When we talk about investment in stocks we often consider only listed stocks that are easily available in the stock markets and investment can be done within minutes through the Demat account. The information on these stocks is easily available hence, an investment decision relating to them is quite easy as compared to investing in unlisted securities. So how do you decide if investing in unlisted security is a good investment decision? Given below are the points that need to be considered for the same.
What are unlisted securities in India?
Let us begin with the basic meaning of unlisted securities. Unlisted securities are usually stocks of companies that are not listed on any recognized stock exchange. These securities are can be equity shares, corporate bonds, government securities, or penny stocks as well as derivative options like SWAPs, forward contracts, etc.
Investment in these securities is not done through the normal route i.e. through the open market. Investors can pick up unlisted stocks by purchasing a stake in upcoming and potentially pathbreaking startups, by purchasing promoter shares through a private placement, or through ESOPs. These companies have the backing of strong financials and unique market positions that prompt the investors to be part of their growth and earn maximum profitability along the way.
What are the factors to consider while investing in unlisted securities?
Investing in unlisted securities is an opportunity for investors to be part of the pre-IPO success and also make maximum returns from their investment. The key points to be considered while investing in unlisted securities are highlighted below.
Aim for industries or sectors that have a futuristic approach
Investors should ideally aim for companies that have a futuristic business model and is at a very budding stage. These are often concept-driven or product-driven companies that are set to have great growth potential in the near future. Companies like OYO, OLA, Navi, Swiggy, etc are considered to be companies with a good business model as well as a futuristic assessment of consumer behavior. Such sectors and companies are considered to be good investment opportunities that should be taken at the right chance.
Analyze the business of the company
For investment in any company, focusing on its business model and the industry that the company belongs to is primary. Investors should therefore check for the latest developments in the sector and the position of the company in the market. This will also help in understanding the growth trajectory of the business as well as that of its closest competition.
Analyze the financials and the growth potential
Investment in listed or unlisted securities warrants a thorough review of the company’s past performance. The company needs to have sound revenue sources and free cash flows to ascertain if investment in the company can be a profitable option. It is also important to evaluate the debt levels of the company at this stage and ascertain if they are not detrimental to the interests of the company. The growth potential of these companies is quite high and has the ability to provide exponential returns to investors.
It is presumed that only shares that are listed on the stock exchange are liquid. However, unlisted securities are also liquid if the demand for the stock is high. Therefore, it is important to invest in companies that may not be listed but have created a huge buzz and have been in demand from many investors. This will assure the potential investors have a good chance of turning their investment profitable.
Analyze the management team
The management team of the company is the driver that ensures the company is profitable. However, if the management team is not efficient, they can turn a profitable company to dust too. Therefore, analysing the management team is crucial and it involves ascertaining their qualifications and capabilities as well as the companies that they have been part of.
Ascertain risks involved on the investment
The risk of investing in an unlisted company is the highest. There is a high chance of the investment not yielding desired returns or the risk becoming quite higher than estimated. These parameters have to be evaluated before taking a plunge into the company by taking the help of professional analysts that have the necessary tools to understand every aspect of the company and read between the lines for information that is not public.
What are the prime risks of investing in unlisted securities?
Risks are part of any investment option, however, when it comes to unlisted securities, the risk is tenfold. The prime risks while investing in unlisted securities are mentioned below.
Most investors invest in pre-IPO companies with the hope to make huge profits. However, if the company does not get listed or the process gets delayed, investors do not get their returns in due time. The lack of enough liquidity is therefore one of the biggest risks faced by investors when dealing with unlisted securities.
One of the many benefits of investing in listed companies is the abundance of data that is public information. This data helps in the effective assessment of the company and its financials to determine if investing decision is optimal. Unlisted securities do not have this benefit and therefore, investors may fall prey to risks of undisclosed information. The promoters and large stakeholders are not obliged to provide the business plan or other financial data to small investors. Therefore, there is a high possibility of the loss of interest of minority shareholders.
The valuation of any company is based on its financials and it is quite possible that the valuation of an unlisted company can be incorrect or misleading to attract investors. Therefore, to have the correct valuation of an unlisted company and thereby its shares often becomes a challenge for potential investors. An investment based on incorrect valuation will not provide desired returns and thereby not serve the ultimate purpose of investing in unlisted securities. Hence, determining the right valuation for the unlisted company may require many rounds of negotiations between the promoters and the potential investors.
Investment in unlisted securities can be a good diversifying option for investors who already are invested in listed stocks, mutual funds, etc. These investment options may be riskier upfront but the return potential that they have outweighs these risks. However, in a bid to gain better returns, investment in unlisted securities should not be outside the overall portfolio risk.
An unlisted security held for a period of more than 2 years is classified as a long-term asset and gains from the same are taxed at the flare rate of 20% after indexation. Short-term gains, on the other hand, are taxed as per the applicable tax slabs for the individual.
An investor can ensure the liquidity of their asset by investing in unlisted securities of a company that is quite popular, has strong financials, and is seeing good demand for its shares from other potential investors too.
In theory, like any other valuable asset, unlisted securities can also be used as collateral against loans. However, the lender will have the financial say if such unlisted securities are enough collateral against the proposed loan or if they can be accepted.
The top sources of acquiring unlisted securities are through the employees having stock of such a company, through its promoters, or by investing in certain value startups