Why It's Challenging for Retail Investors to Purchase Pre-IPO Shares in the United States

Investing in pre-IPO shares has become more accessible, thanks to the JOBS Act introduced in 2016, which enabled unaccredited investors to invest in pre-IPO companies through equity crowdfunding. However, despite this advancement, traditional IPO shares can be equally, if not more, challenging for an average retail investor to secure. This article explores the various factors that make it so difficult for retail investors to participate in pre-IPO investments.

The Role of Underwriters and Investment Banks

The initial public offering (IPO) process is controlled primarily by underwriters and the issuing companies. Underwriters play a crucial role in the allocation of shares, a highly discretionary process aimed at ensuring the demand meets the supply of shares offered. Unlike accredited investors and institutions, retail investors often face significant obstacles in obtaining these shares. This often happens because the initial allocation of IPO shares is primarily handled by the underwriters and investment banks, who focus on bulk sales to institutions before retail investors.

The Allotment System: A Lottery for Retail Investors

For those retail investors who do manage to apply for an IPO through online brokerage firms or other authorized means, the path to acquiring shares is often fraught with uncertainties. When an IPO is oversubscribed, the allocation of shares is often determined by a lucky draw or lottery system. This means that, even with a valid application, there is no certainty of receiving shares. For instance, if an IPO is 10 times oversubscribed, there is only a 10% chance that an individual application will be successful.

Why Retail Investors Face Challenges

The difficulty faced by retail investors in purchasing pre-IPO shares can be attributed to several key factors:

Distribution Strategy: Companies choose to distribute their shares to investment banks, which in turn sell these shares primarily to investment institutions. Retail investors are largely left out of this process. Oversubscription: High demand for IPO shares often leads to oversubscription, making it highly competitive, and thus, allocation is often done through a lottery, not on a first-come, first-served basis. Insufficient Awareness: Many retail investors lack awareness about how the process works, leading to missed opportunities. Complexity of the Process: Navigating the regulations, the application, and the allotment process can be complex and intimidating for an average retail investor.

Factors Involved in IPO Investing

For any investor looking to participate in an IPO, there are several critical factors to consider:

pDilution: Companies often sell shares at a discount to mitigate the dilution of their ownership, which can affect existing shareholders. Long-term Hold: Many institutional investors who receive an allocation of IPO shares are required to hold them for a certain period, limiting immediate resale. Market Speculation: The pre-IPO market is known for its volatility, with prices fluctuating significantly before a company goes public, making it difficult for investors to time their investments accurately.

With the democratization of pre-IPO investing under the JOBS Act, unaccredited investors can now participate in investment opportunities that were once restricted to a more elite investor base. However, understanding the challenges, such as the allocation system and the specificity of demand and supply, is crucial for making informed decisions.

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