IPO Investment Smarts: Buying Public Shares Offered by Private Companies

When a company is privately-held, it’s pretty difficult to invest in it. You can try calling up the company’s CFO, or marketing and investor relations department, but it will almost always result in them turning you away. Part of the problem is legal  — companies are legally prohibited from soliciting investment money from you unless you’re an accredited investor in most circumstances.


Secondly, not being a public company makes it difficult to impossible to sell shares to outside of select shareholders. You either must be an angel investor or part of a crowdfunding arrangement that is organized by an angel investor or some other type of financial intermediary.


This is why most investors wait for a company to go public. Fortunately, one of the best ways to invest in a private company is to wait until it issues it’s IPO, making the transition from private to public. Here’s how the pros do it.


Selling Shares Publicly


When a company wants to go public, it gears up to sell its shares publicly. In order to do this, it needs to register with the SEC or file legal paperwork (often both) in order to have its shares valued properly. If the company has never issued equity to the public, it’s called an IPO or initial public offering.


Most companies fall into two broad categories: public and private. A private company has fewer shareholders and its owners don’t have to disclose a lot of information about the company, but anyone can incorporate a business. All you need to do is pay the money, file the right legal documents, and then follow all the reporting requirements for your state and the federal government.


Most small businesses are, in fact, privately held corporations, too. Companies like IKEA, Domino’s Pizza, and Hallmark Cards are all private. So, there’s many companies that are successful that never “go public.” For investors, these represent “dream companies” if they ever did decide to issue an IPO.


Do Your Homework


No one likes homework, except investors. Before you buy an IPO, you want to make sure that you won’t be burned by the company you’re investing in. Doing research is a good way to guard against that.


Getting information is also tough. Unlike most publicly-traded companies, private companies don’t have a lot of analysts covering them, trying to uncover possible cracks in their corporate shield, and so on. While most companies do try to be transparent, the information is often written by agents working for the company and not third parties.


You should search the Internet for as much information as you can. Even though it’s going to be difficult, do your best to uncover information about the management, the company, its cash flow, its cash on hand and cash reserves.


Pick A Company With Strong Brokers


Choose a company that has a strong underwriter. This doesn’t mean that the company needs to be underwritten by a major investment house though this might be the safest strategy. Many big investment banks never bring dud companies to the public, but smaller banks can. For example, Goldman Sachs can afford to be pickier than a smaller company that needs to underwrite many more companies to remain profitable.


A smaller broker does have its advantages, however. Because of their small size, they can often make it easier for investors to buy pre-IPO shares. The only individual investors who get in on the IPOs are typically long-standing or established customers.


Read The Prospectus


According to many experts, you want to read the prospectus of any company before you buy it. For example, http://moneymorning.com/tag/apple-stock/ is currently telling its readers about Apple stock and why it’s a good buy right now. It’s a good bet that, if you read the prospectus, you will learn why — it’s cash flow, it’s investments, and its expenses (among other things).


A prospectus outlines a company’s risks and opportunities, along with the rules it uses for the money raised by the IPO.


For example, it might outline how the company intends to use the IPO as a way to raise money to pay off debts. In this example, that’s a red flag. A company without sufficient funds to pay off debt without an IPO may be mismanaged.


Most companies have learned that over-promising and under-delivering are mistakes that rookie companies make when they’re trying to garner market share. When reading a prospectus, be on guard for a company that’s making outlandish, or overly optimistic claims about its future.


Laura Hammond has a long-standing career in banking. Now taking time away from her power suits to spend time with her newborn daughter, Laura still likes to keep in touch with her working roots and is enjoying sharing her knowledge with an online audience.