The Ultimate Guide to Pre-IPO Investing

Significant wealth can be generated by investing in companies before investment is open to the public. Here, in the ultimate guide to pre-IPO investing, we're going to show you how.

Many investors think of the initial public offering (IPO) as the first time retail investors get a crack at stocks.

The IPO is the first time retail investors have a chance to buy a stock trading on a major exchange, such as the New York Stock Exchange or Nasdaq. But stocks can be traded privately before they see the lights of the big board.

This is called pre-IPO investing. It doesn't carry the risks of IPO investing, although you'll need a strong strategy to avoid the risks unique to pre-IPO investing.

Money Morning has frequently discussed the potential risks of IPO investing to small retail investors. Let's discuss those risks in turn. Then, we'll show you a strategy for investing that could earn you significantly more than buying a public stock.

What You Lose Investing in IPOs

When a stock prepares to be listed on the public exchanges, it becomes available to large hedge funds and institutional investors before retail investors.

Now, this doesn't occur a long time before it's open to the general public, but it's long enough that large investor interest could have sent the initial price soaring.

So when retail investors put in their order, they could be purchasing at prices already inflated beyond what the financials are worth just because of large institutional interest. In many IPOs, the stocks either trade sideways or down after the IPO for that reason.

Many will eventually trend up if the financials remain strong. But if they don't, the stocks can languish in the wake of an IPO. That's a significant risk.

In pre-IPO investing, on the other hand, you avoid this completely. You hold equity in a company before it is publicly traded.

In fact, if institutional investors are highly interested, it's very good news for you. You get to sell into the excitement, rather than trying to buy on the other side of it.

Private equity investing has historically not been open to retail investors. It currently is, though.

The passage of the JOBS Act during 2012 made 240 million U.S. investors able to invest in the pre-IPO stage. The Angels and Entrepreneurs Network is poised to start you in pre-IPO investing for an initial investment of $50.

That's why we are presenting the ultimate guide to pre-IPO investing now, so you can get started.

How Pre-IPO Investing Works

Pre-IPO investing means buying stakes in early-stage companies. This is risky in itself. Most early-stage companies fail before they become successful. Some failures are triggered by a lack of sufficient funding, one of the issues pre-IPO investing is intended to rectify.

Pre-IPO funding has two stages. The funding stage between initial funding and hitting a $5 million valuation is called angel investing.

Historically, angel investors have been family or friends of a founder. Jeff Bezos, for example, founded Amazon.com Inc. (NASDAQ: AMZN) partly by tapping 22 friends and family members (they, by the way, have made 17 million percent on their collective investment).

After $5 million, the pre-IPO investors are called "venture capitalists."

Venture capitalists often work in firms rather than being, as angel investors are, private. They often focus on taking successful startups public.

When a startup has significant potential, you're in on the ground floor as a pre-IPO investor. For startups that become IPOs, you can realize significant appreciation.

Here's how you begin.

The Early-Stage Investment Strategy

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If you're engaged in early-stage investing, you need to develop a strategy to maximize your potential reward and curb potential risk.

First, most startup companies fail. So you have to face the fact that most of your investments in pre-IPO companies may fail as well.

Failure of a pre-IPO company is different than downturns in the stock market.

With a public stock, as long as it is capitalized strongly enough, it is likely that the share price will turn up again eventually. For stocks in your portfolio not connected to any IPO, as long as they have longevity, good products, and strong capitalization, they will eventually weather any downturn.

Early stage companies, however, are sometimes not well-capitalized. They may not be able to survive until success happens.

So we recommend portfolio allocation that will minimize your early-stage investing risk. Put no more than 10% of your money overall in pre-IPO companies.

The remaining 90% should be put into well-established growth and dividend equities on the public exchanges.

But that's not the entire strategy. The other strand is what you do with the 10%.

You need to invest in many small startups with it, not just one or two - pre-IPO investors need to be prepared to see 80% to 90% of their investments fail. If you place small investments in 10 pre-IPO companies, then one could do well and nine could fail. That's an expectable result - and the reason you want lots of small investments. It increases the possibility of realizing whopping gains in one or two companies.

You can find your full angel investing strategy right here...

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