Ola, Flipkart, PhonePe, Delhivery, Byjus are all market giants, be it in terms of valuations, the number of services and products offered, or their reach in the market. But unlike the bigwigs like Tata, HDFC, and Reliance, these firms are not listed on stock exchanges.
However, this doesn’t change the fact that they are growing, does it? In fact, some of them are growing far more vigorously compared to their listed peers. Ahh! If only we could invest in these startups!
Well, investing in unlisted companies is a not-so-simple yet straightforward task to perform. All you need is to have an eye for detail when you route towards such options. No, no, it’s not as hard as you think. Let us interpret the mystery of investing in unlisted shares for you.
So, if you are an investor who wishes to be a part of a startup’s growth story since its very beginning, this blog is a must for you.
Methods of investing in Unlisted Shares
Most of us are unaware of the various methods to invest in unlisted companies. However, each of those methods comes with its own attributes and cautions. Sneaky bizz, much? Let’s look into them and find out for ourselves!
Under this method, investors and traders buy and sell shares of companies before they get listed on stock exchanges. Thus, making the fact of illiquidity, reduced security in transactions, and less regulatory compliance becomes imminent.
You can buy the unlisted shares through several intermediaries like investment firms, which offer you a platform to facilitate the trade of unlisted shares. Under this method, the shares offered to you are bought from employees through Employee Stock Options (ESOPs).
Now, if these shares get listed anytime, and you see the price soaring, you might try to book profits. But there is the catch in this scenario! You are not allowed to sell these shares before 6 months from the date of listing as per the Indian Pre-IPO market investment regulations.
Another thing that you can do is to approach a broker or a wealth manager, or even an investment bank that can help you with the price discovery and valuation of an unlisted company. Along with this, they can even help you connect with the promoters of the company. You can then buy a portion of shares that they hold at that point. This method of buying shares from the promoters is known as private placements.
Investments in unlisted shares can also be made through Portfolio Management Systems (PMS). These are tailor-made portfolios of shares that can help you diversify the risk by altering the weights of different securities in a portfolio as per the prevailing sentiments of the market.
In addition to this, investors can channel their money towards unlisted shares by investing via Alternative Investment Funds (AIFs). Don’t complicate your brain. AIFs are nothing but a pooled investment vehicle that raises money from High Net-Worth individuals (HNIs) and giant institutional investors. The minimum investment amount for the PMS is ₹ 50 lakhs, and the same for AIF is ₹1 crore.
This method works the same way as mutual funds do. A plethora of funds are offered by several wealth management companies like Edelweiss Wealth Management and Trifecta Capital which invest 100% in the currently listed companies and upcoming IPOs as well. This is a good option for those retail investors who don’t have a lot of money but still want to invest in growth-oriented unlisted companies.
Risks factors of investing in Unlisted Shares
An investment in unlisted shares comes with significant risks like:
In the absence of frequently transacting individuals and the heavy minimum investment amounts, the shares cannot be bought or sold when you want them to. This invests in unlisted shares highly illiquid.
An investment in unlisted shares also carries the risk of losing the capital as these firms are not well regulated, and therefore can willfully get engaged in malpractices, which on scrutinizing, can make the clouds rain on them and wipe out all of your capital invested.
In regulated markets, investors are paid out dividends if they hold shares of the company before the Record date and on the Ex-dividend date. Still, surprisingly there is no such concept of delivering dividends in a structured manner in the unlisted companies. Therefore, they might very well choose not to pay you the dividends at all. Oops-a-daisy!
If you are holding shares of an unlisted company thinking that there will be a surge in price after it gets listed, and unfortunately, things go awry, and the share price goes on falling. Will you be able to exit the investment?
Absolutely not! According to the previously discussed fact, you have to hold the shares for the next 6 months as per the regulatory norms. So yeah, flex your flux!
Short Term Capital Gains: If the shares of an unlisted company are sold within 24 months, the gains from such an investment are taxed as per the norms of short-term capital gains. The gains under this are added to your income, and then you are taxed collectively in accordance with the tax slab you fall under.
Long Term Capital Gains: If the shares of an unlisted company are sold after 24 months, then the gains from such an investment will be taxed at 20% after the indexation benefit. The purchase price of shares under this is adjusted by effect from the rate of inflation on it.
Although, if the price of unlisted shares goes below the Fair Market Value (FMV), a concept homely to the unlisted companies, the price considered for taxation will not be its trading price. It would rather be its Fair Market Value calculated by an authorized investment bank.
If you were holding 50 shares out of the total 100 shares of a company, you are said to hold 50% of the company, but what if the company wants to raise more money by issuing 50 more shares! The issuance of 50 more shares makes the total number of shares change to 150, and since we are of consideration that you haven’t subscribed to these shares, your percentage of ownership slips down to 33.33% from the previously calculated 50%. Good lord!
Therefore, you can think of the risk of dilution as the risk arising out of an issue of additional stocks in the market.
You might think that investing in these companies brings a lot of risk to the table like exposure to high volatility, little or no platform to facilitate price discovery, illiquidity, and lock-in periods. But why not perceive it as an adventurous grind and an attempt to learn? You might as well not lose your money and get to be a part of their success stories!
But beware, because the risk cannot be mitigated. You have no option to hedge your positions other than by entering into a few types of derivatives contracts, which might again lie out of the range of regulated markets. Therefore, it won’t be wrong if investments in unlisted shares can be referred to as a double-edged sword.
Anyway, if given an option, which startup(s) would you invest in? Tell us in the comments below.