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Can we buy unlisted shares?

The question is very simple and the answer to this is more simple, just a word, Yes. However, not everything is so streamlined into the process that you can buy pre-IPO equity just like fruits and vegetables on the street.

For any company, equity share capital is one of the best ways to raise funds that can be used for scaling, growth, and development. When a company lists itself on the stock exchange, it becomes a publicly traded company.

The equity shares of the company get listed on the BSE and/or NSE, where they are freely tradable across retail and institutional investors. If you invest in the shares of a listed company, you purchase those listed shares.

But what about the companies, which were not listed? Actually, the other category of the companies also offers share capital to the investors, which are known as unlisted shares.

The other name for unlisted shares is pre-IPO equity as they are issued by the company to investors before their IPO. For Example, investors can buy unlisted shares of Reliance Retail, OYO, Paytm (One97 communications) among others.

Since unlisted shares are not listed or traded on any of the stock exchanges, investors would have to invest in these shares through other non-conventional modes such as dealers and brokers dealing in such equities.

There are different ways in which you can buy unlisted shares of a company. However, before we delve into the ways of buying unlisted shares, let’s understand the different aspects of investing in them.

Why do unlisted shares attract investors?
The companies issue shares to investors during the early stage, especially when it is growing. Companies, with innovative ideas and new technology, generate revenue and can grow up to become established players.

For example, Paytm is the key payment gateway and fintech player, whereas Ola is a cab aggregator platform. Both of the startups have brought a huge change in people’s life, revolutionizing the big-time change.

Those investors, who wish to become a part of such companies at an early stage, head to an unlisted market. However, not all the companies are available in the unlisted market and not everyone can buy these shares.

Another big reason for investing in unlisted shares of a company is that a few of them are backed by strong parentage or are a part of a big conglomerate. For example, Reliance Retail is a part of Reliance Industries and HDB Financial Services is an arm of the HDFC group.

If investors believe that such subsidiaries will be a big success like their parents and expect them to post strong returns in the future, they invest in such unlisted shares. Investing in innovative and new businesses that have a lot of potentials, investors choose to invest in unlisted shares.

Must know things about unlisted shares
Unlisted shares in India are not very different from the listed shares but investing in them requires a lot of homework. Here are a few keynotes before taking a step ahead:

The process of investment: While buying listed shares includes a quick purchase through the Demat account within trading hours, investing in unlisted shares is a tad bit difficult. It takes some time and you might not be able to buy an unlisted share instantly.

The payment: The payment needs to be done from the bank account of the Demat account holder. It is a mandatory step to eliminate the chances of money laundering and other illegitimate activities.

Paper Work: Various companies require a lot of paperwork to allot your shares and despite completion of documentation, allotment of shares is not a guarantee. Shares of the National Stock Exchange (NSE) are one such big example.

Size of Investment: Unlike listed markets, investors can not buy a small number of unlisted shares. There is a minimum ticket size for every share. However, the retail ticket size is not very big but it is big enough to justify the transaction cost.

Who owns the shares?
More often than not, unlisted shares are owned by employees of the companies, angel investors, venture capitalists or startups and intermediaries. They offload their stake in the open market to liquidate their positions, which requires an unconventional mode or market for such shares.

Liquidity: Finding buyers for unlisted shares is comparatively difficult as there are liquidity issues. However,  the recent interest in such stocks has made them easily tradable.

Risk Element: Unlisted shares are riskier compared to listed shares. This is primarily because the shares belong to companies that are in their growth stages. Such companies might suffer considerable losses in a bad phase making unlisted shares risky.

Valuation of the shares: Since the shares are not listed on the stock exchange, there is no fair price mechanism. The value is completely determined by the demand and supply of the shares. Such a value might not be very reliable and so, it might prove to be risky.

Transparency: There is limited or no transparency in the company’s financial position that offers unlisted shares. Thus extra efforts are needed.

How to buy unlisted shares?
Let’s delve back into the different ways in which you can buy unlisted shares, which can be either of the following:

Through dealers or start-ups: Specialized start-ups have been created to offer investments into unlisted shares. You can buy unlisted shares through these start-ups by opening a Demat account with them.

Usually, a minimum investment of Rs.50, 000 is needed to invest in the unlisted share of each company. You have to make the investment upfront but the delivery of the shares is done on the basis of T+3, that is, after three days of payment.

You have to transfer the amount for buying the shares but the delivery of the same is not guaranteed on the spot. It may be earlier than three days as well.

Since the delivery is done after a few days, there is a counterparty risk involved in buying unlisted shares through this mode. However, not everyone in the industry is a fraudster. Many of them are very helpful names.

From the employees of the company: Start-ups, when hiring employees, usually offer Employee Stock Ownership Plans (ESOPs). This allows employees to have equity ownership in the company that they join. ESOPs allow employees to buy shares of the company at a pre-determined price and after a predefined time.

So, if the employees want to offer their unlisted shares for sale, you can buy the shares from them. To buy shares from them, you contact the broker. Your broker knows which unlisted shares come up for sale and can help you buy the shares from employees offering their stake for sale.

 From the promoters of the company: Many times the promoters place their stake in the company for sale. This is done through a process called Private Placement and the unlisted shares are placed with banks and wealth managers.

You can, then, invest in unlisted shares through Private Placements done by the company’s promoters. However, the price for such placement is very high and you need a heavy amount to invest.

By investing in AIF: If you are a large investor, looking to invest a considerable amount of money in PMS (Portfolio Management Services) or AIF (Alternative Investment Funds), you can get unlisted shares.

Financial institutions that manage a PMS or AIF scheme usually invest in unlisted shares. These institutions bank on the pre IPO share valuation to earn returns when the company lists itself and launches its IPO.

Since the pre-IPO valuation is lower, PMS and AIF funds get a large number of shares and generate profits when the valuation rises due to a subsequent IPO.

PMS and AIF are niche investment categories for HNIs, NRIs, and foreign investors since they involve a considerable amount of funds. This mode is suitable for you only if you are a large investor and don’t mind taking the risk.

Furthermore, though fund managers bank upon the increase in the valuation of shares after the IPO is launched, their call is not always spot on. The same risk lied with other active mutual funds as well.

In some cases, the company’s valuation might suffer after it becomes a publicly listed company and the unlisted shares prices might fall causing losses. So, keep the risks in mind when considering PMS and AIF and investing a large chunk of money in unlisted shares.

Crowdfunding platforms: There are various crowdfunding platforms that allow you to invest in the equity capital of unlisted companies. One can become an angel investor, invest in angel funds and buy unlisted shares of companies registered on such platforms.

When you invest in the business through crowdfunding, you are helping the business venture startup. It involves a considerable risk if the venture fails or is not able to establish itself.

Mistakes to avoid
Whether listed or unlisted market, if you are not careful, you might end up making losses due to some horrible mistakes. vSuch mistakes would be costly as you might block your capital, incur opportunity costs and even incur a loss if the shares are devalued.

* Do not follow the herd mentality. Do your homework and research well about the company before investing.

* If you are getting shares at very low rates, do not jump at the chance. There might be a reason for existing investors taking an exit at lower prices.

* Price fluctuations of unlisted shares are considerably high. In case of major fluctuations, assess the fair value of the share based on the company’s prospects.

* Do not invest in unlisted shares with a short-term investment horizon. Remember, unlisted shares prove their mettle with time when the company grows and establishes itself in the market. Have patience and a long-term perspective.

* Do not invest in unlisted shares without a trusted advisor to guide you. If you need advisory services you can get in touch with many of the reputed names which will help you to reap high returns.

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