For one reason or another, many new Pre-IPO investors think an IPO is a magical road to enormous gains…
But if there’s anything we’ve learned from the Post-COVID IPO frenzy – followed by the apparent stock market slaughter of 2022 – it’s the importance of going public at the right time in the right way for the right reasons.
Sure, a successful IPO may provide a much needed exit for early investors…
But that doesn’t mean it will birth a successful public company that can deliver long-term shareholder value (much less a 1,000x+ return).
That’s why today, we’re going to talk about one of the key conversations with every company seeking to raise capital on the Equifund Crowd Funding Platform.
But first, we have to talk about…
The Math Behind 1,000x Returns
As a Pre-IPO investor, I think we can all agree that we want to see our investments go public…
We’d like to make as much money as possible – in the shortest time period possible – from each investment we make…
And based on the way Pre-IPO is being marketed to investors these days – a “Get Rich Quick” opportunity – it sounds reasonable that we’d want to see our investments go public as soon as possible.
But here’s the thing most investors don’t realize about early stage investing…
With the help of some common knowledge, basic logic, and skepticism… we can see the truth about the extraordinary profit promises behind Pre-iPO investing.
If you want to have any chance of hitting those fabled 1,000x returns – which is when a $1,000 investment turns into $1m – it’s not enough to simply get in right before they go public (and then dump your shares once they do)…
It often requires holding on to your winners for years – potentially decades – as they grow in the public markets.
Why? Let’s take a quick look at the math behind the types of returns being advertised.
For example purposes, let’s assume the Pre-IPO investment you’re considering will complete an IPO exactly 3 years after you’ve invested.
If you plan on dumping your shares during the IPO, in order to generate a 25x return, the stock price would need a compound annual growth rate (CAGR) of 188.45% for three consecutive years.
For 100x, it would require a 362% CAGR over 3 years…
For 1,000x? You’re looking at essentially 10xing every year for three consecutive years.
Unfortunately, those growth numbers are unrealistic. There are examples of companies that went from essentially a standing stop to $1bn valuation in just a few years, but the vast majority of companies don’t grow that quickly, if at all.
But we have to remember something important as an investor…
You – as a shareholder – don’t get paid based off the valuation of the company. You get paid based off the share price!
- Reminder: Share Price = Valuation / Shares Outstanding
And if 2022 has taught us anything, it’s how fast investor sentiment – and share price – can change.
Post-COVID, we saw record breaking IPO activity in 2020 and 2021…
There have been 5,866 IPOs between 2000 and 2022. The least was in 2009 with only 62. The full year 2021 was an all-time record with 1035 IPOs, beating the previous record of 480 in the year 2020.
And if you were following the financial media, it seemed like there was no end in sight to how large these companies could grow (or a price too high to pay for the stock).
Not surprisingly, this environment of “extreme greed” sent the fundraising environment into peak valuation territory…
And also not surprisingly, investors who had been locked up for 7-13 years in these venture-backed companies saw a perfect chance to exit their positions at a favorable price.
For a while, it seemed like analysts everywhere were pricing companies like the pandemic growth was never going to stop…
But then, when the Federal Reserve announcing their plan to raise rates, we saw what can only be described as a stock market bloodbath.
Not only are we seeing public market valuations get crushed…
As companies compete for talent, they are being forced to do things like repricing stock options or issue more aggressive stock compensation plans.
The net effect for shareholders? More dilution that robs them of their gains.
And for early investors, the #1 thing we want to avoid is getting diluted out of our position.
That’s why we work with our Issuers to create a multi-year plan for raising capital, navigating the IPO process, and continuing to raise capital in the public stock market.
The Equifund “Stock Market Slingshot”
Collectively, the Equifund team has more than 40 years of experience with helping early stage companies raise capital, go public, and manage investor relations.
What types of companies you ask? Broadly speaking, most of our team’s experience (prior to Equifund) is working with small publicly traded companies.
- Nano cap (<$50 valuation)
- Micro cap ($50m – $300m valuation)
- Small cap ($250m – $2bn valuation)
One of the most important lessons we’ve learned from our experience:
The biggest risk that no one talks about is management’s ability to continue to raise capital at favorable rates!
In order to generate the types of extraordinary returns expected of Pre-IPO, companies almost always have to raise an extraordinary amount of capital.
As you already know, these companies are high risk and speculative in nature… which means pretty much no bank is going to lend them money.
This means in order to raise capital, most early stage companies issue new shares and sell them to investors.
- For this reason, a company raising money is known as an Issuer.
If you’re investing in the very early stages of a company, sure, we can argue about the valuation and deal terms and debate if we got a good price or not…
But as early shareholders, we know that – assuming the company continues to be successful – they will need to continue to raise more capital…
And the decisions that management makes in every round of fundraising after us can have a significant impact on our potential returns.
According to Adam Epstein’s 2013 book, The Perfect Corporate Board: A Handbook for Mastering the Unique Challenges of Small-Cap Companies…
“Since most small-cap companies don’t generate sufficient cash flow to finance their operations and growth, vast amounts of time and resources are focused on corporate finance.
But unlike larger corporations which raise capital electively and from positions of strength, most small-cap companies enjoy no such luxuries.
Rather, for most small-cap companies infusions of outside capital are mandatory, and there is often little latitude with respect to timing.
Accordingly, small-cap directors are regularly beset by a treadmill of sorts that always seems to move a little faster and a little more uphill—raising sufficient growth capital on the least dilutive terms to fund current operations, and then taking the necessary steps to position the company for future such financings.
And, in many cases, they do that again and again.
As evidenced by the fact that the median market capitalization of U.S.-listed public companies is only $450 million, the number of companies successfully navigating that treadmill is dwarfed by those that are either mired in stasis or soon to be ejected off the back of the treadmill.”
In order for any company to create extraordinary shareholder returns, it’s not enough to raise lots of money and go pulbic.
They must have a long term plan for continually raising – and deploying – capital to drive efficient growth.
If they don’t, they could find themselves in a position where they are desperate for cash… and because of market conditions, they are forced into taking less-than-desirable financing terms that destroy early shareholder value.
And for those of you who are wondering if Equifund has some sort of “secret sauce” when taking on deals…
Our biggest advantage is knowing what challenges wait for our Issuers once they are public companies…
And how proper Pre-IPO planning can prevent many of those problems from happening in the first place.
We call our strategy the Stock Market Slingshot.
The goal of this strategy is simple: we want to maximize potential returns for early shareholders by minimizing mistakes made during fundraising.
That’s why we think crowdfunding is the most exciting opportunity in finance that no one is talking about.
Instead of raising rather “expensive” capital from institutions and financiers – who potentially force the Issuer into an aggressive business plan that might not be in the best interest of the early shareholders…
Founders may be able to raise “friendly” capital from employees, customers, vendors, or other stakeholders – who likely want the company to be great at creating jobs, solving problems, and otherwise and delivering value.
While the industry trend has been “stay private for longer and go public later (if ever)”…
We believe that the JOBS Act – and crowdfunding in general – has the potential to incentivize more companies to go public sooner.
But in order to unlock this opportunity, it means we have to help founders understand how Crowdfunding fits into a long term capital raising – and company building – strategy…
And it means we have to help everyday people become more educated and informed investors.
That’s why we’re dedicated to producing what we believe to be true thought leadership and world class investor education materials.
Because you – a member of our growing Equifund Community – are the reason companies want to list on the Equifund Crowd Funding Portal.
And we want you to have proper expectations – along with the right tools and trainings – when it comes to investing in Pre-IPO opportunities.
- The more educated you are, the more confident you’ll feel when investing…
- The more our community invests, the more likely it is Issuers will have success raising capital on Equifund…
- The more success Issuers have, the more likely it is that more – and higher quality – Issuers will come to Equifund…
- The higher quality the Issuer, the more likely it is they will deliver returns for the investor…
- The more returns our Issuers deliver to Investors, the easier it is to grow our community…
Until one day, we – the Equifund community – become #1 option for companies who want to prepare for life as a public company.
Jake Hoffberg – Publisher
P.S. Have questions about Pre-IPO investing?
We’ve answered some of the most common questions our readers have submitted like:
How Pre-IPO Investors Make Money
Potential Pre-IPO Tax Problems
The Best Time to Sell Your Pre-IPO Shares
How to Track the Value of Your Pre-IPO Portfolio
How to Invest on Equifund With Your Retirement Accounts