Have you ever wondered how some investors become wealthy by investing in companies before they go public? How do they find these hidden treasures named pre-IPO shares, and what are the risks? If you’re curious to know, you’re not alone.
Pre-IPO investing, as the term suggests, is buying shares before a company launches its IPO. It is a growing trend in India’s thriving startup scene. This article will explain pre-IPO investing, why it is appealing, how to find and evaluate pre-IPO opportunities, and what to look for before purchasing pre-IPO shares in India.
What is Pre-IPO Investing?
It’s like you get to watch the premiere of a blockbuster movie much before it hits the cinemas. You can access the tickets at a discounted price before the movie is released. Well, that is what investing in pre-IPO shares is like.
Pre-IPO investing is investing in privately held companies before they launch an initial public offering (IPO). You can purchase shares before they are publicly traded, often at a lower price.
How to Invest in Pre-IPO Shares?
You can invest in Pre-IPO shares through any of these three modes-
- Pre-IPO Placement
In this investment approach, pre-IPO shares are sold in bulk to institutional investors, such as hedge funds, mutual funds, or private equity firms. These investors are granted access to the company’s financial information and can negotiate the terms of the deal.
However, this option is usually unavailable to individual investors unless they have a high net worth and a strong relationship with the company or the broker.
Burger King India conducted a Rs.150 crore pre-IPO placement in 2020 through a rights issue, and a preferential allotment to Amansa Investments Limited was made. [Source: BusinessToday]
- From Primary Marketplace
In the primary market, investors can buy pre-IPO shares directly from the issuing company or its underwriters, who set the price and terms of the deal. The primary market is more regulated and has more disclosure requirements than the secondary market.
Airbnb issued new pre-IPO shares on the New York Stock Exchange as BABA in 2014. [Source: The Guardian]
3. From Secondary Marketplace
The secondary market is more open and flexible for individual investors but has higher fees and commissions. In the secondary market, investors can buy pre-IPO shares from other investors or brokers, who determine the price based on the demand and supply forces.
There are online platforms that connect buyers and sellers of private company shares.
Benefits of Investing in Pre-IPO Shares
Pre-IPO shares are not always beneficial to all investors. Consider it a bouquet of both lovely-smelling flowers and thorny bushes. So, choose the right flower wisely, or your portfolio will suffer.
| Pros | Description |
| Potential for High Returns | Pre-IPO shares are potential high-growth stocks that can generate significant returns if the company goes public and the share price rises. |
| Early Access to Promising Companies | Investors can access innovative and high-potential companies before they become publicly traded. This gives them an edge over other investors who access the IPO route. |
| Portfolio Diversification | Investing in pre-IPO shares allows you to diversify your portfolio by gaining exposure to private markets. |
| Increased Control | Pre-IPO investors may have greater influence or control over the company’s direction, depending on the investment terms. |
| Possibility of Lower Valuations | Pre-IPO investors may have greater influence or control over the company’s direction, depending on the investment terms. |
Disadvantages of IPO Investing
| Cons | Description |
| Lack of Liquidity | Pre-IPO shares are illiquid, meaning they cannot be quickly sold or traded, and investors may encounter difficulties liquidating their positions. |
| Higher Risk | Investing in private companies entails greater risk due to unknowns about the company’s future performance and market conditions. |
| Limited Information | Compared to publicly traded companies, information about pre-IPO shares issuing companies may be limited, making thorough due diligence more difficult. |
| Lock-up Periods | In pre-IPO shares, investors may be subject to lock-up periods during which they are not permitted to sell their shares, limiting their ability to liquidate their investment. |
| UNcertain Exit Strategy | There is uncertainty about when and how investors can exit their positions because exit opportunities frequently depend on the company going public. |
Should You Buy A Pre-IPO Share?
Pre-IPO shares can allow investors to gain exposure to promising companies at a reduced price and potentially earn high returns when the company is listed on the stock exchange. You can take the example of the general insurance giant ICICI Lombard, which was available at Rs. 70/- per share in the pre-IPO market. Upon public listing in 2017, the valuation shot up to Rs. 680/- per share [Source: Stockify.net.in].
Or consider Lux, the inner wear leading company, whose pre-IPO share price was just Rs. 75 in 2014. The following year, when the company hit the bourses, the share prices boosted to Rs. 735, giving its investors almost 9 times the return [Source: Stockify.net.in].
This pre-IPO shares story, however, will be incomplete if the significant risks and challenges are ignored. We also have many failure stories, such as the Zomato IPO or the Paytm IPO, among the most significant financial market failures.
Therefore, you should be mindful of this before choosing and seek advice from SEBI-registered investment advisories or experts whenever needed.
QUICK LINKS:
CURRENT IPOS | LISTED IPOS | UPCOMING IPOS
FAQs
1. What are pre-IPO shares, and how do they differ from IPO shares?
Pre-IPO shares are private company shares sold to investors before the company's initial public offering (IPO). It differs from IPO shares in that they are not traded on a stock exchange, are not subject to the same disclosure and reporting requirements, and may have a lock-in or vesting period.
2. How do I determine the fair value of pre-IPO shares?
There is no single method for valuing pre-IPO shares and determining their fair value because different methods produce different results. The book value method, the last transaction price method, the price-to-earnings ratio or discounted cash flow method, and the net asset value method are some commonly used methods.
3. What are the tax impacts of purchasing and selling pre-IPO shares?
Buying and selling pre-IPO shares may have tax implications depending on the holding period, the nature of the income, and the investor's tax bracket. Pre-IPO shares are generally treated as capital assets, and any gains or losses realized from their sale are taxed as capital gains or losses. Depending on the holding period and the type of capital gain or loss, the tax rate can range from 10% to 30%
4. What are the best practices and advice for investing in pre-IPO shares?
The following are some of the best practices and tips for investing in pre-IPO shares:
1 Conduct your investigation and due diligence on the company and its valuation.
2 Learn about the risks and rewards of investing in pre-IPO stocks.
3 Invest within your means and risk tolerance.
4 Diversify your portfolio by including different types of investments.
5 Be patient and realistic about the timeline and outcome of the IPO.
6 Maintain a record of your investments and tax obligations.
7 Seek professional help if necessary.
Also Read:
How To Make Passive Income | Top 10 AI Stocks in India
What is Compounding | Types of Asset Classes
I’m Archana R. Chettiar, an experienced content creator with
an affinity for writing on personal finance and other financial content. I
love to write on equity investing, retirement, managing money, and more.