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How to Invest in Unlisted Shares in India?

Created on 23 Sep 2021

Wraps up in 6 Min

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Updated on 07 Mar 2024

How to Invest in Unlisted Shares in India?

Ola, Flipkart, PhonePe, Delhivery, and Byjus are all market giants 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. In fact, some of them are increasing 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 an eye for detail when you route towards such options. No, no, it's not as complicated 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 from its beginning, this blog is a must for you.

Methods of Investing in Unlisted Shares

Most of us are unaware of the various investment methods in unlisted companies. However, each of those methods comes with its attributes and cautions. Sneaky bizz, much? Let's look into them and find out for ourselves!

a. Pre-IPO Investment

Under this method, investors and traders buy and sell shares of companies before they get listed on stock exchanges. Thus, factors like illiquidity, reduced security in transactions, and less regulatory compliance become imminent.

You can buy 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), which we will discuss later in the article.

Now, if these shares get listed anytime, and you see the price soaring, you might try to book profits. But there is a catch in this scenario! You are not allowed to sell these shares before six months from the listing date as per the Indian Pre-IPO market investment regulations.

b. Startups:

Invest directly in startups with high growth potential operating in a rapidly evolving market. The minimum investment amounts can vary depending on the platform you use for investments and the startups you wish to invest in.
Just keep one thing in mind.

Investing in startups carries a considerable risk due to the early stage of the companies involved.

c. Employee Stock Ownership Plans (ESOPs):

ESOPs are a form of compensation that grants employees the option to purchase company stock at a predetermined price, usually lower than the fair market value, within a specific timeframe. This gives employees a stake in the company's ownership, aligning their interests with its success.

You can purchase ESOPs from employees of unlisted companies, potentially at a discount. Just pay heed to a significant aspect of this particular investment option: Liquidity in ESOP investments can be limited, and the value of ESOPs depends on the company's future performance.

d. Private Placements

Another thing that you can do is to approach a broker, 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 the shares that they hold at that point. This method of buying shares from the promoters is known as private placements.

e. PMS & AIF schemes

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, 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-worth individuals (HNIs) and giant institutional investors. The minimum investment amount for the PMS is ₹ 50 lakhs, and the same for AIF is ₹ one crore.

f. Pre-IPO funds

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 much money but still want to invest in growth-oriented unlisted companies. 

Risk Factors of Investing in Unlisted Shares

An investment in unlisted shares comes with significant risks like:

a. Liquidity Risk

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 that are highly illiquid.

b. Capital Loss

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 scrutinising, can wipe out all of your capital invested.

c. Risk of Dividends

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. Surprisingly, there is no concept of delivering dividends in a structured manner in unlisted companies. Therefore, they might very well choose not to pay you the dividends at all. Oops-a-daisy!

d. Lock-in Period

If you are holding shares of an unlisted company thinking 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 six months as per the regulatory norms. So yeah, flex your flux!

e. Taxation Norms

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 by 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 the effect of the rate of inflation on it.

However, 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 authorised investment bank.

f. Risk of Dilution

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 considering 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.

g. Information Asymmetry:

Compared to listed companies, unlisted companies are not obligated to disclose detailed financial information regularly. This lack of transparency can make it difficult to assess the company's financial health, performance, and future prospects.

You often rely heavily on information provided by the company promoters, increasing dependence on their credibility and intentions.

SEBI is planning on bringing strict measures to regulate unlisted companies in India. Get all the crucial details about this inside happening by clicking on this link.

The Bottom Line

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.

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Prabudh Mishra

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Prabudh Mishra is a finance and behavioral economics enthusiast. He has a sense of purpose to eliminate irrationality in human behavior while they make the most crucial financial decisions in their life.

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