Want a hot pre-IPO company in your portfolio? Proceed with caution

Here’s what to know.

Who should invest in pre-IPO companies?

Once upon a time, companies like Amazon and Apple made their stock-market debut with market capitalizations under $2 billion. Now, firms wait much longer to go public—SpaceX was recently valued at $1.25 trillion—while institutions and wealthier private-market investors benefit from the growth.

While that leaves many investors curious about snagging a piece of big-name privately held firms, advisers said they rarely recommend it to clients. Those best suited to private-market investing are usually long-term, sophisticated investors who don’t mind taking on quite a bit of risk, they noted. Some platforms for buying private shares are available only to accredited investors, meaning you’ll need at least $1 million in net assets, excluding your primary residence, or at least $200,000 in individual or $300,000 in joint income.

But even then, said Patrick Huey, principal adviser at Victory Independent Planning in Naples, Fla., private-market investments probably shouldn’t make up more than a sliver of your portfolio.

“I understand wanting to be one of the first people in,” he said. ‘But even a good company can be a bad investment because of the wrong price or the wrong size.”

SPVs

One common way of getting access to pre-IPO companies is through something called a special purpose vehicle, or SPV, a private fund created to hold a specific asset. Some SPVs can be layered, meaning the fund owns another fund that owns the private company’s stock.

Those funds can also result in fees: management fees, upfront commissions, a chunk of any gains. Those charges eat into the return on your investment and are often not clearly disclosed, said Neena Mishra, director of ETF Research at Zacks Investment Research.

“There’s a lack of transparency,” Mishra said. “I think it’s best for investors to just wait until these companies go public.”

Secondary marketplaces

One place to find exposure is marketplaces run by companies such as Forge Global and Nasdaq Private Market, where investors can buy, sell or request stock in private firms. For investors interested in direct, singular exposure to a private company, these platforms are probably your best bet, said Matt Chancey, a financial planner and founder of Tax Alpha Companies in Tampa, Fla.

“Many times when investors want to go in on a private firm, they want a concentrated position,” Chancey said. On secondary platforms, he said, “you should be able to obtain a more direct ownership structure.” In the case of Forge and Nasdaq Private Market, stock transactions are completed with the approval of the issuing company, though investors might still be purchasing their stake through an SPV.

But shares of a particular firm might be unavailable, and you still won’t get the perks that come with owning a public stock—like a transparent look at the company’s financials, or the ability to sell whenever you choose.

Exchange-traded funds

A number of exchange-traded funds advertise exposure to private firms. The Tema Space Innovators ETF, for example, includes SpaceX in its holdings alongside publicly traded space companies. The ERShares Private-Public Crossover ETF holds a “sleeve of select private companies” alongside shares of Nvidia, Meta Platforms and other public stocks.

Mishra said there are two things to consider: First, shares of the private company are likely a small portion of an ETF’s overall holdings and are mixed in with other names. Federal regulations generally restrict illiquid securities to 15% of a mutual fund or ETF’s assets.

These funds are also likely holding SPVs, with resulting fees that can be a drag on performance.

Closed-end funds

Another option is closed-end funds. One example is Destiny Tech100, which owns shares of SpaceX and other closely held tech companies. There is also the newly launched Robinhood Ventures Fund I, which started trading this spring and provides exposure to several private companies, including Databricks and OpenAI.

However, the market price of such funds could vary greatly from the net value of their assets, Mishra noted, as trading in those fund shares fluctuates based on investor demand.

“Those are definitely the two biggest things: What are you getting for your money? And how much are you actually spending to get what you want?” said Jeff Judge, a managing partner at Chesapeake Financial Planners in Maryland. “You’ve just got to be careful.”

Stock tokens

Other newfangled ways of accessing private markets have also crept onto investors’ radar in recent years, including digital stock tokens designed to mirror a company’s share-price performance without conferring actual ownership rights.

Tokenized stocks, while not yet permitted in the U.S., have attracted pushback in the past. At a crypto event in Europe last summer, Robinhood CEO Vlad Tenev announced a giveaway of stock tokens tied to the performance of OpenAI and SpaceX. In the days after the event, OpenAI posted on social media that it wasn’t involved and didn’t endorse the tokens.

Huey, the Naples, Fla.-based financial adviser, said he remains deeply skeptical of synthetic products like tokens that purport to reflect the returns of private firms.

“If we can’t draw it on a whiteboard— structure, fees, liquidity, what you actually own—we don’t buy it,” he said.

Waiting for the IPO

The interest in private markets—especially high-profile companies like SpaceX or Anthropic—is understandable, said Tom Geoghegan, the founder of Beacon Hill Private Wealth in Summit, N.J. But he finds that clients’ excitement can fade as they dig into the details.

“There seems to be a lot of FOMO,” he said, using the acronym for “fear of missing out.” Then, “we spend at least two-thirds of the conversation talking through the structure and the pros and cons, as opposed to the fundamentals of the company.”

Even jumping in on the first day of public trading hasn’t historically been the best idea for small-dollar investors. For most traders, advisers said, the best approach might just be the simplest.

“Wait until after the IPO and see where the chips fall,” said Judge, the adviser based in Maryland. “Then you can make an informed decision.”

Write to Hannah Erin Lang at hannaherin.lang@wsj.com