How to Invest in a Company Before It Goes Public

Investing in a company before it becomes publicly traded offers individuals an opportunity to participate in the growth of enterprises. This involves acquiring equity stakes in private companies, distinct from shares on stock exchanges. Private market investing means engaging with businesses in early to mid-stages of development, prior to an Initial Public Offering (IPO) or acquisition. These investments are characterized by a long-term outlook, as a liquidity event, such as an an IPO or sale, can span years.

Engaging with private markets allows investors to benefit from value appreciation. Unlike public market investments, private investments are not subject to daily market fluctuations, though they carry risks and illiquidity. The landscape of private investing has broadened, making it more accessible to individual investors. This accessibility is due to regulatory changes and new investment platforms, democratizing participation in ventures once reserved for institutional investors.

Methods for Individuals to Invest

Individuals seeking to invest in private companies have several avenues available, each with distinct mechanisms. These methods provide different levels of access and engagement with early-stage businesses.

Equity Crowdfunding Platforms

Equity crowdfunding platforms allow individuals to invest in startups and growing private companies. These platforms connect investors with companies seeking capital, often allowing for small investment amounts. Companies present business plans, financial projections, and team information, enabling investors to review opportunities and commit funds. The process involves creating an account, browsing offerings, and subscribing to an investment.

Secondary Marketplaces

Secondary marketplaces facilitate buying and selling existing shares in private companies. Unlike primary investments, these platforms enable transactions between current shareholders and prospective investors. This mechanism provides liquidity for private shares, which are otherwise highly illiquid, allowing early investors to exit or new investors to acquire stakes. Valuation is determined by supply and demand, reflecting the perceived value of the private shares.

Managed Funds or Syndicates

Managed funds or syndicates aggregate and manage capital from investors. These vehicles, such as pre-IPO funds or angel syndicates, deploy capital into a portfolio. The fund manager or syndicate lead identifies opportunities, conducts due diligence, negotiates terms, and manages investments. This method offers individuals diversification and professional management, though it involves management fees and carried interest.

Direct Investment

Direct investment, or angel investing, involves high-net-worth individuals investing capital directly. This method requires direct negotiation with founders or participation in angel networks. Angel investors provide capital, mentorship, and guidance. While this approach offers control and direct engagement, it demands substantial capital, expertise in evaluating private companies, and high risk tolerance, making it less accessible.

Key Considerations Before Investing

Thorough preparation and due diligence are important before committing capital. The information gathered helps in assessing the risks and potential rewards associated with private market opportunities.

Understanding the Company and its Business Model

Understanding the company and its business model is fundamental. Investors should research the company’s product or service, identifying its unique selling proposition and how it addresses a market need. Evaluating target market size, competitive landscape, and growth strategy is also important. Key information sources include the company’s pitch deck, investor presentations, and public news or industry reports.

Reviewing Available Financial Information

Reviewing financial information provides insight into performance and health. While private companies are not subject to rigorous public reporting, they provide financial data to potential investors. This data may include revenue figures, cash flow statements, and details of previous funding rounds and valuations. Interpreting this information involves assessing the company’s burn rate, runway, and ability to generate revenue or achieve profitability within its projected timeline.

Understanding Valuation Concepts

Understanding valuation concepts is important for determining if the investment price is reasonable. Private companies are often valued using methods different from public companies, such as their last funding round’s valuation, revenue multiples, or industry benchmarks. For early-stage companies, valuation might also consider intellectual property, market traction, and management team strength. Investors should assess whether the proposed valuation aligns with their expectations for future growth and return.

The Legal and Regulatory Framework

Careful consideration of the legal and regulatory framework surrounding private investments is required, and investors must review investment agreements, such as term sheets and subscription agreements, to understand the specific terms of their investment. Key terms include the share class being offered (e.g., common or preferred stock), any associated voting rights, and liquidation preferences, which dictate how proceeds are distributed in an acquisition or liquidation event. Regulatory distinctions, particularly the concept of an accredited investor, determine which investment opportunities are accessible. The Securities and Exchange Commission (SEC) defines an accredited investor as an individual with a net worth exceeding $1 million (excluding their primary residence) or an income exceeding $200,000 individually ($300,000 with a spouse) in each of the two most recent years, with a reasonable expectation of the same income level in the current year. Non-accredited investors typically have limitations on how much they can invest in certain offerings, often tied to a percentage of their income or net worth, as defined by regulations like Regulation Crowdfunding and Regulation A+.

The Investment Process

After thorough research, the investment process involves several steps. The process typically begins with engaging a chosen investment platform.

Selecting an Appropriate Platform

Selecting an appropriate platform is the first step, whether it is an equity crowdfunding site, a secondary marketplace, or a platform for managed funds. Once chosen, creating an investment account is necessary, involving personal information for identity verification. Know Your Customer (KYC) and Anti-Money Laundering (AML) procedures are mandatory for financial institutions and investment platforms, ensuring legitimate transactions. This usually includes submitting government-issued identification and proof of address.

Committing to an Investment

Committing to an investment involves formally indicating the desired amount. On most platforms, this is accomplished by clicking an “invest” button and entering the sum. Investors are then required to electronically sign legal documents, such as the subscription agreement, outlining investment terms, and potentially a private placement memorandum or offering circular. These documents legally bind the investor to their commitment and outline their rights and obligations.

Funding the Investment

Funding the investment is the next step, transferring capital to the platform or directly to the company, depending on the arrangement. Common methods include ACH transfers, wire transfers, or credit card payments. The platform or company will provide specific instructions for fund transfer, including bank account details or payment gateway links.

Confirmation and Documentation

Upon successful transfer of funds and documentation completion, investors receive confirmation and documentation. This usually takes the form of a confirmation email, a digital share certificate, or an updated investment dashboard. This documentation serves as proof of ownership, detailing shares acquired and the investment amount. Investors should retain these records for future reference, especially for tax purposes or when a liquidity event occurs.

Post-Investment Tracking

Post-investment tracking allows investors to monitor progress. Most platforms provide an investor dashboard where individuals can view holdings, access company updates, and receive reports. These updates typically include information on operational milestones, financial performance, and significant developments. Maintaining engagement with these updates helps investors stay informed about their investment’s performance and prospects.

Citations

https://www.sec.gov/education/capitalraising/building-blocks/accredited-investor