Know about Pre-IPO investing

5paisa Research Team

Last Updated: 08 Mar, 2022 11:09 AM IST

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Introduction

An IPO (Initial Public Offering) is a golden opportunity for investors to make money above typical gains in the equity market. Almost any investor with a bank and Demat account can invest in an IPO during the offer period. However, IPO allotment depends on the subscription volume. 

If an issue is oversubscribed, a handful of investors get the allotment while the rest get a refund. To avoid the uncertainty of allotment, some investors invest in a company during the pre-IPO investing period. And, if lucky, a pre-IPO investor may strike gold after the company lists on the bourses. 

Hence, if you are the one who likes researching a company before investing in an IPO, pre-IPO may be an excellent opportunity for you to maximise your profit.

What is Pre-IPO Investing?

As the name suggests, pre-IPO investing refers to the investment you make before the company goes public. As a pre-IPO investor, you will be a prominent stakeholder in the company's growth story and may win a significant amount when the company eventually lists. 

Pre-IPO is a common method adopted by many companies or stock promoters to amp up their capital base before launching the IPO process. A pre-IPO can allow you to enter a start-up at the ground floor level and scale your way up to the top. But, if you are not careful, you may also become a victim to dubious companies and lose all your capital.  

Pre-IPO Investing - The Mechanism

Pre-IPOs are managed by sharebrokers. If you want to invest in a pre-IPO, you need to find such a broker and express your interest to invest in a pre-IPO. The broker will inform you of the companies presently accepting pre-IPO investments and tell you the price for each share. The broker will also notify you of the brokerage fee for facilitating the purchase. 

If you agree to the price and the brokerage fee, you need to send the investment amount to the broker who transfers the amount to the company. Consequently, the shares are transferred to your Demat account latest by T+0 evening or T+1 morning. The share purchase is considered complete when you see the ISIN numbers of the unlisted shares in your Demat account.   

Alternatively, you may take the mutual fund route to invest in a pre-IPO. Some mutual fund houses launch limited-subscription pre-IPO mutual funds to allow investors to invest in late-stage companies.  

Earlier, pre-IPO investing was only allowed for High Net-worth Individuals (HNIs), Foreign Institutional Investors (FIIs), and Domestic Institutional Investors (DIIs). But presently, even retail investors may also invest in pre-IPOs. While in an IPO, a retail investor can only invest up to INR 2 lakh, there is no such limit on pre-IPO investments. Hence, you may invest as much as you want, depending on your risk profile and financial capability.

Factors to Consider Before Investing in a Pre-IPO

The following are some factors you must evaluate before investing in a pre-IPO:

Liquidity 

Since a pre-IPO is offered by an unlisted company, it might not witness regular buying or selling. The shares of unlisted companies are sold through brokers. So, both buyers and sellers depend on the broker's inputs. And if there is a scarcity of buyers or sellers, you may find it challenging to purchase or sell your shares. This is why most investors invest in a pre-IPO with a long-term horizon.  

The Company's Fundamentals 

Although an unlisted company might not divulge a lot of information about its operations, you must still collect as much information as you can to gauge the company's financial condition and growth prospects. The Ministry of Corporate Affairs (MCA) website usually contains vital information about the company. You can also find the information from brokers or the company website. Also, scan available news by looking up media websites and newspapers. Similar to IPO or equity market investments, pre-IPO investments must also be governed by the company's fundamentals and growth potential. 

The Probability of Going Public

A late-stage company has a higher probability of going public or getting listed on the bourses. Companies with a higher likelihood of listing will most likely create more value for investors. These companies also have higher liquidity, and you can sell them after listing. Moreover, selling a listed company is more beneficial from the tax point of view than selling an unlisted company.

What Are The Risks of Investing in a Pre-IPO Stock?

While pre-IPO investing can be pretty remunerative at times, it also carries some risks. Here are the most common risks associated with pre-IPO investment:

Low Returns

Companies seeking money through a pre-IPO might not have a proven financial history. Hence, you may find it difficult to sell the shares you own. Moreover, there is little guarantee that the IPO will be priced or will list above your purchase price. Hence, the returns might be muted.

Listing Problems

Generally, investors invest in a pre-IPO for selling them at a premium when the IPO launches or lists. However, the IPO application depends on SEBI's approval, and if SEBI does not approve the IPO, it may not see the light of the day. Moreover, the company may itself decide not to go public.

Open a Demat Account Now and Invest in Pre-IPOs

Visit 5paisa to open a Demat account and invest seamlessly in pre-IPOs. 5paisa provides a one-click account opening process and an online gateway to trade and invest conveniently. You can also read research reports and industry news to pick the best investment instruments. Click on this link to level up your investment journey.

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