What to Consider Before Choosing Alternative Investments

You should talk with your financial adviser about these five things before investing in private companies. Plus, find out how to explore pre-IPO opportunities.

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(Image credit: Getty Images)

Savvy investors are often looking to invest in the next big thing, while aiming to maximize potential returns. Because of this, alternative investments and, in particular, pre-IPO (initial public offering) stock investing have gained traction among a growing number of accredited investors. On EquityZen’s platform alone, over 550,000 investors come to explore pre-IPO investment opportunities — and with regulatory changes, this market, which used to be primarily available only for institutional investors, is more accessible than ever.

While alternative investments can be an exciting and important part of a diversified portfolio, investing in the private markets requires additional consideration, beyond what one might evaluate when investing in the public markets. If you work with a financial adviser, it’s important to evaluate these investment opportunities with your adviser in the context of your broader portfolio, goals, liquidity needs and risk appetite. Here, we'll explore the essential topics to cover with your financial adviser to determine if allocating capital to alternatives via pre-IPO investing is right for you.

Things to consider

Alignment with financial goals. Before exploring any investment, it's important to have a clear understanding of your financial goals and if that particular investment aligns with these goals. Whether your goals include long-term wealth accumulation, retirement planning or funding a specific milestone like buying a home, your financial adviser should know your financial goals.

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This is the foundation that they will use to tailor their advice to align with your unique financial situation and aspirations. Often, investors interested in pre-IPO investing are looking to achieve outsized returns that outperform public benchmarks over the long term. Conversely, investors with low risk and return goals are less likely to be a fit for pre-IPO investing.

Risk tolerance. Pre-IPO investments come with a higher level of risk compared to traditional investments. With their knowledge of your risk appetite, your financial adviser can determine if pre-IPO investing is right for you. Investing in private companies means buying a stake in their future. While there's a potential for significant returns if the company succeeds, there's also a risk of total loss if it fails.

Pre-IPO companies also are required to disclose less information than publicly traded companies, which can add additional risk. Investors must be comfortable with this risk in the context of their broader investment portfolio, and your financial adviser can help determine if your risk appetite aligns.

Existing portfolio composition. Like any investment, pre-IPO investments need to be considered in the context of your broader investment strategy. Most investors consider pre-IPO investments as a core part of their alternatives allocation, which some professional advisers suggest should account for 15% to 30% of your overall portfolio.

As companies stay private longer than ever, pre-IPO investments may also be considered part of an overall growth equity allocation that may span both public and private company investments.

The role of diversification. Your financial adviser should be keenly focused on making sure your portfolio is diversified enough to weather market volatility, reducing the risk that any one position overly sways your portfolio performance for the positive or negative. Pre-IPO investments can include investments in single private companies or in diversified managed funds.

Regardless of your portfolio composition and risk tolerance, your adviser will likely suggest that you invest in several different pre-IPO companies to reduce your performance reliance on any single investment. They will likely look to pick private companies across sectors and stages to further diversify, while making sure that private companies as a whole make up a reasonable, but not too large, percentage of your overall portfolio.

Liquidity needs. Pre-IPO investments are often long-term investments that investors should expect to hold for up to five to seven years. Even after an IPO, newly public companies typically have a lock-up period, during which investors may not be able to sell their shares.

Discuss your liquidity needs with your financial adviser to ensure that pre-IPO investments won't hinder your ability to access funds when necessary. Pre-IPO investments should be made only with capital intended to be invested over the long term, not capital you may need in the next few years.

While more options for pre-IPO liquidity are becoming available, such as Express Deals, balancing long-term growth with short-term cash needs is essential. Make sure your financial adviser understands both your near-term and long-term goals to ensure illiquid investments like pre-IPO companies are right for you.

How to explore pre-IPO opportunities

If you and your adviser have determined that pre-IPO investments are a fit for your portfolio, it’s now time to explore the available opportunities. Platforms like EquityZen work with many financial advisers to help them identify the right investments for their clients goals and needs. Advisers who are informed about the private markets can provide insights on companies potentially considering going public and the potential risks and rewards associated with such investments.

It’s important to keep an open dialogue about what you’re looking for and how it aligns with your overall investment strategy.

Before making any investment decisions, your financial adviser can help you conduct the appropriate due diligence. They can assist in analyzing the structure of any particular pre-IPO offering along with the business fundamentals of any given company. EquityZen’s guide to investing in pre-IPO secondaries can be a helpful resource for both you and your adviser.

If you choose to invest in a diversified fund, your adviser can review marketing materials, fund terms and prior performance and conduct due diligence of the investment manager to help ensure you’re making a smart investment with a reputable firm.

Like with any investment, macroeconomic factors can significantly impact the success of pre-IPO investments. Your adviser can help you stay informed about market trends, economic indicators and any factors that may influence the success of your investments and what your overall investment allocation should look like. While many advisers advise their clients to invest for the long term, tactical investment positioning may also be considered.

When considering alternative investments, and pre-IPO investments more specifically, having an open line of communication with your financial adviser can help set you up for success. Their unique knowledge of your financial goals, risk tolerance and liquidity needs, among other considerations, can help you determine if pre-IPO investments are right for you and the role they should play in your portfolio.

They can also help you assess opportunities, conduct due diligence and make informed decisions that align with your unique financial situation and goals. After all, a well-informed investor is better positioned to make strategic and successful investment choices.

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This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

Brianne Lynch, CAIA
Head of Market Insight, EquityZen

Brianne started her career at Barclays and an equity long-short hedge fund in sales and relationship management roles before pivoting into the startup world. She joined a seed-stage startup as their first hire and was responsible for anything and everything growth oriented. From there, she joined EquityZen, a pre-IPO investment platform and investment manager, in 2018 and has held roles spanning business development, partnerships, marketing and market intelligence.