The world looks far different for a set of new-age companies listed in recent times. The excitement over many like Paytm and Nykaa seems to be over. While broader markets may have done well, many stocks have witnessed pronounced selling for specific reasons. New-age stocks were witness to offloading of shares post the expiry of lock-in period for many pre-IPO investors.

For many, the reason to sell was out of compulsion, for VC funds who have to show exits to their investors. Softbank sold Paytm shares worth ₹1,631 crore; Lighthouse sold shares of Nykaa exceeding ₹800 crore. Angel investors who got into these companies at a very early stage and have a meagre acquisition cost have sold out of choice, as even after the drop in prices, they are making good profits. As the bulk deals data suggested, some employees monetised their ESOPs.

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Don’t ignore risks

However, another aspect is the individual investors who invested in these companies at just pre- IPO stage. 2021 was the year when suddenly investing in unlisted companies at pre-IPO stage became a thing in vogue for investors who wanted to invest in shares of companies that are likely to go for IPO shortly. That frenzy did two things: it created an unjustified demand for the shares without proper due diligence. Secondly, it made investors ignore the risks of investing in unlisted shares at the pre-IPO stage.

Driven by euphoria to invest in unlisted companies, many investors have bought shares at unreasonable prices. At one time, Paytm was being bought at more than ₹2,500 per share in the private markets. PharmEasy (that goes by its company name API Holdings) also had no sellers. Today, there are few takers for PharmEasy in over-the-counter deals in private markets. The company has postponed its IPO plans and recently raised debt financing.

Liquidity a key aspect

Investing in equities is about risk awareness and risk management. Furthermore, investing in unlisted shares is more fraught with risks. The most significant risk in unlisted shares is liquidity risk. Since the fortunes largely depend on a specific liquidity event called IPO, there is no assurance that one can liquidate these investments at will. SEBI has mandated a lock-in of six months for the pre-IPO investors post-IPO, which also works as a deterrent in selling. Any change by the companies of their listing plans according to market conditions would impact liquidity timelines for an investor investing at the pre-IPO stage.

Another considerable risk of investing in unlisted shares is related to the quality of information available. Till the pre-IPO stage, the unlisted companies are primarily owned by a close-knit group of founders, angel investors, and VCs, where access to quality information for individual investors is simply not there. Hence, investors rely on either their broker’s inputs or the internet. Both are not greatly helpful in making a prudently informed investment decision.

Unlisted equity opportunities

As with any investment, there are distinct advantages to investing in unlisted companies. Unlisted shares at the pre-IPO stage allow HNIs to participate in companies from sunrise sectors at the early stage, usually unavailable in the listed markets. Some examples could be SpaceTech companies, DNA sequencing, battery alternatives to lithium, or artificial intelligence. This way, the investors can diversify their portfolios into themes & sectors that are non-existent in the listed space.

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The bottom line, when it comes to investing in an unlisted company at the pre-IPO stage, is that some unusual risks and rewards are involved. Hence, rather than chasing the opportunities during times of euphoria, one can use times like the current one to cherry-pick opportunities in unlisted space that are available at an attractive valuation. Proper risk management by keeping a cap on exposure, enhanced due diligence, and an advisor’s input will make all the difference to an investor’s investments in unlisted shares.

The author is Director and Founder, Valtrust Capital