Personal Finance

Should you go for pre-IPO investing?

Aditya Kondawar | Updated on March 20, 2021

You can buy companies at an earlier stage and at a cheaper valuation, but be aware of the risks involved

With IPO subscriptions going through the roof and the pricing in IPOs expensive in many cases, investors have an option to participate early by investing in companies through the pre-IPO market or the unlisted market. This market, in which HNIs and even retail investors have started investing, helps invest in companies that are unlisted and are expected to go for an IPO in the mid to long term.

According to Unlisted Zone (amongst top 10 unlisted share brokers), their gross transaction value in the unlisted market has gone up from ₹2.1 crore in 2018-19 to ₹19.1 crore in 2019-20. In FY21 (so far), it has been more than ₹40 crore. Also, the number of transactions earlier were 5-10 per day compared to 20 per day now.

How it works

A typical deal in the unlisted market starts with a buyer (with a demat account) getting connected to an unlisted shares dealer. The price and brokerage is agreed upon. The buyer sends money to the seller after which the share transfer is done along with a transaction proof exchange. By T+0 evening or T+1 morning, the transaction is completed with unlisted shares reflecting as ISIN numbers in the demat account of the buyer.

There are no set rules on what is the minimum and maximum investment limit under the pre-IPO investing. It usually depends on the broker you are interacting with. Earlier, the minimum size for pre-IPO deals used to be a few lakh of rupees. But with the ecosystem gaining more depth, i.e., more brokers, more buyers, more ESOP sellers, more research and start-up investing gaining traction, one can start transacting with as little as ₹25,000.

The benefit of a pre-IPO deal is that you buy the companies at an earlier stage and at a cheaper valuation, if available, compared to buying as a normal investor at the IPO. If you can identify opportunities before the market at large does, it can translate to much greater gain when the company goes for an IPO and lists its shares.

Beware the risks

Pre-IPO investing certainly does look interesting but before pushing the pedal on this instrument, understand that it involves high risk.

First, the pre-IPO market is illiquid. You may not be able to sell your shares when you want as there may not be any buyer in the market. The liquidity is low because it is a niche segment that trades over the counter and not through an exchange.

Second, the risk of IPO timeline. The IPO of the unlisted company you invested in can get delayed due to market conditions. Also, it is better to check if the management has provided any guidance on their IPO plans.

Next is the valuation at which the unlisted shares are being bought. Unless, a comprehensive valuation check with listed peers is done, you may end up buying at high valuations.

Further, there is the risk of being charged higher transaction costs by the broker you are dealing with. Investors should note that they can pay maximum 1-2 per cent premium on the cost price as brokerage. So, check prices with a few other dealers and compare before you enter a transaction.

Note that pre-IPO investing comes with a one year lock-in once the company’s shares get listed. So, one may miss the listing gains if the company makes a successful debut on the markets.

Also, if the fundamentals of the company changes and that warrants selling the stock, you may not be able to do so until one year.

Finally, one has to be cautious of frauds. Last year, a Bangalore-based prominent wealth management firm’s founder was arrested for a pre-IPO investing fraud. They took the money for the shares but never delivered the shares. Always deal with a trusted broker with a good track record.

Note that since there is no ombudsman or appointed entity for redressal, the only legal option left is to file a police complaint against the individual or directors of the company.

Taking into consideration all of the above, it becomes apparent that only investors with mid to high risk appetite should take a look at this instrument.

The writer is COO at JST Investments

Published on March 20, 2021

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