360 review - Pre IPO investments

I spent a while thinking what the subject header should read like. Should it be a sensational one or just a boring 360 review....zzzzz... make sure you read till the end of the post....

What are pre IPO investments?

You can find the definition here. In lay man terms, it is to invest in a company just before it goes for listing, usually 6-12 months prior to listing. For early stage investing, it will be called venture investing, so don't confuse a VC investing, with growth investing with pre-ipo investing. They are all different and has different risk reward profiles. The strategies are very different as well. You can have a quick comparison between the various strategies i mentioned above here in terms of risk profiles and returns.

Is Pre-IPO investing a high risk game?

Is pre IPO investing risky? Of course! In fact it is so risky that SEC actually has some advisory on it. The link is here.

If the Company fails to be listed or fold up, you will lose the invested capital. 

Have i invested in pre IPO company before?

In case you are wondering, my first pre IPO company was in a Chinese S chip in 2008. I have to say that I was quite lucky to get out unscathed despite the financial crisis due to a personal put option we had against the founder and we opted for cash instead of shares when the company was listed. The share price tanked post IPO (See chart below) but luckily the returns was locked in at around 1.66x with high teens IRR (based on my recollection) after 4 years. The share is still listed today but is languishing below its IPO price due to lack of investors' appreciation for Chinese stocks. It was a small investment which i co-invested with my ex colleagues.

How you make money in a pre-IPO investment?

This is a pictorial view in an "ideal" world where you invest at a lower valuation before the IPO and the Company's business plans progressed as planned and managed to list at a higher valuation 6-12 months later. Hopefully, the Company can continue to grow its earnings using the proceeds from the IPO.

You might ask why the Company even want to have Pre-Ipo investors in the first place. There are a few reasons for this.

1.The picture always look clearer with hindsight

At the point of investing for Pre IPO investors, the Company may be at an inflexion point where success or failure is a binary outcome. As such, pre IPO investors are assuming quite a bit of risk in return of a higher return. If things are so clear, investors would have piled into Alibaba, Google or Facebook way before they became 'big'.  Even the so called experts can missed it. I will just share with you some interesting articles in case you are interested in this private equity world.

Goldman Sachs missed out on Alibaba pay off big time. Goldman made about 7x but would have made much much more while Softbank's initial $20m investment has turned into a return exceeding $60 billion.

2. The Company does not want to get diluted too early

By having a pre-ipo round at a lower valuation, the Company can issue less shares to tide their finances till the next big sale or milestone. This is less dilutive than having a full blown IPO. If the business plans did materialize as planned, the Company can sell its shares for a higher valuation in an IPO later.

3. The Company may want to have some 'quality names'

The Company might open a pre-ipo round to investors who can bring 'prestige' to the IPO later. For example in QT Vascular, the Company managed to get EDB and JnJ into the pre-IPO round.

The pre-IPO round can also be one way to 'incentivized' the 'who's who' to support the actual IPO later given that they would have a lower cost base. It can help to ensure a good IPO debut later. 

Some pre-IPO investors can also add value by helping to open doors and create new business opportunities for the Company.

What are the things a small pre-IPO investor should look out for?

This will be the things which i will look out for prior to investing.

1. A sustainable business model in an attractive sector.
2. A good story line at IPO and post IPO. 
3. Reputable co-investors. Obviously i don't belong to this category but if i am investing alongside reputable companies and co-investors, it will be more assuring for me.
4. Downside protection. There must be adequate downside protection to ensure the Company is able to redeem my shares in the event it can't be listed. 
5. Upside. There must be adequate upside with formula crafted into the agreement on the conversion formula. In Singapore, it is usually based on a discount to the IPO valuation that ranges from 25% to 50%. 
6. Lock up. There will always be at least 6 to 12 month lock up requirement. This is inevitable and usually unavoidable. One way to mitigate this risk is to sell some shares at IPO price and be subject to lock up for the remaining shares. In other cases, you just have to keep your fingers crossed that liquidity and valuation will continue for the next 6-12 months and allow you to exit from the investment safely.

Rubbing shoulders with the who's and who

Here comes to the crux of my post today if you bother to read till here. :-P 

Recently I invested in a pre IPO company alongside the who's who in the local investment scene. Those type of names who I know them but they don't know me. Haha. It's quite a key "milestone" for me to invest along side A.Wang, T.Goh and some other familiar names. Of course I ranked at the rock bottom of the list of investors in terms of the amount put in and has to practically "beg" my way in. I will not embarrass myself with the quantum here but in terms of milestone, I will regard this investment as my first official investment into the pre-IPO world. Wish me luck! :)

Mr. IPO is going to be famous !?

If the company is successfully listed next year and my name appears in the prospectus as a pre IPO investor, I am going to frame up the prospectus and hang it in my study room or create a tombstone from it hahaha. In case you are wondering, a tombstone looks like this....

Happy pre IPOing