WHAT IS PRE-IPO INVESTING?Advantage,Disadvantage

Pre-IPO investing involves purchasing shares in a company before they become available to the general public. In India, this practice is quite popular among specific groups, including institutional investors, high-net-worth individuals (HNIs), and family offices. While the price of acquiring pre-IPO shares may be slightly higher, investors can take comfort in the fact that they are guaranteed an allocation and know in advance how many shares they will receive, eliminating the anxiety associated with uncertainty. Now, let’s delve into what pre-IPO investing entails and explore its advantages and disadvantages in more detail.

Pre-Apply in IPO

An Initial Public Offering (IPO) represents a company’s effort to secure capital from both retail and institutional investors. It’s essentially a public invitation for any eligible investor to place their bids. However, a common hurdle in many public offerings is oversubscription, where investors don’t receive the desired quantity of shares. This is why many investors opt for the pre-IPO investment route, which offers a more reliable avenue for potentially better returns.

Pre-IPO investing presents an opportunity for investors to acquire shares in a company before it goes public, addressing the issue of under or insufficient allotment. You can apply for shares in a prospective company even before the official IPO launch date. Often, pre-IPO shares are priced at a premium, given the assurance of allocation.

Let’s explore how pre-IPO investing works in practice: Before a stock becomes available to the general public through an IPO, a significant portion is privately sold through a pre-IPO placement. Typically, companies set a minimum qualifying limit, which may vary based on the pre-IPO portion’s size, usually around Rs5 crore or Rs10 crore. As the stakes are substantial, so are the associated risks. The pricing may vary, depending on demand, and can either be discounted or offered at a premium relative to the indicative value. Pre-IPO stocks are in demand among Private Equity (PE) investors, hedge funds, High-Net-Worth Individuals (HNIs), and family offices.

Today, even retail investors can participate in the pre-IPO market, not only through direct involvement but also through various Portfolio Management Services (PMS) that allow investors to subscribe to pre-IPO PMS, with the condition that their funds will solely be invested in pre-IPO allotments. This indirect approach offers retail investors access to pre-IPO opportunities.

How do IPO pre-applications function?

Let’s begin by clarifying that the profitability of pre-IPO investments depends on when you enter the company’s development stage. Typically, pre-IPO shares come with a one-year lock-in period during which they cannot be sold. These shares can only be held in demat form; otherwise, they won’t be eligible for sale once the lock-in period expires. Once you acquire pre-IPO shares and the lock-in period concludes, you have several options as an investor:

1. Private Off-Market Transfer: You can engage in a private off-market transfer of these unlisted shares to a potential buyer. This involves a direct transaction between two investors, where the price is negotiated, and the transfer and payments are carried out without utilizing the stock market. This method is feasible only if the shares are already in dematerialized (demat) form.
2. Exit via IPO: Another option for pre-IPO investors is to exit through the company’s IPO. For instance, if you acquired pre-IPO shares at Rs180, and the IPO is priced at Rs270 after a year, this represents a 50% return within a year. Many institutions and High-Net-Worth Individuals (HNIs) consider this a highly attractive return for a one-year period. In such cases, pre-IPO investors may offer their shares acquired through pre-IPO allotment in the IPO as part of an offer for sale (OFS) to exit their positions.
3. Hold for Potential Growth: If pre-IPO investors believe in the company’s growth potential, they might choose to hold onto their shares. Their rationale could be to benefit from potential price discovery and long-term appreciation. If there’s a possibility that the stock could increase four to five times in three years, it makes business sense to hold onto these shares. Often, investors opt for a combination approach, partially selling some of their pre-IPO shares in the IPO and retaining the rest for potentially better returns.

Additionally, you can opt for the mutual fund approach to invest in such companies. Some mutual fund houses offer IPO-based thematic funds that invest in recently listed companies or those planning to go public.

Unlike IPOs, there’s usually no set limit on the amount you can invest in pre-IPOs. Your investment amount can be tailored to your financial capacity and risk tolerance. This flexibility allows you to invest as much as you deem appropriate.

Advantage of Pre-Ipo Investing

Pre-IPO investing comes with its share of advantages. Here, we’ll explore some of the major benefits of investing through the pre-IPO route:

1. Potential for Higher Returns: Pre-IPO investing can yield substantial returns, especially in emerging sectors such as Information Technology (IT), digital, IT-enabled services (ITES), biotechnology, Contract Research and Manufacturing Services (CRAMS), Artificial Intelligence (AI), and Machine Learning (ML). Early investment in companies from these sectors can offer impressive gains as they grow and go public.
2. Limited Market Volatility: The pre-IPO market typically experiences less market volatility compared to the public stock market. Pricing in pre-IPO deals is often negotiated directly between parties, allowing for more comprehensive research and analysis. This can provide a degree of stability and predictability for investors.
3. Bulk Investment Discounts: Pre-IPO investors often have the opportunity to secure discounts for making bulk investments. These discounts can act as a safety buffer, even if the stock’s value experiences some volatility after going public. It can enhance the potential for favorable returns.
4. Indicator of Company Quality: The participation of family offices and institutional investors in a pre-IPO offering can serve as an indicator of the company’s fundamental strength and credibility. These experienced investors conduct thorough due diligence before getting involved, offering additional confidence to potential investors.

Now, let’s take a closer look at some of the downside risks associated with pre-IPO investing.

Disadvantage of Pre-Ipo Investing

The disadvantages associated with investing in an unlisted company:

1. Low Returns Potential: Unlisted companies seeking capital through pre-investment often lack a proven financial track record. As a result, selling shares in such companies can be challenging. Additionally, there’s no guarantee that the initial public offering (IPO) price will exceed what you initially paid for the shares, potentially leading to subdued returns.
2. Listing Uncertainty: Many investors opt for pre-IPO investments with the expectation of selling shares at a premium when the company goes public through an IPO. However, the company’s ability to proceed with an IPO hinges on approval from the Securities and Exchange Board of India (SEBI). If the company fails to secure SEBI approval, it may never go public, affecting your exit strategy.

These disadvantages underscore the importance of thorough research and due diligence when considering pre-IPO investments. It’s crucial to assess the company’s financial health, growth prospects, and the likelihood of successfully launching an IPO before making investment decisions.

Is the pre-IPO price cheaper?

Pre-IPO shares often come at a lower and more affordable price compared to their IPO counterparts. This presents a unique opportunity for investors to acquire stakes in well-established corporations at a more accessible entry point. Consequently, when these shares eventually become available to the broader public through an IPO, they may command a significantly higher market value. This potential for price appreciation can make pre-IPO investing an attractive avenue for those looking to invest in reputable companies and potentially realize substantial gains when the shares go public.