Is Pre-IPO Investing the Right Fit for Your Clients?

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Many investors are familiar with the reward potential of buying shares in startups at the IPO (Initial Public Offering) stage, but there is another investment option that can put your investors one step ahead of the public offering stage. Investment options referred to as Pre-IPO investing allow investors to buy shares sold by a private company prior to their public transition.

Private companies may offer pre-IPO shares to investors for a number of reasons, including:

  • Raising Funds – Because shares are not subject to typical market volatility, the company is able to sell shares at a fixed price, allowing them to accurately predict the amount of funds they will be able to collect.
  • Investor Guidance – Many pre-IPO investors are investment firms, institutional investors, or hedge funds; these investors tend to have the resources, experience, and expertise to help guide the company’s decision-making processes and aid in the transition from a private organization to a publicly traded company.

Portfolio Diversification Benefits

Because the shares are connected to a company that is still classified as a private entity, pre-IPO investing falls under the private investing category commonly referred to as private placement investments. As a financial professional, you already know investing in both private and public entities is an ideal way to balance and diversify your client’s investment portfolio. Two of the main benefits of portfolio diversification were emphasized in recent studies.

Compounded Over Time

A 2020 research analysis by EBRI and JP Morgan Chase and Co found that a “more diversified portfolio produces a higher return at each risk level.” The findings stated that those focused on savings and portfolio diversification had a nearly 20% higher success rate, and the diversification benefits were compounded over time.

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Portfolio diversification is a key component of finding the right balance of reward vs. risk that suits each investor. In fact, 62 percent of respondents reported in STRATA’s 2021 Self-Directed IRA Investor Survey Report that they were invested in two or more different alternative investment sectors.

Reduces Impact of Volatility

Investors that house the majority of their assets within the stock market are no doubt feeling the effects of the investment rollercoaster that started in 2019 and continues persistently. Because they are reactive to market conditions, portfolios that hold primarily stocks and bonds are historically challenging and tend to underperform. Alternative investments, like private placement investments, real estate, commodities, and other asset classes investors can hold within a self-directed IRA are investments that can help shield portfolios from significant swings in the stock market and have historically lower associations to current economic conditions. McKinsey & Company reported private market fundraising was up nearly 20% YoY in 2021, reaching a record breaking $1.2 trillion. This annual review supports investor sentiment across financial markets – investors are looking for alternatives outside the stock market.

Things to Consider When Investing

As with any investment, it is important that the investor practice due diligence and do the necessary research before making investment decisions. Self-directed IRAs (SDIRAs) hold alternative investments like pre-IPOs, which allow investors greater investment flexibility and true diversification from the stock market. This investment vehicle also comes with additional responsibilities—because they are self-directed, the due diligence responsibility falls on the account holder.

As you may know, alternative investments like pre-IPOs can be tricky: while publicly traded companies are required by law to disclose their financial information to the public, private entities have no such requirements—making it tougher for investors to make an informed decision. To help combat the risk of pre-IPO investment scams, investors should read the Private Placement Memorandum (PPM) and carefully review all aspects of the business, the individuals behind the offering, and the security being offered. PPMs typically contain the company’s management and product information, as well as past performance, financial resources, and potential risk factors that may be associated with the company.

Besides the limited financial information available, there are some other risks to take into consideration. Change in market sentiment, government and regulatory roadblocks, and profitability requirements could all influence the return on your investment. These considerations are just a few of the reasons it is important investors seek professional advice when finding out if alternative investments are the right fit for them.

You can find additional resources about SDIRA investing and tips for performing investor due diligence from the U.S. Securities and Exchange Commission (SEC), North American Securities Administrators Association (NASAA), Internal Revenue Service (IRS), and other credible sources, listed here.

Are Alternative Investments the Right Fit For Your Clients?

As you look at your client’s portfolios and work towards helping them meet their retirement goals, understanding if alternative investments are well suited for them is just as important as conducting due diligence on a new potential investment option.

Alternative investments are best suited for investors who understand the risk and rewards related to nontraditional investments. These types of investors tend to seek more control and investment freedom for their retirement savings—that’s where SDIRAs can assist financial professionals in providing options that modern investors are seeking.

SDIRAs are a unique alternative investment vehicle that:

  • Empowers investors to leverage a wide range of investment options
  • Enables greater control and flexibility over investments
  • Provides investors with the power to invest in companies that share their beliefs and ideas
  • Offers tax-deferred or tax-free growth, tax deductions, asset protection, and estate planning benefits
  • Delivers financial advisors and investors a tool to better manage market volatility and portfolio diversification

In STRATA’s 2021 Self-Directed IRA Investor Survey Report, we asked respondents how a SDIRA helps them meet their retirement goals. Besides the tax advantages, chances of higher returns/income, and lower fees, investors also appreciated that SDIRAs allow investment flexibility, retirement savings channel diversification, and the ability to hold limited access investments.

Talking to your clients about portfolio diversification and investment risk may be top of mind right now. Having alternative investment options available to them, like pre-IPO investments, real estate, private debt, commodities, and other non-traditional investments that tend to fare well in times of economic uncertainty, could be the key to securing a successful, well-balanced retirement portfolio.

The information provided in this article is educational content and not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.