The AI craze, which has sent stocks like Nvidia up by almost 184% over the last 12 months, has investors scurrying to find more opportunities within the sector.
But investing in growth stocks is riskier because you're betting on a company's future prospectsUdabur Stock. Those who can stomach the uncertainty are going one step further by investing in AI startups before they go public and begin trading on a stock exchange. This is known as the pre-IPO phase.
Venture capitalists have made their money in this market by finding young companies with promising futures, injecting capital, and then waiting for them to go public to pull out their cash and move to the next company.
It's a riskier strategy that isn't for everyone, nor does it have great near-term returns. As of September 2023, the Cambridge Associates LLC US Venture Capital Index, a benchmark for private fund performance that tracks over 9,800 funds in venture capital, growth equity, and buyout funds, had a one-year loss of about 10% compared to the small-cap Russell 2000 that gained nearly 9% over the same periodVaranasi Stock. It's not until a three-year period that payoffs begin to show: the private-fund index returned 16% over three years, while the Russell returned about 6%Jaipur Wealth Management. However, even with the private benchmark which tracks wide exposure, investing in individual projects doesn't guarantee any returns.
Traditionally, the pre-IPO phase has been reserved for a handful of large investors or those classified as accredited because they have salaries above $200,000 annually or at least million-dollar net worths. That's because unregistered securities have more risk and aren't subject to as much scrutiny by the Securities and Exchange Commission.
More recently, an increasing number of platforms are providing retail investors with access to the pre-IPO market by purchasing large chunks of shares and then reselling them to users on their platforms. This could be an option if you have a few thousand dollars and are willing to risk them by investing in early-stage companies.
Joe Endoso, the CEO of Linqto, one of many investment platforms that grants access to private companies, says it's a great option considering fewer companies are going public and more are taking longer to IPO due to the work and costs associated with it. The increasing amount of venture capital money and private credit has also given companies less reason to go public sooner, he added.
For those looking to make early bets on sectors such as AI, it's an opportunity to grab shares before they reach extremes on the public market. Once a company goes public, investors who purchased private shares from a platform provider can decide if they want to receive their shares in cash or have them transferred into public shares in kind, allowing them to keep their exposure to the company, he noted.
However, investors must consider a few things before deciding whether this is a good option for diversifying the growth part of a portfolio.Lucknow Wealth Management
The first caveat Endoso points to is information asymmetry, which occurs when one side has more information than the other. In this instance, an investor would have very limited data on a private company's health because there's less transparency, unlike publicly traded firms that issue quarterly reports about the business to shareholders.
Second, there's less liquidity in the private market. This means there's a lag time when selling private shares, unlike stocks that can be sold within a millisecond of hitting a button. While you can sell your shares through these platforms, there has to be a willing buyer on the other end within the same platform, Endoso noted.Kanpur Stock
Third, while companies listed on some of these platforms are expected to go public in the next few months to years, there's no guarantee they will.
Finally, when a company goes public, there's a lock-up period. Investors who hold pre-IPO shares can't sell them on the public market for some time, usually three to six months, depending on the duration decided on by the bank that underwrites the IPO. Meanwhile, those who purchased after the IPO are free to sell at any time. Depending on the platform the shares were purchased through, pre-IPO holders may still sell their shares to others within the platform, Endoso said.
One example of a private AI company that recently went public in late March is Astera Labs (ALAB), which was trading near $69 as of Tuesday. Data from Linqto's platform provided by Endoso showed shares between December 2023 and February 2024 sold at the volume-weighted average price (VWAP) of $24.22 through the platform, indicating an unrealized gain of 184%. However, shareholders who decided to retain their shares are in a lock-in period of about four to five months, he noted.
As for forward-looking AI investment opportunities with IPO prospects, Endoso pointed to five promising companies he's excited about.
The first is AI chip maker and service provider Cerebras, which recently introduced WSE-3, the world's fastest AI chip with twice the performance of its predecessor, Endoso said. The company helps institutions and companies build custom models for chatbots and research.
Cerebras is targeting an IPO as early as the second half of 2024, according to Bloomberg.
AI safety and research company Anthropic has three models called Claude 3 formulated to assist with professional tasks such as writing, research, math, and coding.
xAI is an AI startup founded by Elon Musk in a series B funding round. Its GenAI model is Grok-1.5V, which pegs itself as having leading abilities in understanding the physical world including visual information like objects, diagrams, and spatial comprehension.
Shield AI is an aerospace and defense company building Hivemind, an AI pilot that enables drones and aircraft to operate autonomously without GPS, communications, or a pilot.
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