearly $47 billion based on ambitious growth projections and a charismatic leadership narrative.
However, as the company prepared for its IPO, deeper scrutiny revealed significant financial instability and unsustainable business practices. This led to a rapid decline in confidence, and the company's valuation plummeted to as low as $8 billion.
Eventually, WeWork's stock price fell even further, closing at $0.84 per share, representing a 99.8% decrease from its initial public offering.
Another big one? The lack of transparency. Public companies are required to disclose a ton of information, but private companies don’t play by the same rules. You’re betting on a company with limited financial data and often little insight into their long-term plans.
Lastly, there’s the risk of total loss. It’s not pretty, but startups fail all the time. If the company goes under, your investment could vanish with it. That’s why it’s important not to put all your eggs in one basket - spread your investments out to manage risk.
So, while pre-IPO investing can be exciting and potentially very lucrative, it’s not a “set it and forget it” kind of play. You need to go in with eyes wide open and be prepared for a bumpy ride.
Hope this was helpful!
Jason
DISCLAIMER: None of this is financial advice. Finbrain is strictly for educational purposes.