How to invest in companies before their IPO?

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“There are basically three ways that investors can buy in companies that can go public,” said Munish Randev, founder of Cervin Family Office. “The first is to invest in a pre-IPO fund. These are generally structured as an AIF (alternative investment fund) and have a minimum ticket size of 1 crore. “

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For example, Kotak Investment Advisors Ltd, the alternative asset arm of Kotak Group, is launching a pre-IPO fund with a target size of 2,000 crores. The fund, a Class II AIF, has been positioned as an “advanced stage fund focused on India to invest in high quality companies with strong technological potential”.

The IIFR launched several of these AIFs as part of the Special Opportunities Funds series from May 2017.

“The IIFR AMC was the first asset management company to launch a dedicated pre-IPO fund in 2017, giving investors the ability to invest in pre-IPO opportunities. Today, we manage an asset under management of more than 10,000 crore on pre-IPO funds, generating returns in the range of 10-15% (the listed portfolio having generated an IRR of 16-30%), ”said Manoj Shenoy, CEO of IIFL AMC.

Some of the renowned IIFR holding companies that have been listed in recent years include Nazara Technologies Ltd, ICICI Lombard General Insurance Company Ltd, Indian Energy Exchange Ltd, and Nippon Life India Asset Management Ltd.

According to Shenoy, the institutional weight of large financial services firms offers an advantage to investors in such AIFs.

In addition, investors who wish to invest in pre-IPO companies find it convenient to invest through pre-IPO funds, as investors benefit from institutional access to pre-IPO transactions, which have been filtered through a process. rigorous investment, ”he said.

The second route is to buy shares directly through intermediaries such as brokers or wealth management companies. Large wealth managers try to leverage their corporate relationships to get deals for clients.

“Once we have selected companies, we leverage our ecosystem of relationships between private equity funds, venture capital funds, sovereign wealth funds, financial institutions and family offices to access senior positions. or secondary in these companies. We then use a combination of metrics to value such transactions and often the valuations also depend on the dynamics of supply and demand for the asset. For example, over the past year, we have made one of the largest non-institutional placements of NSE equities with our HNI clients (high net worth individuals). CIBIL and Policy Bazaar are other names we have traded in, ”said Amrita Farmahan, MD and CEO, Wealth Management, Ambit Pvt. Ltd.

“The stocks themselves come either from an early stage investor in the company, mainly individuals wishing to exit for liquidity needs, or from employee stock option pools (ESOPs) already. acquired. Note that in the latter case, most companies (employers) retain the first right of refusal. If you are trying to buy from an employee, check if it has been honored according to the shareholders’ agreement, ”said Randev.

The third method is to use small brokers and unregulated entities that periodically publish quotes for these stocks. The last route is the least reliable.

“Often, the brokers in question are not able to source the shares at the price they have quoted; these are only indicative quotes, ”Randev said.

Investing in unlisted stocks before companies list them has some advantages. The allocation of shares in IPOs is uncertain, especially if the security is in high demand. You can also get the stock for less than the price of the IPO offering.

However, not all experts are optimistic about this path. “Most of the wealth management companies that trade such stocks buy and sell from their own portfolio and charge a markup of 4-5%. Price discovery is difficult in this market and therefore margins are high. In this space, investors who are genuinely interested should stick with established profitable companies rather than loss-making startups funded by the PE, ”said Feroze Azeez, Deputy CEO of Anand Rathi Private Wealth Management.

“I do not recommend such unlisted stocks at all. I think the returns on listed stocks are sufficient to meet the financial goals of most of my clients. Some investors who have bought such unlisted stocks look at their earnings in isolation rather than comparing them to a benchmark like Nifty or Sensex, ”he added.

Investors who are considering investing in such stocks should also take into account the different tax treatment.

Capital gains on unlisted shares are taxed at 20% if held for more than two years and benefiting from indexation.

This is different from the 10% long-term capital gains tax on profits from the listed shares above. 1 lakh.

For shorter holding periods, capital gains on unlisted shares are taxed at the slab rate unlike the 15% tax on capital gains on listed shares. The stamp duty on unlisted shares is also higher at 0.25% against 0.01% for listed shares.

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