Pre-IPO private placements: Not just something for tech IPOs in the US.

16 Mar 2020

Pre-IPO private placements: Not just something for tech IPOs in the US.Peter Huber/Prof. Dr. Michael Schlitt, Partner Hogan Lovells

IPO windows sometimes close very abruptly and rather unpredictably, such as in the second half of October 2018 or the current spring window, which did not open at all due to the coronavirus. It is therefore no surprise that private placements of shares with investors in the run-up to an IPO have become very important in the recent past. They have meanwhile become part of the standard repertoire for raising capital for growth companies, not only for tech IPOs in the US but also in Europe across all sectors. 


There is, of course, no standard case of a pre-IPO private placement but a multitude of varieties instead.

Private placements are made at different stages in a company's history. If they are offered shortly before the IPO, they are similar to attracting a cornerstone investor at the IPO. If, on the other hand, an IPO is only planned in the mid term, they come close to a classic venture-capital late-stage round.

Two types of private placements can be distinguished with regard to the origin of the shares placed. Either the company places new shares created as part of a capital increase or the shareholders sell existing shares in the company. In the first case, the company receives the proceeds of the sale(primary); in the second case the selling shareholder receives them(secondary). The two types of primary and secondary are often combined, so that both the company and the shareholders place shares with investors.

The company also attracts a wide range of investors in the course of a private placement. Private equity investors are frequently observed taking charge of the private placement as lead investor and investing a significant amount. Other investors then join the lead investor. These include investors who traditionally invest in listed securities (e.g. pension funds) as well as government and hedge funds, in addition to private equity investors and late-stage VC investors. Sometimes listed growth funds, family offices, strategic investors and even some “very high net worth individuals” also participate. The private placement process ideally attracts several cross-over investors – investors who can invest in both unlisted and listed companies – as shareholders. Oftentimes, cross-over investors are not interested in immediately reducing their stake in an IPO; on the contrary, they typically buy more shares. Due to their earlier participation, they know the company and the people involved and have a better understanding of their business.

The investment banks supporting the transactions in the role of financial advisors frequently use specialised private placement teams to this end. It is common, however, for such deals to also be processed with the help of an ECM desk.

Reasons for pre-IPO placement

Pre-IPO private placements are very attractive from several points of view. There is currently an abundance of private capital outside the capital markets, thus rendering it very cheap. At present, investors are almost desperately looking for investment opportunities. Investments in companies that are evaluating an IPO are particularly attractive. Firstly, there is the opportunity to invest at a price that is (presumably) lower than the later IPO placement price. Secondly, an investment in a mature stock market candidate is typically less risky than a venture capital investment in a company at an early stage of its corporate development. In addition, an IPO already looming on the horizon offers investors a direct opportunity to exit their investment in the near future and to realise double-digit returns within a short period of time at limited risk. Therefore, there is sometimes a quite clear path to liquidity and investors hardly need to fear being trapped for years in a non-fungible shareholding.

For the company issuing the private placement, in turn, the cheap private capital gives it a chance to further develop with the newly acquired funds without necessarily having to go directly to the capital market. Even the premature exit, which is often encountered in Germany for lack of other financing options, can be brought under control by means of a private placement. The shareholders are not dependent on selling their company at a valuation that does not reflect the full potential of the business concept. They can tackle the next stage in the company’s growth, such as demonstrating a greater track record in product development, possibly already achieving the profitability stage, and thus significantly increasing the later IPO or exit valuation. In order to ensure that founders, early investors and employees follow this somewhat longer path to exit, initial proceeds can be realised in the course of a pre-IPO private placement. The company often has the opportunity to distribute part of the funds raised via the employee stock purchase plans by buying back (virtual) employee options. Founders and investors can sell shares via the secondary tranche and thus realise the company’s increase in value, e.g. in order to make distributions to their own investors and consequently reduce their investment risk. Lock-up agreements preventing the sale of shares for a specified period of time after the IPO (6-12 months), which are normally concluded during the IPO, are also much easier to negotiate with existing shareholders if substantial funds have already flowed before the IPO.

Barring market volatility, a private placement is also an effective instrument for increasing transaction security for the IPO. Well-known investors acquiring a stake in the company in the run-up to the IPO sends a strong positive signal for IPO marketing. Strong demand for shares from existing shareholders is a very convincing marketing tool for the company. Moreover, it gives the company greater certainty that there is sufficient market demand for a successful IPO. 

Technical implementation

Technical implementation is similar to that of a late-stage venture investment combined with an M&A transaction. A shareholders' agreement must be concluded in addition to an investment agreement, which regulates the primary private placement, and to a share purchase agreement for the secondary (secondary SPA). It is important for the entire documentation to be IPO-compliant in this context. The shareholders’ agreement should, for example, clearly outline the path to the stock exchange, contain corresponding cooperation obligations for all parties involved and also make provisions in case the IPO fails to materialise, contrary to expectations.

The prospectus that will later be required for an IPO is not yet needed at this stage. However, if the potential investors want to see target figures, certain contractual features must be taken into account when concluding the non-disclosure agreements to be negotiated at the beginning of the process. 

Also the determination of the price of the shares for placement is not without complexity, as it constitutes a certain kind of anchor. The purchase price agreed in the private placement, plus a certain premium, is likely often regarded as the lower limit for the placement price in an IPO, as the investors who entered the pre-IPO private placement will not allow a documented book loss shortly after their investment. Conversely, there need to be good arguments to establish a valuation of the company at the IPO that is much higher than the valuation in the pre-IPO private placement.

It may even be advisable from the company’s perspective to set up a pre-IPO private placement process parallel to an IPO process under certain circumstances. Although such a dual track ties up management capacities, it increases the options for the parties involved and thus transaction security. A pre-IPO private placement can often be initiated during IPO preparations, as the period from market address to completion is manageably short at 3-4 months.

In view of the rapid feasibility and market volatility decoupling, pre-IPO private placement is therefore often an interesting preparatory measure for an IPO. Pre-IPO private placements 6 to 24 months prior to an IPO will therefore play an increasingly important role in Germany in the foreseeable future.

The authors

Peter Huber


Hogan Lovells

Prof. Dr. Michael Schlitt

Partner, Leiter Praxisgruppe Kapitalmarktrecht

Hogan Lovells