5 Things to Know About Pre-IPO Stocks

The so-called secondary market for shares of private companies held by employees and other investors is booming because of the runaway popularity of up-and-comers like Uber Technologies. Participants in pre-IPO trading estimate that $10 billion to $30 billion in stock changed hands last year.

#1: Pre-IPO Stocks Are Red Hot

During the dot-com bubble of the 1990s, the biggest gains came after companies went public. These days, far more wealth is being created as private companies raise financing from venture-capital firms, pushing valuations of those companies higher and higher. At least 78 such companies are now worth at least $1 billion apiece, up from 49 a year ago. As a result, investors are clamoring to get in on the action right now.

#2: It’s Hard to Buy or Sell

Uber, Snapchat and Airbnb are among the many privately held companies that set tight limits on selling shares. Few companies make it easy for outsiders to buy stock. Many individual investors turn to market makers such as SharesPost and SecondMarket. Well-connected investors sometimes get access to special funds created by firms that get privately held shares directly from companies.

#3: Why Would Employees Want to Sell?

Privately held companies generally are waiting longer to go public than they used to, which frustrates some employees who hope to boost the value of their holdings through an initial public offering. Cashing in now helps “reward employees for the work they have done and time they put in,” says Kent Wakeford, chief operating officer at Kabam, a video-gaming company in San Francisco.

#4: Buyer Beware

Prices used in transactions can be based on little more than a guess, since private companies keep almost all their financial information secret. Fees can be high because of the runaway demand for pre-IPO shares and effort involved in arranging transactions. Many of the companies are young and unprofitable.

#5: Regulators Are Circling the Pre-IPO Market

While buying and selling private-company stock is permitted under federal and state rules for unregistered securities, the Securities and Exchange Commission has filed a handful of enforcement actions related to pre-IPO trading. One area of concern: investment advisers who say they are raising money to buy pre-IPO shares but don’t actually purchase them.