How investments in pre-IPO work

Dmitry Belousov, CEO of United Traders,
and Eduard Tsinker, Partnership Programs Director

What pre-IPO means Pre-IPO in Silicon Valley Pre-IPO on UT platform Pre-IPO via SPV Pre-IPO Results Risks

The United Traders platform offers investments in late-stage companies prior to their listing on a stock exchange (pre-IPO). But before we delve into how to invest in pre-IPO through United Traders, here’s our explaining how investments in companies based in Silicon Valley actually work.

Capitalization

First things first, where does a startup get its value? A company’s value, its capitalization, is equal to the share price multiplied by the number of shares. Growing capitalization means earnings for everyone: founders, employees with stock options, early stage investors and, of course, us — those who invest in late stage startups: pre-IPO and IPO — shortly before a company goes public.

A company’s growth that is measured quantitatively by its capitalization growth is a lengthy process that takes years. The most successful companies grow rapidly, constantly accelerating, but all go through several stages: early, mid- and late. Let’s take a close look at each of them.

Early stage

Seed, Pre-Seed, pitch, accelerators, business angels

At the very beginning of your entrepreneurial journey, you consider the feasibility of your business idea and sell it to first investors. Investors “seed” by investing money in several startups hoping that some of them will get off the ground and cover the losses of the rest of the failures. The first investment stage is commonly known as “Seed” or “Pre-Seed”.

At the prime stage a company hasn’t yet built an idea into a product, so it has to sell it to investors by making a pitch. Even if a business idea seems far-fetched, a short and impressive story must make an investor believe in the idea and invest his or her money.

But money can get you only so far. Connections and experience are what startups are lacking in most. At this stage, you want to turn to accelerators (a fixed-term intensive training program to help new businesses get established) and business angels (private investors who provide financial backing and advice for small startups).

Accelerators sift through a multitude of ideas and select the best ones, provide initial funding and help build business processes, and launch a product/ service in exchange for a startup’s equity. There are nearly 7000 business incubators globally. Of them, the largest ones are concentrated in the U.S.

Startups that eventually become successful, do not always get past the highly competitive application process. Many of them struggle to find the required money, so owners look elsewhere for investments.

If you at the very beginning of your business journey, chances are the list of your potential investors comes down to the three classical FFF — Fools, Friends and Family.

The first stage is considered to be successful if owners obtain initial, the so-called “seed” investments.

The largest accelerators by number of successful investments. Left to right: Y Combinator, 500 Startups, Techstars, Plug and Play, MassChallenge, Startupbootcamp.

Mid-stage

Early stage, investment funds, rounds

A company has succeeded in finding initial investments, but its development requires more money. In order to attract necessary financing, this company will do investment rounds: research investors (or investors may come to it) and raise the required sum of cash. Usually, startups associate funding rounds with an important milestone in their development.

At this stage, startups use the help of investment funds. Funds vary by the types of industry they support (tech, biotech, AI, robotics), by the capital they manage and by the startup stages they specialize in when investing (well-established, mid-stage, early stage).

Every investment round (А, В, С, D, etc.) means more money, issuance of stock to this round’s investors and new valuation for the company. The subsequent letters represent subsequent rounds. Investors’ rights at every round may vary, but in general, an investor always gets an equity stake in the company being funded and the option to sell its stocks to profit from his investment.

Every startup goes through its own trials and tribulations, but let’s say we have an average company in question.

Most well-known funds: Andreessen Horowitz, Sequoia Capital, Accel, Benchmark, Index Ventures, Kleiner Perkins, Founders Fund.

Series A — early growth

By series A stage, the company already has a developed product and customer base (it has succeeded at both in pre-Seed and Seed rounds). Now the company organizes production, improves the first versions of its product, brings it to market and tests unit economics.

Series В — scaling stage

If the previous stages served to prove the company’s viability, Series B round sets bigger, even more ambitious goals — scaling, expansion of production and sales, capturing new markets.

Series С...F — maturity stage

At this stage, a company captures a larger market share, develops new products and acquires another startup as a merger. This company is well-established and has procured stable revenue streams.

A company’s valuation is drawn by venture investors that build financial models and take into account multiple factors — potential market size, revenue growth and unit economics indicators, size of costs, product’s functionality, etc.

There are no pre-determined funding rounds a company must do. There is no fixed amount of time that must pass between rounds — every company decides for itself. Likewise, it decides if it should seek venture funding or bootstrap, how many investors will be in the next round and on what terms it will trade its equity.

There are no regulatory authorities on the over-the-counter market that oblige a company to disclose financial statements four times a year, the way public companies do (balance sheet, profit and loss statement, cash flow statement). Here investors want to profit without waiting for IPO, companies want to get big but non-toxic money, bring their product to market, capture a portion of it or tailor it to meet their needs, then go public or remain a private company.

The growing value indicates that a company is on the right track. As it progresses from one funding round to another, its valuation becomes more accurate. Gradually the public gets to know more and more information about its business: revenue numbers, customer base, growth rates. Provided, of course, founders and management want to disclose these financials.

Late stage

Late stage, Pre-IPO

A company’s growth culminates in IPO, the process of offering corporate shares to the public for the first time. When a startup goes public, its investors in all previous funding rounds get an opportunity to cash it out.

However, in recent years companies more and more often remain private: now a startup may take 10-12 years to reach IPO from its inception. Large investors have long-term money and are ready to wait to profit more, while small and midsize investors who are used to buying stocks after IPO don’t have the opportunity to make money using the same instruments.

Nowadays more and more people see the results of their investments in pre-IPO stocks and feel ready to invest in private companies though some 5-10 years ago they invested only in publicly traded stocks. The private stocks market gradually ceases to be a) a gray area with muddled rules, b) a playground exclusive for large investors.

The market is gradually embracing the concept of investments in private companies even if you have a small amount of money. We at United Traders are pushing the market toward this trend: we are looking for ways to let midsize and small investors profit from investments in private stocks, and we work hard to make this process as user-friendly as possible.

IPO

Exit, underwriters, listing, direct listing

Most companies aspire to do an IPO. Investors in previous rounds see IPO as an opportunity to exit, while a startup looks to get a fair valuation and solid clients that prefer to work with public companies (it’s easier to evaluate their product and business condition, openness plays a vital role here).

When a startup decides to go public, it employs underwriters — investment banks responsible for administering a public offering and files its prospectus with the SEC. This startup will prepare documentation and list on a stock exchange (listing). After IPO (Initial Public Offering), the company’s stocks are publicly traded and anyone can easily buy them.

However, if a startup intends to do an IPO, it doesn’t necessarily need to employ investment banks. Some (like Spotify, Slack) do their own listing (direct listing). In this case you don’t have an opportunity to buy stocks shortly before IPO, and those investors who bought pre-IPO stocks hold an advantage.

SEC (the Securities and Exchange Commission) is a federal agency that regulates securities markets in the United States.

M&A

One way to exit is to go the way of Mergers & Acquisitions. In this case a larger company acquires the other company’s stocks. If a company is acquired with a premium — at a higher price than it was valued before, investor will profit. The later the funding rounds, the lower the risk level for investor.

Negative scenario

When investing in the seed stage, investors believe that only a few companies from their list will take off. The rest of them will go bankrupt, and investors include this risk. The closer a startup to an IPO, the more stable its operations, the lower risks it will go bankrupt. However, one cannot rule out such risk.

In a nutshell

Hundreds of new companies emerge every day. Many of them go bankrupt, few of them will grow into unicorns (privately held startup companies valued at over $1 billion). Picking the right time is of utmost importance to investor. In our opinion, late-stage rounds (pre-IPO) are one of the best such moments.

We at United Traders offer investments in startups at pre-IPO since we believe that at this stage investor has the most opportunity to make money.

We ourselves invest in companies that we select for our platform because we see opportunity in profiting within an investment horizon of few years. Most of these companies develop technologies that transform the world creating a new market around them. We are also passionate about investing in private companies because they create novel things capable of disrupting our daily life.

Renting an apartment from Airbnb, taking a course through Coursera, buying Lemonade insurance or eating a plant-based burger from Impossible Foods — all this has gradually become part of our daily routine. And investments in private companies are no longer something abstract, they too have become a reality now.