A favorite trade of 2020 and 2021—buying into a startup shortly before the company is expected to go public, often through the sale of notes convertible into equity—is bubbling again as more startups inch toward public listings. These convertible notes can act as a strong signal the company is intent on an IPO, well before it files a prospectus. They can also flag that large institutional investors have faith in a company, even if they’re uncertain about when it could go public. As we reported last week, cloud provider Lambda Labs is seeking to raise $350 million ahead of an IPO expected later this year. In November, the crypto exchange Kraken said it had filed for an IPO, the day after it announced a $200 million fundraising. And Motive, the trucking dashcam company formerly known as KeepTruckin, sold $150 million in convertible notes last year, it disclosed in its recent IPO filing.
A favorite trade of 2020 and 2021—buying into a startup shortly before the company is expected to go public, often through the sale of notes convertible into equity—is bubbling again as more startups inch toward public listings. These convertible notes can act as a strong signal the company is intent on an IPO, well before it files a prospectus. They can also flag that large institutional investors have faith in a company, even if they’re uncertain about when it could go public.
As we reported last week, cloud provider Lambda Labs is seeking to raise $350 million ahead of an IPO expected later this year. In November, the crypto exchange Kraken said it had filed for an IPO, the day after it announced a $200 million fundraising. And Motive, the trucking dashcam company formerly known as KeepTruckin, sold $150 million in convertible notes last year, it disclosed in its recent IPO filing.
“Companies want to attract long-term investors in these pre-IPO rounds,” said Rachel Gerring, EY's Americas IPO Leader. “They can serve as a positive data point that fuels confidence when looking ahead to a future IPO.”
The money can also come in handy. Motive’s operating losses had whittled its cash to $48 million by the end of 2024, its filings show.
The rounds can also pave the way for a public listing by inviting large investors that typically hold stocks to buy into the company. Kraken, before two rounds late last year, hadn’t raised much from large outside investors, so the funding helped raise its stature with those types of firms.
These types of rounds were popular in 2021 and 2022, when deep-pocketed investors like Fidelity Management, T. Rowe, Tiger Global Management and others snapped up shares in Snowflake, Zoom, Coinbase and others on the cusp of their public listings. Buying into companies as well established as those three is, for sure, a far cry from investing in a young startup.
Instead, investors are banking on companies that are already usually making hundreds of millions in revenue and are getting close to turning a profit, if they haven’t already. Because these companies are typically about to go public, these investments offer a quick return, which in theory allows investors to recycle proceeds into another trade.
As this chart of several 2021 listings show, investors in Affirm, SentinelOne and DigitalOcean were able to at least double their money within a year of investing in the last private equity round before an IPO, according to data from the Prime Unicorn Index, which tracks private startups with a valuation of more than $1 billion. Those gains were often even higher if investors hung onto those shares, we wrote in early 2022, when the stock market was still not far from its pandemic-era peak.
There is, of course, the danger that a stock drops after the IPO, before companies have a chance to sell. But this is where the convertible notes come in. Buying via convertible notes gives investors a discount on stock it converts to. Lambda’s offering, for instance, would allow investors to convert their notes at a 20% discount to the IPO price and would give investors priority to invest in the IPO. What’s more if an IPO doesn’t happen, the investors may earn interest or additional equity.
Motive says investors in its convertible round, which include Greenoaks, IVP and Kleiner Perkins, will receive 1.8 worth of shares for every convertible security during an IPO and a 18% annual interest a year after the note issuance if the company doesn’t go public.
For companies, these securities are good ways to raise extra cash before the IPO but they come with risks: if the startup doesn’t list, it is saddled with debt and may need to come up with the cash to repay the investor. And if the company offers investors too steep a discount to the IPO price, existing investors—including employees—can be diluted, or see the value of their shares decline.
When tech stocks crashed in late 2022, annihilating demand for IPOs and sinking late-stage valuations, the trade soured. That year, cybersecurity security startup Arctic Wolf raised $300 million in convertible debt from Blue Owl Capital’s Owl Rock and others, as we first reported. The company’s CEO, Nick Schneider, had said he expected the company would go public by year-end. That didn’t happen, and it continued to pay interest—though at a pretty low rate of 3% annually, according to Owl Rock’s securities filings. —Cory Weinberg contributed to this report.
