Buying Shares In Hot Pre-IPO AI Companies Is Complex, Risky, Very Expensive

Everyone would love to get in on the hot private AI companies that are making pre-IPO noises. 

The problem is that it is very hard to do - cuz who really really wants to share their potential windfall with you or me? - and if you can find access, the associated fees may end up costing more than the expected profits. But in an industry where FOMO rules, demand continues to surge. JL

Jason Zweig reports in the Wall Street Journal:

Who wouldn’t want to get an early stake in the companies creating the future like OpenAI, SpaceX or Anthropic? But you're more likely to be struck by lightning than you are to buy shares directly in most pre-IPO companies. Regulations discourage private companies from taking on more than 2,000 shareholders of record. And you have to be an accredited investor with $1 million in net assets, excluding your primary residence, or at least $200,000 in individual or $300,000 in joint income. The most common form of access is often called a special-purpose vehicle with upfront fees that could be 5% to 12% or more. Some also charge performance fees that take 10% to 30% of any gains. The promise of this market is great. So far, the perils are even greater.

“I keep hearing about ‘democratizing’ access to private assets,” says John DiCarlo, a Wall Street Journal reader. “But nearly all of it seems to be on the fee sharks’ terms.”

DiCarlo, an engineer in the Washington, D.C., area, recently reached out to me because he has been trying—with no luck—for at least two years to buy a stake in private companies before they launch an initial public offering of their shares.

For me, his dilemma epitomizes both the potential and pitfalls of investing in private assets. Who wouldn’t want to get an early stake in the companies creating the future? But the democratization of private markets is about as problematic as the democratization of former dictatorships. We have a long way to go before individual investors can participate with ease and at a competitive price.

Firms such as EquityZen, Forge Global, Hiive and Nasdaq Private Market have made considerable progress in making information available on their websites and apps. For hot, “pre-IPO” companies expected to go public soon, such as SpaceX, OpenAI or Anthropic, you can track share prices over time, see what’s available, and seek to transact in shares or in other investment vehicles that track their performance.

But you’re more likely to be struck by lightning than you are to buy shares directly in most pre-IPO companies.

Regulations generally discourage private companies from taking on more than 2,000 shareholders of record. And you have to be a so-called accredited investor with at least $1 million in net assets, excluding your primary residence, or at least $200,000 in individual or $300,000 in joint income.

The most common form of access is often called a special-purpose vehicle. Some managers of SPVs, knowing they’re among the few ways to buy into coveted pre-IPO companies, charge fees that would make a bandit blush.

SPVs can bear upfront fees that could hit 5% to 12% or more, say industry executives. Some also charge performance fees that take 10% to 30% of any gains. The highest costs are hard to overcome, says Tom Callahan, chief executive of Nasdaq Private Market. “You better hope that company 10X’es or your return will be eroded away in fees,” he says.

Less-expensive alternatives are becoming available, but they still aren’t cheap compared with the costs of investing in public markets.

Hiive, for instance, offers single-stock SPVs that hold shares in such private companies as Databricks or xAI, with no management or performance fees. Purchase fees run from 1.85% (on amounts above $1 million) to 5%. If you sell, you’ll pay a commission of up to 4.9%.

 

At least you can sell those. For most SPVs and similar pre-IPO vehicles, no secondary market exists. Some vehicles explicitly warn that you might never be able to sell. Other risks abound.

DiCarlo says he would be happy to pay “a large one-time fee” to buy and hold such firms as Helion, Anthropic, Stripe, Cerebras or Groq—for as long as 10 to 25 years. But it’s virtually impossible to find an SPV or other vehicle that doesn’t assess many more costs than a one-time fee.

And while high costs are certain, future returns are a crapshoot.

Consider one offering, Series 62-1, from a firm called StartEngine. Series 62-1 was formed to invest in Grammarly, an online writing app. An unnamed affiliate of StartEngine bought Grammarly shares in September for the equivalent of $14 a share; Series 62-1 then agreed to buy them at $20.

So investors in Series 62-1 paid a 43% premium over the previous price. According to the offering document, the manager would take 20% of any future gains—and “may be entitled to receive” an annual management fee. The amount of that possible fee wasn’t specified. (The manager later informed investors that it wouldn’t take the 20% cut of gains.)

Grammarly has since been renamed Superhuman. If it were to go public and hit $140 a share, or 10 times what the StartEngine affiliate paid, investors in Series 62-1 would make a sevenfold gain.

Unfortunately, industry executives say Superhuman is sparsely traded, with bids well below $15 a share.

StartEngine didn’t make anyone available to comment.

“I’d be hard-pressed to think anybody would want an investment with so much upfront markup on it,” says Doug Kinsey, founding partner at Artifex Financial Group, an investment-advisory firm in Dayton, Ohio. “When your costs are this high, the odds are stacked against you.”

Or consider a new offering from Republic, which enables you to “invest in the performance of SpaceX,” according to Republic’s app and website. The minimum investment is $100.

The investment comes in the form of cryptocurrency tokens priced at $2 apiece. Their value, says Republic, should synthetically replicate, or “mirror,” the return on SpaceX shares. And how would that happen?

The proceeds of the offering, which seeks to raise up to $25 million, won’t go to purchase equity in SpaceX. Instead, you get an unsecured, 10-year debt obligation, with no regular interest payments, issued by a Republic affiliate.

The proceeds—after 23% is deducted for expenses—will fund “the further development of the tokenization business” of a Republic affiliate, says Hassan Asif, a Republic executive.

Then there’s a 3.5% one-time “administrative fee.”

 

Each $2 token entitles you to a $1 position in the debt offering. In plain English, you’re paying a 100% entry charge. 

Republic doesn’t explain exactly how it will invest so the tokens can mirror SpaceX’s shares, saying that its offering is “designed to reference the economic performance” of the stock.

No wonder DiCarlo says, “I generally fear I’ll need a lawyer and an accountant if I sell a $50,000 investment 20 years from now, even if it ends up worth $5,000.”

For individual investors, the promise of this market is great. So far, the perils are even greater.

Corrections & Amplifications
The Intelligent Investor column described an offering from StartEngine by stating that according to the offering document, the manager would take 20% of any future gains. StartEngine informed investors that it is waiving its 20% performance fee on this offering, although it didn’t update the offering document. (Corrected on Feb. 3).