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In the ever-changing stage of financial markets, an investor seeks opportunities for significant profit returns. One of such opportunities deals with IPOs soon to occur, which enable the possibility of buying shares of a company before those shares become available for the general public. In this arena, one of the better-known but extremely strategic investment options is Pre-IPO placement.
What is Pre-IPO Placement?
Pre-IPO placement is the process wherein a company gets its shares allocated to private investors at the time before an IPO. These institutions usually include hedge funds, private equity firms, venture capitalists, and ultra-high-net-worth individuals. The general aim of investment during these early stages is to raise capital for a company while offering shareholding at a discounted price to institutional investors before availability to the open market.
Why Do Companies Engage in Pre IPO Placements?
– Early Capital Infusion: Raising pre-IPO funds makes the company realize the balance sheet strength and preparation for the public debut.
– Preemptive Reduction of IPO Risk: Investment brings good investors on board before the IPO and mitigates risk from bad market conditions that render unpredictable pricing in the public domain after the listing.
– Attract Strategic Investor: Early engagement of major financial institutions adds credibility to the IPO.
– Price Stabilization: Pre-IPO placement will help set a fair value for the shares before they touch the public platform and effectively reduce the volatility.
Types of IPOs and How Pre-IPO Placement Interrelates
1. Fixed Price IPO
- A predetermined price is set by the company for the shares.
- Investors are to pay the full price at the time they subscribe to the IPO.
- By pre-IPO placements, the market price might be indicated for a fixed price IPO.
2. Book Building IPO
- The price is discovered by demand-based criteria within a price band rather than a fixed price.
- Investors bid in the price range provided, and the price is fixed as per the demand.
- In these situations, pre-IPO investors usually buy shares at discounted prices.
3. Dutch Auction IPO
- The auctioneer is accepting bids from investors and all shares are sold at the price specified by the lowest successful bidder.
- Pre-IPO placements then serve as an advertisement to test the waters before the auction
4. Direct Listing
- Companies go public without creating new shares, and allow prior investors to sell directly on the market.
- In such cases, the pre-IPO placement would most likely be limited because no fresh capital is raised.
How Pre-IPO Placement Impacts Investors?
Advantages for Investors
Discounted Shares – Institutional investors get shares at a price lower than the IPO price, which translates into greater upside potential.
Early Access – Investors get an opportunity to participate in the growth story of the company before it becomes widely available.
Potential for High Returns – If the IPO is successful, these early investors could see a high upside.
Preference in Allocation – Given that most IPOs are oversubscribed, retail investors often struggle to get allotments, while pre-IPO investors get guaranteed shares.
Risks & Challenges for Investors
Lock-in Periods – Generally, pre-IPO placements come with certain lock-in agreements preventing their investors from selling the shares immediately after the IPO.
Market Uncertainty – If negative sentiment builds up in the market, the IPO could then get delayed or withdrawn, which is bound to affect one’s investment.
Illiquidity – The shares of the entity are not traded, giving investors no chance to exit the investment before the public listing.
Regulation- Pre-IPO placements and marketing are highly scrutinized in terms of compliance, and any deviation from regulation can shake investor confidence.
Should Retail Investors Look Out for Pre-IPO Placements?
Pre-IPO placements are generally reserved for institutional and high-net-worth (HNW) investors, given the high capital requirements and regulatory restrictions involved. Yet retail investors indirectly have some exposure through:
Mutual funds or ETFs investing in such pre-IPO companies.
Platforms that allow the trading of shares in pre-IPO companies through special investment vehicles.
Watching for new IPO projects of companies that have also done pre-IPO placements and assess their prospect.
Conclusion
The preliminary IPO placement is a strategic tool for companies to raise capital while offering unique opportunities to early investors. Understanding IPO types and the role of pre-IPO placements in the broader investment horizon is fundamental to informed decision-making.