Everyone has heard of IPOs (initial public offerings), especially the wildly successful ones the financial media loves to glamorize. These stories entice our imaginations and give us dreams of becoming millionaires overnight.
A great example of this is Beyond Meat (NASDAQ: BYND). Prior to May 2, 2019, few investors had ever heard of the company. They produce what is known as “alternative meat.”
They had one of the most successful IPOs of 2019… The stock price opened at $46 per share and skyrocketed up to a high of $72.95 on the first day of trading. A 58% gain in a couple of hours of trading.
And that was just the first day… Beyond Meat hit a high of $239.71 on July 26, 2019, and is currently around $156. Quite an impressive run, regardless of the pullback from the high point.
Now, imagine how much the early investors made… the ones that invested before the IPO.
Let’s take a look at how it all works.
Angel Investing 101
Angel Investing (also known as startup investing and private equity investing) is an investment in a private company by a group of private investors. The private company is usually a startup that needs a capital infusion to grow the business.
The company and the investors agree on a valuation of the company, the amount of the investment, and the percentage of the company's equity the private investors will receive.
Both the company and the investors enter into this transaction to grow the company and produce a large return on investment (ROI) for the existing shareholders and the new private investors.
In addition to taking money from private investors, many startups work with Private Equity firms (PE firms).
Along with providing the capital to grow the business, PE firms often provide startup companies with management oversight. The PE firm's experience with many companies can be very valuable to the young company. The PE firm can provide guidance in strategic planning, creating operational efficiencies, best practices in accounting and reporting processes, consulting on IT systems, and many other areas of the business.
Just as important as getting into an angel investment is getting out of the investment. Building the value of a company is great, but it doesn't mean much if you can't cash out. Most private equity investments have a time horizon of 4 – 7 years. At that time, investors exit the investment through one of the below strategies.
- The Owners Sell the Company to a Competitor – If the Company has continued to grow, it will attract the attention of the big boys in the industry. You hear about this a lot with companies like Google and Facebook. For example, Facebook purchased Instagram for $1 Billion just 2 years after the company was founded. There are reports of a private equity investment just weeks prior that valued Instagram at $500 Million. That's a 100% return on investment in a matter of weeks.
- Sell the Company to another Private Equity Firm – Private Equity Firms need to make deals. Sometimes, they make deals with each other. This happens frequently when the time horizon of a Private Equity investment runs out. The initial PE Firm needs to cash out and pay their investors, the acquiring PE Firm has a fresh fund and needs to make an investment. Generally, this type of exit isn't the most glamorous, but it is a way for a PE Firm to cash out.
- Initial Public Offering (IPO) – The last strategy is to sell the company to the public through an IPO. They can have large price swings once the stock starts trading on an open market. When a company decides to “go public” through an IPO, it engages one or more investment banks to underwrite the IPO process. The investment bankers go on what's called a “roadshow,” which just means they market the company's stock to large institutional investors. Based on the interest gauged during the roadshow, the investment bank and the company decide how many shares and what price they'll sell for. For example, they may decide to sell 10 million shares for $50 each.
How to Invest in Companies Before The IPO
Under Title III of the JOBS Act, all equity crowdfunding transactions by a non-accredited investor must take place within an SEC-regulated intermediary, either a broker-dealer or a funding portal like Angel List or Crowdfunder.
Investors making less than $100,000 per year are able to invest up to $2,000 or 5% of annual income through equity crowdfunding. Investors making over $100,000 per year can invest up to 10% of their annual income, but no more than $100,000 per year.
Non-accredited investors can only sell their shares after one year. Because of the smaller amounts of money being invested, a non-accredited investor’s investment is not liquid. Therefore, they must wait at least one year before the investment is eligible to be sold. If an investment needs to be sold, an accredited investor may purchase it from the non-accredited investor before one year.
You could also buy Mutual Funds or ETF's that hold a basket of Private Equity Firm stocks. This will give you a broader exposure to the private equity market. An example of a Private Equity ETF is Invesco Global Listed Private Equity ETF (PSP).
If you are an Accredited Investor, you can invest directly into a Private Equity Fund. Private Equity Funds generally have a minimum investment requirement anywhere from $250,000 to several million. You must also meet income and net worth requirements to become classified as an Accredited Investor.
Several large Private Equity Firms are traded on public stock exchanges. These firms include Blackstone Group (BX), Apollo Global Management (APO), Carlyle Group (CG), and Kohlberg Kravis Roberts Co (KKR). You could buy stock of these companies directly which then gives you exposure to their private equity holdings.
Is Angel Investing Right for You?
Let's take a look at some key differences between investing in private companies and public companies. Since there are different ways to invest in Private Equity, let's take a look at 1) direct investment in a private company or PE fund 2) Investment in the public stock of a PE Firm and 3) Investment in a publicly-traded company.
|Direct Investment in Private Company or Private Equity Fund||Investment in Public Stock of a PE Firm||Investment in Publicly Traded Company|
|Minimum Requirements||Minimums ranging from $50 to several million||The cost of a single share of stock||The cost of a single share of stock|
|Government Oversight||Private companies are not subject to the rules and regulations of the SEC.
But, for private deals falling under Title III of the JOBS ACT, companies must disclose an extensive amount of information surrounding the company and the company’s financial data, such as the price to the public of the securities, the target offering amount, the deadline to reach the target offering amount, a discussion of the company’s financial condition, and financial statements of the company.
|The PE Firm is subject to SEC requirements, but the underlying private companies are not.||Fully subject to all SEC rules, regulations, and financial reporting requirements.|
|Investment Liquidity||Investors can only exit through a sale of the company, the company being acquired or going public.
Under Title III of the JOBS act, unaccredited investors can sell their investment to accredited investors.
|Very liquid. Investors can easily sell anytime the stock exchange is open.||Very liquid. Investors can easily sell anytime the stock exchange is open.|
|Potential Gains||Potential for massive gains.||Greater volatility than the S&P 500 average provides greater opportunity for gains or losses||Dependent on the particular stock. In general, the lowest upside and downside|
|Time Horizon||4 – 7 years on average||Can enter and exit at any time||Can enter and exit at any time|
So, is angel investing right for you?
As with any investment, it comes down to balancing risk and return.
For most investors, the potential for tremendous gains of private equity investing deserves a place in their portfolio.
How to Get Started Today
I can tell you firsthand, the path to success isn't always an easy ride.
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Well, I could put a number on it – but you probably won't believe me.
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After you do, you could easily and quickly breeze past your wildest moneymaking goals.