Last month, I asked our Equifund readers to send in their questions about Pre-IPO investing.
Not surprisingly, a LOT of people ask questions about how – and when – to sell their Pre-IPO shares.
And as much as I wish I could just say something like “sell your Pre-IPO shares four days after they go public at 9:53am EST for maximum gains”…
That’s not how this works.
The only way to answer this question is to go back to basics and talk about one of the most important things in investing that many retail investors are bad at…
How to Build and Manage Wealth
Here’s the very unfortunate truth we all need to accept about money…
Many people – who usually don’t know anything about money, finance or investing – want to believe there’s a secret “money button” on the internet that when pushed…
Will send massive amounts of money into their bank account (with little to no effort or skill).
But no matter what the advertisements you see on the internet tell you about “getting rich quick” in the stock market…
Wealthy people don’t become wealthy – and stay wealthy – by day trading and gambling. In fact, pretty much no one does.
How do they actually do it?
They rely on proven wealth building strategies designed to help them meet their own personal financial needs…
Not an arbitrary benchmark like “beating the market.”
Which brings us to the first, and most important, question we all have to answer when asking what sounds like a simple question, “When is the best time to sell my Pre-IPO shares?”
- What are your financial goals?
I’ve asked a LOT of people over the years what they’re trying to accomplish by investing…
And sadly, most people I’ve surveyed can’t get more specific than “I want to make more money and avoid losing money.”
This, in my opinion, is the source of almost all problems people have when investing.
Why? Because this isn’t a specific goal that has a clear and measurable outcome (like “get out of debt” or “buy a house” or “save for college” or “retire at age 65”).
It is a representation of your desire to stop feeling the fear and anxiety you have around money.
Put another way, you’re in survival mode…
And when you’re in survival mode, it’s almost impossible to engage in any higher-level, long-term thinking required to invest.
It’s also a primary reason why people get sucked into “get rich quick” opportunities that are – in hindsight – obviously scams.
How do you deal with this problem? It all starts with an Investment Policy Statement.
This document is a requirement for all professional investors that outlines important questions like…
- How big is the portfolio you’re managing?
You might be a true self directed investor and you’re managing substantially ALL of your investments…
Or, you might have the bulk of your wealth with a professional money manager and you’re managing a small amount (i.e. a “sleeve”) on your own.
- What are your expected returns?
If we took that entire number that you’re managing…
Are you looking for a 5-7% annual return across the entire portfolio of assets?
Are you managing a sleeve of the portfolio and are looking for a 3-5x return over the next 5 years?
Remember: “as much money as possible, as fast as possible” is not an expected return. It’s a fantasy.
You must define your expected return so you have a clear benchmark.
- What strategy will you use to generate those returns?
Are you going to be an active investor/trader and build your own portfolio of assets (i.e. stock picking)?
Are you going to be a passive investor and invest in things like mutual funds and ETFs?
Are you going to be an owner/operator of a privately held business?
- What asset classes will you (and won’t you) consider?
If you’re looking for income… are you investing in blue chip, dividend paying stocks? Junk bonds? Multi-family real estate in the south east?
If you’re looking for growth… are you betting on high risk, early-stage companies? Crypto?
If you’re looking for defense… are you buying gold? TIPS? Other hard assets?
Again, be specific here about what assets make sense for the strategy you’re choosing!
- How many open positions will you have at any one time?
If you are building and managing your own portfolio – meaning, you are stock picking – it means you have to be responsible for finding, selecting, and managing all of the investment you make.
The more positions you have open at any given time means the more work you have to do to “check in” on how those investments are performing.
For professional VCs, they are typically going to make 50-75 investments from the fund they are managing.
This means they are looking at 1,000+ potential investment opportunities in order to find the 50-75 they want… and then they have to keep tabs on those companies on an ongoing basis.
This brings us back to maybe the most important question for Pre-IPO investors…
Do you realistically have enough time, money, and interest to build a diversified portfolio the way professionals do?
Or do you need to “outsource” some of this ongoing work to an advisor?
- How much risk are you willing to take?
To be clear… volatility and risk are two different things.
Volatility is how much price can move. Risk is permanent loss of capital.
If you are not comfortable losing money, investing in high risk investment opportunities – like Pre-IPO – is not for you.
But if you’re comfortable with the fact that MOST of the early stage investments you make will go to zero… a few will break even (or maybe 3-5x)… and if you’re lucky, you’ll get a 100x -1,000x+ winner that returns your whole fund (and then some)…
Then you have the proper risk tolerance to be in highly speculative opportunities.
- What are your liquidity requirements?
If you’re going to invest in Pre-IPO companies, you have to be willing to take the good with the bad.
Unlike the public markets where prices are quoted in real time and you can buy and sell during market hours…
Private market investments don’t have any of those features. Instead, your money is locked up for usually 3,5, even 10 years…
And statistically speaking, the very best companies can often take 10+ years before they start to fully mature and generate the kinds of substantial returns needed for these high-risk bets to pay off.
Furthermore, unless there is an established secondary market for your Pre-IPO shares, you can’t sell them anyway.
This means you’re locked up in the company until it goes public, if it ever does.
If you’re not okay with buying and holding Pre-IPO shares for 3-5 years, it probably means you’re investing money you can’t afford to lose or otherwise need immediate access to!
Or, you’re looking for an opportunity to “Get rich quick” by flipping stock (which we know doesn’t work, long term).
Let’s assume that you do, in fact, have proper expectations about speculative investment opportunities…
The only way to answer the question, “When is the best time to sell?” is to come back to your Investment Policy Statement.
If you’ve been managing your positions, you should have an opinion about the stock in question.
- Do you understand their business model?
- Are you happy with management and their ability to create shareholder value?
- Do you think the company will continue to grow at a fast enough rate to meet your return profile?
If not, maybe you should consider trimming your position (or selling it completely).
But at the end of the day, only you can make the decision to buy/sell based on your own personal financial needs.
Jake Hoffberg – Publisher