How can you invest in a company before its IPO?

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With a flurry of unicorns lining up to launch their initial public offerings (IPO) including the likes of Paytm, Urban Company, Nykaa, and Zomato, retail investors are waiting to grab a pie.

However, looking at the recent data of oversubscriptions in IPOs and disappointment on the non-allotment for many, investors are now looking for opportunities in the pre-IPO space to be able to explore opportunities of investing in companies that are not traded on the exchanges.

What is pre-IPO?

Pre-IPO stands for “pre-initial public offering.” This is the stage when founders would sell shares in their startup before it’s included in a public exchange listing.

Why do people invest in pre-IPO?

Large private equity (PE) players and seasoned investors usually jump on the chance to invest in such startup pre-IPOs because they can sell their shares for a much higher rate once the company goes public. These investors continue to earn passive income through dividends over time. Also, pre-IPO investments are less likely to be affected by societal events that trigger shifts within the stock market, as shares are not yet made public.

Can retail investors invest in pre-IPO?

Investing in pre-IPO companies has garnered retail investor interest in India of late with IPO subscriptions going through the roof.

Gaurav Garg is head of research at CapitalVia Global Research told Money9, “Retail investors have an option to participate early by investing in companies. There are a lot of platforms available which bring equity to retain investors before IPO. One has to get a DMAT account opened and deposit money with these platforms and then the shares are credited to DMAT account in T=2 days”

Is it legal to trade in unlisted stocks?

Smit Jhaveri, Co-Founding Partner at Ekvity, a financial services firm that provides tailor-made solutions in the areas of unlisted/pre-IPO shares says, “Investing in unlisted/pre-IPO shares is completely legal as it finds its mention even in the Income Tax Act. The sale of unlisted shares is a capital gains income as per the Income Tax Act”

“While the Securities and Exchange Board of India (SEBI) does not regulate this space, it is noticing the huge interest in this market and has just last month proposed to liberalise the holding period pre-IPO non-promoters as well”, he added.

Jhaveri believes there is huge potential in this space as Indians are always looking for newer opportunities and avenues for investments. He says right now there is a universe of around 450 unlisted companies and delisted companies (companies which were once listed ) in India.

What are the risks involved?

For pre-IPO investing in particular, investors run the risk of losing money once the company goes public with a low valuation. There is also the possibility that private companies and startups may delay going public due to various reasons or worse drop the plans for listing.

Jhaveri points out the fact that there is no regulation yet in this space is something one must keep in mind especially as there is no guarantee of delivery of shares. He said there have been \instances where a Bengaluru-based startup could not deliver the shares and siphoned off the clients’ money. Investors for now only have consumer courts to the rescue in such cases as there is no clearing corporation as well.

He said, “It is extremely risky for investors to trade in pre-IPO. The money can get stuck if the company drops the plan too bring the IPO and therefore there could be a scenario of no takers for your shares.

How are prices determined in the unlisted market?

For stocks in the unlisted market, experts say that about 80% of the factor is supply-demand and the rest 20% is based on large / block deals.

For instance – within a week of the news of Paytm’s IPO plans, the company’s share price in the grey market has more than doubled up to Rs 24,000, according to UnlistedArena.com, which facilitates investments in pre-IPO. Grey market refers to the unofficial markets for IPOs where the share of a company is traded before they get listed. The company expects to raise around Rs 21,000-22,000 crore from the IPO, news agency PTI reported.

Should one invest in unlisted shares?

Gaurav Garg says, “While the benefit for investors here could be that they can participate in wealth creation by tapping the equity earlier than a large pool of investors. There can be a lack of information and determining the actual price of share could be a challenge”

On the other hand, Smit Jhaveri says, “We advise investors to have only 10-20% of their overall equity portfolio to get exposure in unlisted stocks, while first-time investors must not foray in this space instead choose from the wide variety of listed stocks.

Upcoming Unicorn IPOs 

Beauty products retailer Nykaa is planning to go public later this fiscal year at a valuation of $4.5 billion as per media reports. The public offer will be coupled with an offer for sale to provide an exit to existing investors. The price band is yet to be decided, but a 10-20% stake of the firm could be offered to the public for an adequate free float as per reports.

Zomato, the food tech platform filed its draft red herring prospectus (DRHP) proposing an offering of Rs8,250 crore. The company will be issuing fresh equity shares worth Rs 7,500 crore, along with the company’s early backer Info Edge India Ltd selling its stake worth Rs 750 crore in Zomato’s upcoming public offering.

Urban Company, a tech-enabled home services marketplace, also plans to go public in the next 18-24 months after it announced a fresh $255 million funding round this week.