India’s investment horizons are rapidly expanding. Investors are seeking diverse investment instruments in their portfolios. It paved a path for several unconventional avenues, such as, venture capital (VC), portfolio management services, private credit, etc., in India
Usually, startups and unlisted companies are in the headlines for raising private funding in India. As per the data on the 2nd quarter of FY 2024-25, the VC investment value has surged by 21% in 1 year and looks in favourable momentum. In exchange for such funding, the companies may issue equity shares to these entities.
These are known as unlisted shares. However, its process is usually perceived to be complex. Few investors know about this unique option and are unclear about how to buy unlisted shares. Let’s decode the ways to invest in unlisted shares.
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What are unlisted shares?
The listing on capital markets is preceded by several conditions as per the Securities Exchange Board of India (SEBI). However, companies not qualifying these considerations also have growth potential and funding requirements.
Instruments used by such unlisted companies to raise funds in exchange for fractional ownership are known as unlisted shares. These are not traded on the regular stock market but in the over-the-counter (OTC) market settings. Investors can invest through OTC with the help of registered brokers. In India, the over-the-counter exchange of India (OTCEI) provides the electronic facility for regular and derivatives OTC trades.
Key features of unlisted shares
- Potential returns: The unlisted entities can be in their early stage of business, and their shares can be a way to invest in their prospective growth. The shares can deliver unprecedented returns. For example, Mr. Ratan Tata’s investment in Upstox during its early stage gave him 23,000% returns when he sold 5% of his stake in 2024.
- High risk: The higher returns are accompanied by high-risk factors. In the early years, a business is in its vulnerable stage and prone to uncertainties. Moreover, unlisted shares are not strictly regulated as listed ones.
- Lack of liquidity: These shares are traded on the OTC markets and are highly risky. Therefore, investors may find it difficult to search for sellers. Unlisted share prices are defined by market forces in the OTC market. Thus, a lack of investors may affect these prices.
- High tax implications: The taxation rules for unlisted shares are separate, and their holding period is 24 months. Such shares held for less than 24 months will be taxed at the investor’s income tax slab, while those held for more than 24 months will be taxed at 12.5%.
- Instruments: Some types of investments under unlisted shares are private equity shares, preference shares, convertible securities, compulsory convertible preference shares, etc. Apart from these specific instruments, investors can invest through angel investors, VCs, etc.
How to buy unlisted shares?
Usually, it is perceived that only VC firms, High Networth Individuals (HNIs) or institutional investors are offered these shares. However, it is not totally correct and all investors can invest in these through different methods. Investors can inquire for this facility with their registered broker or can explore the following direct and indirect ways.
Pre-IPO (Pre-Initial Public Offer) investment
It is one of the most popular ways used by affluent investors and firms for investments in unlisted shares. A company willing to issue shares to the public may invite investors for funding rounds before getting listed. It is a private opportunity that can attract the investors to invest at a lower share price and reap the benefit after listing.
Companies with strong brand popularity and unique and viable business models may raise significant amounts in such private funding. Moreover, positive pre-IPO news may encourage investors to participate in the IPO. Interested investors can invest in this via VC firms or angel investor funds. For example, the ongoing trend of celebrities investing in Swiggy’s pre-IPO. The company is willing to raise ₹3,750 crores through fresh issues in its upcoming IPO.
Also, read Understanding IPO valuation through relative and absolute methods
PMS and AIF investment
Modern alternative funds like Alternative Investment Funds (AIFs) pool money from investors through their first and second categories via VC funds, private equity funds, small and medium enterprise (SME) funds, etc. Investors need to invest a minimum of ₹1 crore in the AIFs. These can give indirect access to the unlisted shares and the benefit of professionally managed funds. It can further help in planning exits from the ventures at suitable times.
Apart from this, Portfolio Management Services are one of the best alternatives to invest in unlisted shares. A non-discretionary type of PMS can invest up to 25% of its Asset Under Management (AUM) in unlisted securities like equity shares. Moreover, this type of PMS allows investors to participate actively in their portfolio management.
ESOPs
The Employee Stock Options (ESPOs) are offered to the employees by the company to purchase the shares at a predetermined price from the company’s trust after the vesting period. The rates decided are usually lower than the market value. Under this right, employees can buy these shares or sell them and gain the difference.
Investors can access such brokers who connect with these employees to buy unlisted shares after the vesting period.
Promoter’s transfer
Promoters of some companies sell their shares in a private setting. Such transactions are usually catalysed by an intermediary such as a wealth manager or broker. Investors willing to purchase such shares can contact these intermediaries.
Pros and cons of investing in unlisted shares
| Pros | Cons |
| It is a lesser-known instrument and can provide proper diversification for the portfolio. | OTC markets do not have regulated functions like other stock markets, which can lack credibility. |
| Due to inadequate buyers and sellers or lack of market information and projections, shares may be undervalued. Investing in such shares can be beneficial in the long run. | The market may not have adequate buyers, which may create liquidity risk. Moreover, unlisted share prices may be adversely affected in case of a lack of buyers. |
| The pre-IPO unlisted shares may surge post the issue and make significant gains for an investor. | Companies may not publish regular information regarding performance, which can risk the transparency of the investment. |
Factors to consider while investing in unlisted shares
These investments are not regular for retail investors. Therefore, some of the following measures should be checked before investing.
- Unlisted shares have high risk, and investors comfortable with such risk profiles should only invest in them.
- The ongoing momentum in the concerned businesses and sectors should be checked in case of inadequate fundamental information.
- Scalability of the business and future aspirations are crucial indicators.
- Investors should plan their exit strategy during the investment to avoid devaluation of their investment. One can also consult their financial advisors.
Future of private equity in India
Private equity is one of the most common forms used for unlisted shares. It is gaining significant traction in India, and investor’s investment horizons are expanding. Moreover, the growth prospects of Indian businesses are seeking new heights, and funding is its inseparable element.
In the first half of FY 2024-25, the private equity deal value in India was approximately $17 billion. Moreover, factors like the growing IPO market, ESG (Environmental, Social, Government) investing, technological advancements, evolving government policies, etc., can provide the required push to these investments in the upcoming period.
An interesting read: Investing in pre-IPO companies: Meaning, benefits and factors to consider
Bottomline
Unlisted shares can be one of the alternatives to conventional investing. It can provide exposure to companies which have potential growth prospects but are not listed due to norms. Investors can access these shares in various ways. However, they are accompanied by various risks, and investors should check their risk appetite accordingly.
FAQs
- Why do investors invest in pre-IPO?
Pre-IPOs can be referred to as the private funding scenario, where investors are allotted an unlisted share of the company which is about to raise public funds through an IPO. Investors are attracted to such an opportunity as they can buy shares at a price less than market value. Moreover, the prospects are favourable, these shares may gain after public listing.
- Can I buy unlisted shares?
Yes, the unlisted shares can be traded on OTC markets, and investors can access them through SEBI-registered brokers. Apart from this, shares can also be purchased through PMS, AIFs, ESOPs, promoter’s transfers, private equity funds, etc. Investors should authenticate the purchasing source before investing.
- What are taxes applicable on unlisted shares?
Gains arising from the shares of unlisted companies are taxed under the Income Tax Act 1961. Their holding period is decided as 24 months. If these shares are sold before 24 months, the short-term capital gains are levied at the investor’s slab rate, and otherwise, it is taxed at 12.5%.
- What are the risks of investing in unlisted shares?
Unlisted shares are traded on the OTC markets, which may encounter liquidity risk due to a lack of buyers. Moreover, credibility is also at risk due to the absence of central regulations for the market. It can also create transparency risk as it may not be compulsory for these companies to publish their details.
- What types of companies are usually found in unlisted shares?
Unlisted shares can provide the required diversification for an investor. Usually, companies that are about to get listed by IPO or in their early-stage, can issue unlisted shares. Moreover, the companies not fulfilling or not willing to bind to IPO norms can issue unlisted shares to raise funds.
