Know the Risks of Pre-IPO Funds and Potential Fraud

When a hot company is in the news, it might be tempting to take advantage of offers to invest before it goes public through an initial public offering (IPO). That's what "pre-IPO" investing promises: a chance to buy shares of a private company before it lists on a stock exchange.

If you're offered early access to shares of a popular private company or a fund that claims to own shares of the private company, be aware that these transactions carry significant risk, and some are outright scams designed to steal your money.

Understanding Pre-IPO Risks

Many pre-IPO opportunities today, especially those involving highly publicized private companies, aren't direct purchases of company stock. Instead, you're likely buying indirectly through a fund formed to acquire interests in the company. Such funds raise money from many investors to attempt to acquire shares or future interests in shares of one or more companies anticipated to conduct an IPO. Some of the risks of these investments include the following:

• You can't be certain the private company will actually complete an IPO or otherwise become public.
• It might be difficult to accurately value the securities and, therefore, gauge your investment value.
• You might have significantly limited exit options when you want to sell due to lack of a readily available secondary market, resale restrictions, or post-IPO lock-up periods during which specified early investors cannot sell their share.
• In some cases, the fund itself might own the company stock indirectly, leaving you several layers removed from the actual stock.
• There may be significant costs associated with acquiring interests in the company, requiring material growth to achieve an investment gain.
• Many private companies require that the company approve any transfer of their shares. Without that approval, the transaction might be void, and you or the fund could end up not owning the company stock.

When considering a "pre-IPO" investment, review the offering materials carefully to make sure you fully understand what you're purchasing, identify whether any of the risks noted above are present, and evaluate whether you're comfortable with assuming these risks as part of your investment. Consider consulting a registered financial professional or securities attorney not connected with the offer.

Protecting Yourself From Fraud

Beyond the inherent risks of any pre-IPO investment, some offerings are outright scams. The fund manager might not have a real plan or ability to acquire the shares they promise--or they might not own shares they claim to already have acquired--leaving you with nothing but a loss.

Fraudsters aim to convince investors that opportunities to participate in pre-IPO deals of large, popular companies are available to anyone. In some cases, though, a social media advertisement or unsolicited email claiming to have shares of a "hot company" might very well be a scam.

Never rely solely on information contained in an email, text, social media message, blog post or online discussion, especially if it was unsolicited. To help steer clear of potential scams, follow these tips:

• Ignore unsolicited offers. Legitimate pre-IPO opportunities don't typically arrive in your inbox or in text messages from unknown senders. Promoters might claim almost anything about the shares they purport to have access to, even providing fake photos of share certificates.
• Always ask, "Why me?" An unsolicited offer to buy pre-IPO shares raises the question: Why would a total stranger tell you about a great investment opportunity? The likely answer is that there's no such opportunity.
• Be alert to persuasion tactics. Scams almost always involve urgency, "exclusive" access, steep discounts, or claims of association with a well-known firm.
• Verify registrations. Always research financial professionals before making an investment. Check registrations of both professionals and firms by going directly to the sources that collect regulatory information, including FINRA's BrokerCheck and the SEC's Investment Adviser Public Disclosure database and Public Alert: Unregistered Soliciting Entities (PAUSE) site, and contact your state regulator.
• Be a detective. Use publicly available resources to find out as much as you can about a solicitation and those behind it. For instance, if the individual promoting the investment has a history of fraud or criminal activity, you might find news reports or court documents with details. And if a brokerage firm or financial professional is mentioned, carefully check website addresses and contact information (even after you look up the firm or individual in BrokerCheck) to avoid impersonation scams. Be especially skeptical of any fund whose website and other online resources don't clearly identify the fund manager.
• Never send money directly to an individual. Even if you've met or spoken personally with someone selling an investment, never send funds directly to the individual. Funds for a legitimate investment should go to a registered firm or a regulated custodian and never to a personal account or a wire to an individual.
• Get an unbiased second opinion. Before committing money, ask a registered financial professional with no connection to the deal to review the offering. And if you have access to other resources, like a securities attorney, ask for their help too. They can read the fund documents and help you identify any red flags you should be aware of.

If you believe you've encountered a pre-IPO scam or have information about other potentially fraudulent, illegal or unethical activity, contact your local law enforcement, and submit a regulatory tip to FINRA. If you think you've been the victim of any cyber-enabled scam, file a report with the FBI's Internet Crime Complaint Center.

Learn more about how to protect your money from fraud.

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