IPOs, Private Markets, and the Pre-IPO Growth Opportunity

The IPO market is one of America’s most popular avenues for investors seeking to make a big return, underscoring the large amount of venture capital and private equity investment in private companies. But the ability of even well-heeled investors to obtain pre-IPO shares, as well as employees of privately held businesses to realize the same lucrative gains from selling equity in pre-public companies, has proved an elusive proposition for many.

Indeed. Wall Street’s investment bank underwriters are notorious for allocating blocks of IPO shares to preferred clients, especially those associated with hot name companies. At the same time, employees of pre-IPO businesses seeking liquidity on their shares ahead of a public offering usually have to negotiate with company founders or board members who are often reluctant to change the make-up of their shareholder “cap table”, until now. Enter Equidate, a Bay Area company that’s connecting accredited investors seeking to buy stock in the next Facebook with employee shareholders seeking to cash out their shares ahead of an IPO.

"Our platform democratizes pre-IPO investing, giving accredited retail investors access they've never had before to the private markets," said Sohail Prasad, chief executive officer of Equidate.

Backed by entrepreneurial angels like Scott Bannister, the San Francisco-based company has already carried out millions of dollars of pre-IPO transactions, with employees of leading tech firms liquidating their pre-public shares via Equidate’s platform. So far, Equidate has made available shares in premier name private companies like Dropbox, Airbnb, and Pinterest, and other companies, like GoPro Inc., that have since gone public, Prasad said.

These pre-public cash-outs are where savvy investors are turning to find new investment opportunities, Prasad said. “Value creation and growth has increasingly shifted from public to private markets. Consider the increase in market cap from Ebay, which was valued at $1.9 billion when it went public, to Facebook, which had a $100 billion valuation at its IPO. Uber is still private and is [already] valued at $41 billion.”

With further IPOs of big name companies like Uber, Pinterest, Snapchat, and others looming this year, Equidate and users of its technology could be facing a banner year. In order to access the company’s platform, prospective investors must have a minimum net worth of $1 million or more, or generate $200,000 in annual earnings if the investor is single or $300,000 in yearly earnings if married.

In return, they receive background information about private companies with employee shareholders seeking to exit their holdings, including financial metrics, such as a company’s revenue if it’s been publicly disclosed. The company does not favor one hot name company over another when it presents information to prospective investors on its platform, Prasad noted.

"We don't recommend one company over another. We aggregate public information about companies, including a reconstructed cap table, information on recent funding rounds and prices, and display it on the platform, so that investors can review it before making an investment. We want investors to be able to come to our platform and make an informed decision," he said.

They must also be willing to make a minimum investment of $20,000 to acquire shares of pre-IPO companies, but the company doesn’t limit how much an investor can spend to acquire shares.

For private company employee shareholders, the opportunity to monetize their investment would seem an increasingly appealing option considering that the media time from a company’s initial equity financing to an IPO amounted to 9.4 years at the end of 2013, or three years more than in 2011, according to Ernst and Young.

Equidate’s approach to unlocking the value in illiquid stock is novel. Instead of obtaining consent to sell pre-IPO shares from a company’s board or founders, the company links a worker’s equity stake to a contract based on the value of their shares. When an investor is interested in purchasing shares from an employee they submit a bid for the shares and over a 2-week period the bid is evaluated against other bids for the same shares and a “market price” for the shares is subsequently set.

When an investor consummates their purchase of pre-IPO stock, that investor isn’t able to realize its full equity value until the company goes public or gets acquired via an M&A transaction. Conversely, pre-IPO employees seeking to sell their shares via Equidate still maintain their voting rights over the shares, so the employer doesn’t have to worry about the shares being bought by someone outside of the company or need to make any adjustments to their listing of shareholders for regulatory purposes.

It’s hardly a secret that investing in pre-IPO shares can generate big increases in equity value for stakeholders once a company goes public. For instance, consider the public offering by GoPro Inc. (GPRO: Nasdaq) last June when the company’s shares opened at the high range of $24 per share, valuing the San Mateo, Calif.-based company at $2.96 billion. Since then, its shares have soared to a high of $98.47 over the past year.

It would be remiss to suggest that sales of privately held stock through organized marketplaces haven’t happened in recent years. The appeal of private stock has lately led to new secondary marketplaces for private stock managed by companies like SecondMarket and others. However, some of these same players have shifted their business models since the 2009 time frame and left pre-IPO shareholders with less user-friendly options for cashing out their private shares than in years past.

So, what types of investors are accessing the Equidate platform?

Prasad said the investor users of the company’s platform range widely from being angel and technology-focused investors to others outside of technology or finance. “We had a doctor in New Hampshire that heard about us and he signed up,” he added.