The past year and the year before the Indian stock markets were buzzing with many IPOs coming back to back and giving investors a chance to be part of successful investment options. This period also saw the top IPOs in the Indian markets like LIC, PayTM, and Zomato. However, do investors get a chance to invest in companies that are not listed? Investing in such companies is a huge market for institutional investors and HNIs and this option is also available for retail investors. Here are the details of how and when you can invest in Unlisted/Pre-IPO stocks.
Unlisted shares are shares of a company that are not traded on a stock exchange. These shares are often owned by the company’s founders, early investors, and employees. Unlisted shares are typically bought and sold in private transactions between investors.
Pre-IPO shares, on the other hand, are shares of a company that will soon become publicly traded through an Initial Public Offering (IPO). These shares are often sold to institutional investors or High Net Worth Individuals (HNIs) before the IPO. The idea is that investors can buy shares at a lower price before the company goes public, and then potentially sell those shares for a higher price once the company’s stock is publicly traded.
Buying unlisted or Pre-IPO (Initial Public Offering) shares can potentially offer higher returns compared to buying shares in a company that has already gone public. However, investing in unlisted or Pre-IPO shares can also be riskier due to the lack of transparency and regulatory oversight. Some of the factors to be considered while investing in Pre-IPO or unlisted shares are discussed hereunder.
1. Company performance
The first step for investment in any company is thoroughly researching the same before considering investing in it. This requires analysing the company’s financial statements to see how much revenue it’s generating, how profitable it is, and what its cash flow situation looks like. Furthermore, investors are required to research the company’s management team and see if they have a track record of success along with the industry the company operates in and see if it has growth potential.
The valuation of a company is the price that investors are willing to pay for the company’s stock. A company’s valuation can be affected by many factors, such as revenue growth, profitability, and industry trends. Investors should primarily research the company’s valuation to see if it’s overvalued or undervalued. An undervalued company may be a good investment opportunity because its stock price may be lower than what it’s really worth.
3. Investment timeline
Unlisted shares and Pre-IPO shares are typically illiquid investments, which means they cannot be easily bought or sold. Therefore, investors should have a long-term investment horizon and be willing to hold the shares for a while. This is because it may take time for the company to go public or for the shares to become tradable. Investors should also consider their personal financial situation and make sure they’re not investing money they may need in the short term.
4. Lock-in period
Pre-IPO shares are often subject to a lock-up period, which means the shares cannot be sold for a certain period of time after the IPO. This can range from a few months to a few years. Investors should understand the lock-up period and how it may affect their investment strategy. For example, if investors need the money from their investment in the short term, then investing in pre-IPO shares with a long lock-up period may not be suitable for them.
5. Risk tolerance
Investing in unlisted or Pre-IPO shares can be risky due to the lack of transparency and regulatory oversight. Investors should understand their risk tolerance and be comfortable with the potential risks before investing. For example, if investors are risk-averse, then investing in unlisted or Pre-IPO shares may not be suitable for them. It’s important to diversify the portfolio and not invest all the money in a single company, as this can increase the overall risk significantly.
Here are some of the ways in which you can invest in unlisted or Pre-IPO shares
Through Angel Investing
Angel investing is when you invest in early-stage startups in exchange for equity in the company. Angel investing is typically done by High Net Worth Individuals (HNIs) who are looking for high-risk, high-return investments. To invest in angel rounds, investors can join angel investing networks or platforms that connect them with startups. When investing in angel rounds, it’s important to do sufficient research and understand the risks associated with investing in early-stage companies.
Through Venture Capital Funds
Venture capital firms invest in startups and early-stage companies. These firms typically raise money from institutional investors, such as pension funds and endowments. Investors can invest in venture capital funds that focus on investing in unlisted or Pre-IPO shares. However, it is important to keep in mind that venture capital funds typically have high minimum investment amounts and long lock-up periods.
Unlisted shares can be bought in Demat account and it is an off-market transaction (not on the exchange) between the buyer and seller. Hence it is very important to deal with reputed/trustworthy intermediaries to avoid any counter-party risk.
ESOPs (Employee Stock Option Plans)
ESOPs are a popular way for startups and other unlisted companies to incentivize and reward their employees. Employees are granted the option to purchase shares of the company at a future date and at a predetermined price. As an outside investor, one may be able to purchase these shares from employees who have exercised their options and are looking to sell their shares. To do this, investors will need to identify employees who have shares and are looking to sell them and negotiate a suitable price.
Directly from Promoters
Another way to purchase unlisted shares is to buy them directly from the promoters or founders of the company. This typically involves negotiating with the promoters or their representatives to agree on the terms of the purchase, including the price per share, the number of shares to be purchased, and any other conditions or requirements. This can be a more difficult process than purchasing shares from ESOPs, as promoters may be less willing to sell their shares and may have a higher valuation for the company.
Pre-IPO companies and unlisted shares make a very attractive investment option for investors as the growth potential and the return potential is quite high in such companies. However, such investment needs to be backed by detailed research of the companies to ensure the safety of the capital investment. Many investors shy away from investing in unlisted shares or pre-IPO companies as there is limited transparency and a lack of proper channels for necessary disclosures.
Taxation of investment in unlisted shares and Pre-IPO companies is not similar to that of listed equity shares. Short-term gains for any sale of such investments held for a period of less than 2 years is taxable as per the applicable slab rates of the investor. On the other hand, long-term gains from the sale of such investments is when the asset is held for a period of more than 2 years and is taxed at a rate of 20% after the benefit of indexation.
As per SEBI, the lock-in period for investment in unlisted shares or Pre-IPO companies is 6 months.
Some of the top advantages of investing in unlisted shares and Pre-IPO companies is the potential for higher returns, lower regulations, a chance for strategic partnership, diversification of portfolio, etc.
Some of the top disadvantages of investing in unlisted shares and Pre-IPO companies include the high risk of investment, uncertainty of investment and valuation, lack of adequate information, etc.