IPO stands for Initial Public Offering of the stock. Pre IPO companies are the ones who are going to get listed on the stock exchange in a short span. These companies have established business models, revenues, and profits ( There are some exceptions too.). People wait for the company to get listed on the stock market, to invest in, but here in this article, we will go through the ways to invest in the company even before they get listed on the exchange, the benefits of investing in unlisted companies and also the disadvantages of it.
Even many experts believe investing in unlisted companies can reward you with very high profits but such investments are only for those who have a high-risk appetite, high level of patience, and can even bear a loss. One should invest in the company before the IPO which has a high growth rate or can have high demand when it gets listed on the exchange. In current times there is a high level of subscription for every IPO and allotment is like a lottery. People are making up to 100% of returns on the day of listing. One of the major advantages of investing in the unlisted company is the volatility of prices of the shares, volatility of the price is lesser than the listed companies.
What are Pre-IPO shares?
Pre-IPO shares are the shares of a company that is not listed on the stock market but their shares are traded between the promoters and the investors or institutions.
How to buy Pre-IPO Stock?
According to earlier rules, only large institutions and funds were allowed to invest in unlisted companies but currently, even individual retail investors like us can invest in such companies.
Now we will go through some of the ways in which one can buy unlisted company shares.
- Pre IPO Funds: This type of fund invests in startups and unlisted companies. These types of funds are only suitable for wealthy investors. IIFL AMC introduced such funds which invest in such companies.
- Buying shares from the broker: This whole process is based on the intermediaries which make the trades possible. They buy the shares from the existing investors and the existing employees (ESOPs) and sell them to the investors who are interested to invest in the company.
One can get the shares in his/her Demat account. But the transaction is made as an off-market transaction. One should only deal with the reputed broker. This payment has to be done upfront and delivery of shares takes T+3 days and this whole process is on the basis of trust you have on the broker or intermediary.
- Buying from the employees: One can directly buy the shares of the company from the employees having ESOPs. The process is the same as buying shares from the brokers but there will be no intermediary or broker, you will directly buy from the seller.
Advantages of investing in Pre-IPO stock:
- Possibility of exponential gains: In current times as mentioned above there is a high amount of gains made when any company gets listed on the stock market.
For e.g. We will go through one of the examples of it. Info Edge invested Rs 4.7 crores in Zomato back in 2010 and in 202, Zomato got listed on the stock exchange and their stake is valued at around Rs 15000 crores, around 1050 times returns were achieved on the investment. Though this is an extreme scenario because they invested in the early days of Zomato
- Diversification: This is one of the ways to diversify investments into different assets.
- Negotiation: Negotiation of the share price is possible because there are fewer buyers as well as fewer sellers.
Now let us go through some of the drawbacks of investing in unlisted or Pre-IPO companies.
Disadvantages of investing in Pre-IPO stock:
- Low Liquidity: We mentioned less volatility of price as one of the advantages, it comes with a drawback of liquidity. One can’t sell off his/her share easily like any listed company.
- Less Information: Less information is available of the company. One should only invest in such companies after doing proper research and analysis.
- Lock-in Period: SEBI made a rule for the shareholders of the unlisted companies. If an investor has invested in the unlisted company at a lower price than it is offered to the public, during the preceding one year will have a lock-in of 3 years from the date of allotment of the proposed issue of capital.
- Almost Zero Dividend: If you are a conservative investor and you want dividends at a certain interval of time then unlisted companies are not for you. There is a high possibility that such companies reinvest their profits to expand their business.
- Lack of Security: Those who invest in such companies don't get the safety and security provided by SEBI for investing in the listed companies.
How are Pre-IPO shares priced?
Prices of shares are based on the supply and demand in the unlisted market. It works with the same concept of price movement as any listed company does. Retail investors should only invest a surplus amount in unlisted companies because it is one of the riskiest forms of investment.