Need to Know | Pre-IPO Investing

HOSTS Candice Bourke & Felicity Thomas|17 September, 2021

Meet your hosts

  • Candice Bourke

    Candice Bourke is a Senior Investment Adviser with over six years' experience in capital markets and wealth management, specialising in investment advice including equities, listed fixed interest, ethical investing, portfolio risk management and lombard loans. She discovered her passion for finance and baguettes, when working and living in France, and soon afterwards started her own business (all before the age of 23). Candice is passionate about financial literacy for women which lead her to co found Her Financial Network, and in her downtime, you’ll find her doing any of the following: surfing, skiing, reading a book by the fire, or walking her black lab, Cooper, with a soy cappuccino in hand.
  • Felicity Thomas

    Felicity Thomas is a Senior Private Wealth Adviser with over nine years experience in wealth management and strategic financial planning, covering areas including Australian and Global equities, portfolio construction and risk management, bonds, fixed interest, lombard loans, margin lending , insurance, superannuation and SMSFs. Felicity started her career in finance at BT Financial Group, speaking to customers about their superannuation and investments. This led to the realisation becoming a Financial Advisor would be the perfect marriage of her skills and interests - interpersonal relationships and economics. She is passionate about improving women’s access to financial resources and professionals, and co founded Her Financial Network. On the weekends you’ll find her on the beach, or going for an adventure with her black cavoodle, Loki.

In our last Need to Know episode, Felicity and Candice discussed the difference between early stage and late stage investing, so this episode, they do a deep dive on what exactly is pre-IPO investing. Together they talk about recent examples, outline the due diligence you should undertake before considering a company, and examine the risks of assigning your capital to a business pre-IPO.

Follow Talk Money To Me on Instagram, or send Candice and Felicity an email with all your thoughts here.

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In the spirit of reconciliation, Equity Mates Media and the hosts of Talk Money To Me acknowledge the Traditional Custodians of country throughout Australia and their connections to land, sea and community. We pay our respects to their elders past and present and extend that respect to all Aboriginal and Torres Strait Islander people today. 

Candice: [00:00:00] Welcome to talk money to me. I'm Candice Bourke. 

Felicity: [00:00:06] And I'm Felicity Thomas. And this is your Need to Know Wealth podcast, where we make the complex simple. Now, Talk Money to Me is a podcast where we would draw on our expertise and experience to help educate you on all aspects of your financial landscape. 

Candice: [00:00:21] But before we get in today's episode, you guessed it, here comes the legal disclaimer. So even though we are registered financial advisors, please note that this podcast and the content discuss does not constitute as financial advice, nor is it a financial product. The content on this podcast is general in nature and you should seek professional advice before making any financial decisions. So today, Felicity, it's our Need to Know episode and we're going to be talking about pre-IPO investing 

Felicity: [00:00:50] and the last time we explored the difference between early stage and late stage investing. So to understand exactly what pre-IPO investing is, Candice, what's an IPO?

Candice: [00:01:01] Well, an IPO stands for initial public offering and it refers to the process of offering shares of a private business to the public market. Companies, therefore, seek certain requirements set out by the exchanges, you know, in order to hold their IPO and join the public market. IPOs provide companies with an opportunity to obtain capital by offering shares to the primary market. Companies, therefore, need to hire investment banks such as UBS, Credit Suisse, Shorey Partners, where we work in order to market gauge the demand, set the IPO price, set the date, set the valuation. They are your broker in the IPO. So the IPO is often seen as an exit strategy for companies, you know, early founders and early investors to realise their full profit from once they locked in. And that private business, recent IPOs, which come to my mind, one is Airbnb that listed for 35 billion back in December of 2020, which actually was delayed a little bit because of the pandemic. And, you know, there was a lot of, you know, is it going to go well? How's it going to go day one? 

Felicity: [00:02:10] Also, not great timing, right? Because, you know, we weren't really able to move around that much. 

Candice: [00:02:16] No, we weren't. So that's the other thing is companies need to think, is this the right time to list? Should we push it back? Should we not? So there's a lot that you need to navigate when it comes to an IPO. And but now looking at Airbnb, you know, it's it's well and truly well up above IPO price, 

Felicity: [00:02:34] except we still can't move around. 

Candice: [00:02:36] We can't move around. That day will come one day soon. Krispy Kreme Doughnuts, you know, another recent IPO more recently in July. That IPO actually was overhyped, in my opinion. It actually has really been trading down since IPO price. And then literally in the last two, three days, the share price is gone gangbusters. So it's important to look for day one IPO because not necessarily will every investor go, I'm going to get a pop day one on the flip side and Australian business, you're probably more familiar with best and less that came to the Australian market for two dollars per share back in July. Market cap was around 330 million. And day one, that share price popped 11 per cent. I think because Australia was in lockdown at the time. You know, Bestinvest is known as value apparel. They have a lot of online sales. And I think the business was a little bit undervalued and a little bit unloved. But when you look at the P&L, you know, it was offering really attractive metrics. So makes sense why that IPO was a big day, one trading. 

Felicity: [00:03:39] Yeah. And I think, you know, investors at the moment wanting to put their cash in the market. So, you know, it's very hot, I think, before you invest or consider investing into an IPO, it's very important first to do your homework.

Candice: [00:03:53] Very much so. So going back to the investment bankers, that's their job to list the IPO. One of the roles that the company has to play here is they have to engage legal advice in order to write a legal document called a prospectus. This prospectus initially kind of sets out your roadmap for what the company has done to date, what the future looks like. So, you know, reading the prospectus, you're going to understand the business. You're going to understand the risks. You're going to look at the company management. And who are the key stakeholders? Does management have skin in the game? And that's often something that you and I look for always. Felicity, you know, why are they appealing? Why do they need capital? What are they going to do with this cash? Understand the capital structure now. Understand the P&L now and the balance sheet now and what it's going to look like in the future. And then you come down to the valuation. Do you think this is the right price to pay for this company? So now we know exactly what an IPO is. Felicity, tell us more about the INS and out when it comes to pre-IPO investing.

Felicity: [00:04:55] So I think with pre-IPO investing, it's best to explain with an example. So he saw Bumbo IPO back in February 2021, which closed up 63 per cent on its first day of trading. But imagine actually be invested before the IPO listing and how much return on investment you could earn. That's why for our clients investing at pre-IPO stage, which usually occurs 12 to 24 months out from IPO, is one of the best ways to capture as much return as possible. Now, pre-IPO offer exposure to private companies that plan to go public, but it differs in that you're still investing in a private company, not one that's just become public. In fact, there's actually no guarantee that a pre-IPO will ever go public. Now, since more and more companies are choosing to stay private for longer, a pre-IPO company offers exclusive benefits and access to a broader range of investment opportunities, which we discussed in our previous episode. A pre IPO placement is a sale of a large block of stock in a company in advance of its listing on a public exchange. The purchaser gets the shares at a discount from the IPO price for the company. The placement is a way to raise funds and offset the risk that the IPO may not be as successful as it hoped. But of course, not all start ups are wildly successful or unsuccessful. I mean, in reality, a lot of these companies do fail. Pre-IPO can carry significant risk and knowing how to assess pre-IPO companies and their associated investment offers is essential in making sure you make intelligent, calculated decisions now to gain access to pre-IPO deals. You usually need to be a sophisticated or professional investor, and usually the minimum threshold is 250000 dollars, for example. However, there are some fund managers like Perineal that have private to public fund, and it's been so successful that they actually have three different series of this managed fund. 

Candice: [00:06:54] Yeah, and also you can look at crowdfunding opportunities as well. So every day in retail, investors can get an opportunity to invest in exciting pre-IPO deals that way as well. 

Felicity: [00:07:04] I think so. And I think you can do a minimum of about 10000 Dollars. There's a company called Equities in which allows you to do that, which is quite, quite interesting. Klein is on there. Yeah.

Candice: [00:07:14] So let's talk about what's an example of a pre-IPO investment. 

Felicity: [00:07:18] Okay. So familiar household names we all know is Alibaba. It's the e-commerce giant based in China. Now, they first announced it be listed on the New York Stock Exchange as BABBA in September in 2014. Now, ahead of their public debut, Alibaba opened up a pre-IPO placement for large funds and wealthy private investors. One such investor was Ozon Amanat, a venture capitalist based in Singapore. He purchased a block of 35 million pre-IPO shares at a price below sixty dollars per share. And then he allocated the shares amongst investors who had ties to his fund, which is called the Kaita Global Fund. Now its first day of trading public, Bobba closed just below ninety dollars per share. So day one trading the fund was up 50 per cent on that investment. Now, more recently, Bobber has gone from strength to strength and is trading at around 157 dollars per share, which we would consider quite a good price for Alibaba. Now, in a moment, we'll talk about the red flags to look out for when it comes to pre-IPO investing. Let's first hear from our sponsors.

Candice: [00:08:23] So now we've learnt more about the ins and outs of pre-IPO investing. I want to now discuss the potential red flags that we need. Look out for some major red flags include unregistered securities and a lack of liquidity. So what do I mean by that? The main difference between an a pre-IPO investment and an IPO is the ability to trade shares freely on the public market. Naturally, pre-IPO shares are often unregistered and not given the same legal protections as the public markets. So for whatever reason, you change your mind about your investment, you need to sell your holding or you're misled by management. You're going to face a challenging outcome. There's very little liquidity for pre-IPO shares. You can't just, you know, sell your holding to another retail investor on the public market like we're all used to when you trade on the ASX, for example, and it becomes more complicated to offload your shares to other private investors if the company's fortunes go bad. So ensuring your pre-IPO opportunity is close to an IPO or has that road map that we talked about is one key way to avoid this risk. Secondly, another red flag to look out for is one that you can't see a clear path forward for the company to list. So as with any investment, there's no guarantee of a return at all. Propose a no different. The investment thesis lies in the expectation that the company one day will go from private to public via the IPO. In some instances, this never eventuates, which leaves pre-IPO investors holding the bag thinking what went wrong here? So here are some reasons why this might happen. Numerous hurdles present themselves when it comes to the IPO process, such as registration, approval from the stock exchange and meeting a long list of financial documentation and criteria. The process may therefore be delayed by a regulatory oversight, such as what we saw with any group IPO last year getting delayed without the public liquidity event of an IPO. The upside of any pre-IPO investment is heavily limited. Risks will always remain. Although you can do your due diligence, which I want to call data. From now on, you can do your data to avoid a disaster. So what do I mean by that? You know, what is the company's plan to go public? Do they have one? How detailed is it? What's the timeline? Answering these types of questions may help you save a massive headache down the track. Another red flag I personally look out for are the use of funds and what current shareholders are selling down, if any, what position and why?

Felicity: [00:11:06] Yeah, and I think this point is also closely linked to understanding and doing your due diligence on the management board and main decision makers of the business. We always refer to the term who has skin in the game like previously mentioned, and are these individuals willing to leave their capital invested into the business so that they're also incentivised to grow market share along with fellow investors? 

Candice: [00:11:29] Exactly. So the terms to look out for here are the drag and tag along clauses and escrow dragon tag along essentially means to the larger original and institutional investors and the smaller retail future investors. Do these shareholders have the same rights to buy or sell more shares in the company, meaning no one shareholder has preferential terms or treatments over another? Escrow refers to a shareholder having to hold their shares in a company, meaning that they can't buy or sell any of their position until a certain period is met. So, for example, an ideal scenario that we look out for would be that the founders of the private business are buying more shares in the pre-IPO round at the same offered price as new investors like you and me, and that they're willing to lock in their positions in escrow for a period of time that extends beyond the IPO listing date.

Felicity: [00:12:24] Definitely. And look, another red flag we often look out for is the valuation. Massive valuations not backed up by reality. Putting IPOs can be great deals, but they can also be massively hyped. A business is worth what the market is prepared to pay, usually based on projected sales and profitability. Valuing businesses is a complex process, although at the headline level the valuation should really make a lot of sense to everyday. Investors will cover how to value a business in another episode. Now, no matter how good an idea is for a private company, it will struggle to gain investor support in the future if it cannot detail an effective business model that generates a profit after sufficiently scaling revenue. A recent example of this could be the code is an excel on the ASX now, although it's a niche promising space being investigative analytics, the company is under investigation by ASIC due to concerns that new prospectus contained false information. Namely, whether it's financial forecasts were inflated. Now that's a flashing red flag, definitely is. 

Candice: [00:13:28] And for those that aren't aware, ASIC is really the financial regulators or the watchdog in our industry. So when they get involved, it's it's always a concern. It's never good news. It's never good news. And almost the saying is right. No news is good news. But Netflix is a good example of potentially paying an inflated IPO price. And the valuation was just wrong from the get go. You know, I think it was valued at something around the mid five point fifty at the IPO price and now it's currently trading around two point sixty five. So ouch. So, Felicity, there's been a lot of bad press surrounding the management of new leaks. Tell us more about this. And do you think it's been a contributing factor to the current share price weakness since it's really iPod? 

Felicity: [00:14:14] So the experience of a company's management is one of the best indicators of a successful or an unsuccessful IPO. The executive management, as well as the corporate advisors to complete the IPO process, are critical to the outcome of your investment. Take a closer look at the executive team, including their background and experience. If they have little experience running a company and no history of growing or completing the IPO process, it may be a red flag that the team might not be up for the job. It's very different running a private company to a public company. Questions that we often asked. Management include does the board have listed company experience to any C suite? Management members have listed company experience. How many years in the industry for Newark specifically, it would be the ASIC investigation into the company's former CFO and their family on allegations of insider trading. There was also the share options debacle with the previous founder, where he thought that he was owed specific options at a certain price. And you said that he wasn't. There's also been two downgrades since listing.

Candice: [00:15:19] Yes. So a few different areas of concern have come out. Another factor is the company also reported revenue of 85 million, being down 40 per cent on what they promised in the prospectus. So, again, missing expectations, more bad news. All this leads to share price weakness really in the markets.

Felicity: [00:15:39] However, it's not all clouds and rain. There's actually some good news. The CFO and the CEO have stepped down and they're currently doing a search internationally for a new CEO and Macquarie Bank as their corporate adviser who helped list New X still has very high conviction in the business. It just needs a change of governance. So the final aspect I think investors should look out for is the alignment with the founders of the company, meaning is their motivation the same as ours? Do they want a liquidity event in the next three years?

Candice: [00:16:10] Right. Because personally, for me, I'm going to be less likely to invest in a pre-IPO business where I can't see an obvious path forward, or if only a few years time the major shareholders are selling down or out major red flag. For me personally, companies running out of cash is one of the biggest risks in the private markets because you just don't get the luxury of liquidity. If a company's not already cash flow positive, you want to know before jumping in that the capital we're providing will allow the company to be one day cash flow positive and more secure in the future. For example, if the IPO window is delayed an extra six months, which we know that can happen, we saw our group, you know, is their balance sheet solid enough to hold on or do they need to raise more capital to survive? While the lack of liquidity is undoubtably one of the biggest risks when it comes to pre-IPO investing, it also presents the opportunity for additional reward. Valuations of unlisted private companies typically will attract a discount to their peers in the listed markets to help compensate for the lack of liquidity. 

Felicity: [00:17:16] Well, that's a wrap. We hope you learnt something new about investing in IPOs. As we've discussed, there are certain risks investors need to look out for. But if you do your Dedé on a company and there's a clear roadmap to listing on the stock exchange, pre-IPO investment opportunities can deliver solid return on investment. So with that in mind, we have an exciting interview planned with the very unique mining company which recently underwent the pre IPO process and is now undergoing the IPO process. If you'd like to get in contact with either Candace or I, all our details are in the show. Notes below. Until next time.

Candice: [00:17:51] Sayonara. 

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