How to Buy Unlisted Shares of Pre IPO Companies?

As an investor, you might be familiar with purchasing the shares of companies listed or about to be listed on a stock exchange. However, did you know that you can buy unlisted shares as well? Yes, you read that right. There are multiple ways through which you can gain exposure to companies that haven’t yet been listed on an exchange. Here’s a comprehensive look at what you need to do to buy unlisted stocks.

What are Unlisted Shares?

Unlisted shares are shares of companies that haven’t yet been listed on a stock exchange. Since they’re not present on any stock exchange, you can only purchase them over-the-counter (OTC). Unlisted companies are generally new or small entities that are yet to become financially stable.

Types of Unlisted Instruments

Before we learn ‘how to buy unlisted shares’, you must know that stocks of companies aren’t the only unlisted financial instruments available in India. There are a few other instruments as well that are typically not listed on stock exchanges. They are:

• Corporate Bonds:

  They are a type of debt security issued by companies to raise funds from investors, unlike shares that give investors ownership. Corporate bonds are a company’s commitment to return the investor’s money and also pay some interest after a certain time period. Although such bonds are not traded on the stock exchange, they can be sold over the counter (OTC) through dealers.

• Government Securities:

  These are like corporate bonds except that they are issued by government entities. The Government of India guarantees these securities such as treasury bills, government bonds, and savings bonds. They carry very low risk. OTC trading is possible as they are not listed on any exchanges.

• Swaps and Other Derivative Instruments:

  Swaps refer to contracts between two parties whose value depends on an underlying asset or group of assets. This results in cash flow being exchanged among participants based on predetermined terms. Some examples include currency swaps, commodity swaps among others as well as interest rate swaps.

Read Also: Top 10 IPO Investment Tips and Strategies

Investing in Unlisted Indian Shares

If you’re planning to buy unlisted shares, here’s a quick overview of the different ways through which you can purchase them.

• From Employees

  Many companies issue ESOPs (Employee Stock Option Plans) to their employees to reward their contribution and loyalty. You can approach the employees of companies who have been in receipt of ESOPs and purchase the shares directly from them through an off-market transfer.

• From Promoters

  Alternatively, you can also directly buy unlisted shares from the promoters of the company. However, this method might work only if you’re willing to take up a significant stake in the unlisted company.

• From Startups

  Many Indian startups in a bid to raise funds are willing to offer their shares to investors. You can approach such startups to purchase their shares. However, there’s usually a minimum investment amount that you need to meet to be able to buy their shares.

• From Intermediaries

  Pre-IPO companies are entities that have filed their Draft Red Herring Prospectus (DRHP) with the SEBI with the intent to go public in the future. Such companies generally have high-growth potential and investing in them before their IPO debut can help you create wealth. There are several intermediaries that you can get in touch with to buy the unlisted shares of such pre-IPO companies.

Invest in PMS and AIF Schemes with Exposure to Unlisted Companies

Portfolio Management Services (PMS) are provided by full-service stockbrokers. PMS allows you to customize your investment portfolio according to your financial goals. By subscribing to such services, you can buy unlisted stocks of companies including those that are in the pre-IPO stage. However, most stockbrokers offer PMS services only to high-net-worth individuals and have a minimum investment limit that you need to meet.

Alternative Investment Funds (AIFs), on the other hand, are private mutual funds that invest in alternative investments such as distressed assets, unlisted stocks, commodities, and real estate investment trusts (REITs), among others. You can gain exposure to pre-IPO entities by investing in AIFs that buy unlisted shares.

Risks of Investing in Unlisted Companies

Now that you know about the different ways to buy unlisted shares in India, let us look at some risks associated with this type of investment.

• Liquidity Concerns:

  Unlisted shares often raise illiquidity concerns as there is no dedicated platform where investors can buy and sell them. This means that you either have to wait until the end of the holding period to sell your stocks or after the company issues an IPO, whichever happens earlier.

• Inaccurate Pricing:

  Since there is no organised marketplace for trading in unlisted shares, some brokers may overstate their investment value in order to earn higher commissions. The substantial difference between prices and fair value impairs overall company valuation. Hence, it becomes difficult to make financial decisions based on it.

• Lacks Transparency:

  Unlisted companies are not mandated to make a public disclosure about their annual or quarterly financial reports, unlike listed companies. Even major corporate announcements are not shared with investors.

• Increased Risk:

  Unlisted firms and their equities are not regulated by the Securities and Exchange Board of India (SEBI). This lack of regulatory agency makes dealing in unlisted shares susceptible to various risks. It increases the chances of the dealer misleading investors about the price or even failing to deliver the stock.

• Minimum Regulation:

  There is minimal regulation involved in unlisted share transactions. Only a few aspects of transactions including stamp duty and DP charges are controlled. This makes it more likely for frauds and other material misstatements that arise out of a lack of accountability to occur.

How to Invest in Unlisted Shares

Since they’re not available on stock exchanges, you may not be able to buy unlisted shares online. Instead, you will have to either get in touch with the unlisted company, its promoters, its employees, or an intermediary to purchase such shares.

If the shares of such companies are maintained in the physical form, you will be provided with physical share certificates bearing your name. Alternatively, if the unlisted shares are in the dematerialized form, they will be transferred to your demat account.

Things to Consider

There are a few factors that you need to keep in mind before you buy unlisted shares. Let’s take a look at some of the most important ones.

• Industry

  Consider investing in unlisted companies that are a part of futuristic and nascent industries like solar energy or drone manufacturing. Since the industry itself is new, the competition would be low and the growth prospects will likely be high. Entities operating under such industries are often featured in lists of the best unlisted shares to buy.

• Existing Investor Base

  Before you buy unlisted stocks, remember to always look into the existing investor base. Companies that are backed up by well-known angel investors, experienced promoters, or successful entrepreneurs are likely to perform much better in the long run.

• Liquidity

  It is important to assess the demand for an unlisted company’s stock in the market before you invest in it. The level of demand should give you a fair idea of whether the investment is worthwhile or not.

• Financial Performance

  If possible, always examine the financials of the unlisted company before investing. In the case of pre-IPO companies, you could read through their DRHP to get details of their financial performance. In the case of other companies, however, request for a copy of its audited financial statements.

• Taxation

  Another major factor you need to consider is capital gains tax. Selling unlisted shares over the counter will also attract long-term or short-term capital gains tax depending on your holding tenure.

Read Also: Things To Watch Out For Before Buying an IPO

Conclusion

Although unlisted companies are riskier than listed entities, they do have their own set of advantages. Firstly, you get to participate in the wealth creation process early on. And secondly, you can get access to undervalued stocks. However, before you proceed to buy unlisted shares, remember to consider your financial goals and risk profile.

Speaking of unlisted stocks, you might need a Demat account to invest in them, especially if the shares are in the dematerialized form. m.Stock offers a robust trading and Demat account without any platform fee and zero AMC for life. Additionally, if you’re trading via the stock exchanges, you get no brokerage trades across all investment options as well.