Explained: The real picture of unlisted shares, a look at biggest risks involved

EXPLAINED: What IPO grey market really is

If investment in unlisted securities is done with care and at the right time, the returns can be huge. Sometimes, companies sell shares to AMCs or brokerages, which, in turn, sell these at a profit to nigh net worth individuals (HNIs). The listing gains can be huge for all.

Sometimes, securities may be available from promoters or employees (investors can buy the ESOPs of employees) before the IPO. If done at the right time at the right price, returns can be huge, if the IPO is successful and listing gains are impressive.

Many recent IPOs have listed at a substantial premium to the issue price.

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Many promoters make preferential allotment of securities before listing. Investors opting for this route should carefully study the promoters’ track record as well as the firm’s financials.

Investors should be aware of the fact that the risks of dealing in unlisted securities are huge. The risk of capital loss cannot be ruled out. If investment is made without due diligence of the quality of the promoters and the financials of the firm, investors may lose their entire capital. There have been many instances where promoters gave inadequate information about a company’s fundamentals to raise money from gullible investors.

Again, there is the risk of further equity dilution after the allotment has been made. If the company is not making profit and paying no dividend, there is the risk of no return on investment for some time. The opportunity cost of this can be huge, if the waiting period is long.

A major risk in the unlisted space is the lack of liquidity. If the investor needs money, it would be difficult to find buyers and sell the securities.

In the listed space, even in a bear market, quality stocks can be sold at any time and converted into cash. Therefore, only the money that investors don’t need for many years should be invested in unlisted shares.

Investing in unlisted securities also involves unfavourable tax implications compared to listed shares. If sold within 24 months of investing, unlisted shares attract short-term capital gains tax. If sold after 24 months, the long-term capital gains are taxed at 20 percent with indexation benefits.

It would be difficult for ordinary retail investors to do due diligence before investing in the unlisted space. Therefore, a better option would be to invest in this segment through alternate investment funds (AIFs), which invest in venture capital, private equity, real estate and hedge funds.

AIFs have competent professionals who can do due diligence and assess the prospects of the potential investment. This alternative is less risky and can be more rewarding compared to individual investors directly putting their money in unlisted securities.

Only investors who can do an in depth and thorough analysis of a company’s fundamentals should enter the unlisted space. For others, listed shares, either directly or through the mutual fund route, provide a safer and better option.