Investment in startups is an effective way to make exponential returns. Today, we hear a lot about companies going public through an IPO (Initial Public Offering). Before the dot-com bubble, privately held companies raised whopping funds with initial public offering (IPO). However in recent years, startups are enjoying large capital flows and growing their valuation prior to their listing. Pre-IPO funds are relatively a new asset class. Have you ever invested or do you know how to invest in pre-IPO funds? Here is everything you need to know about pre-IPO investment.
What is Pre-IPO investment?
Pre-IPO stocks are shares of a private company that sells them to investors before its listing on a public exchange. The act of purchasing such shares is known as pre-IPO investment. Usually, companies that sell pre-IPO stock use a process called pre-IPO placement. Investors who invest in a company at the pre-IPO stage freeze their investments for a longer period of time in the hope of receiving quality assets. Pre-IPO investors are prominent stakeholders in a company and can get higher returns when the company goes public. Here are the key features of pre-IPO funds:
- Expected returns – 20% to 25%
- Time horizon – 3 to 5 years
- Minimum investment – INR 1 cr
- Investors – High net worth individuals (HNIs) and family offices
Is it legal to buy pre-IPO shares in India?
It is one of the most common questions about pre-IPO investing. Yes, you can lawfully invest in pre-IPO funds in India and get benefits of good ROI when the firm lists. However, before investing in such funds, you should take financial advice to understand all your responsibilities.
The pre-IPO investment requires a profound understanding of the financial sector and prevailing market structures. Everyone including private equity firms, banks, venture capital firms and retail investors are allowed to participate in pre-IPO markets.
Who can invest in Pre-IPO funds?
Earlier only HNI (High Net-work individuals), FIIs (Foreign Institutional Investors) and DIIs (Domestic Institutional Investors) could invest in pre-IPO funds. However presently, retail investors who want to invest in early-stage enterprises can invest in pre-IPO funds. As per the SEBI guidelines, the minimum investment in these types of funds is Rs. 1 crore. Venture capital firms, private equity firms, AMCs are the most common investors of pre-IPO funds. Investors can exit a pre-IPO deal after the company goes public or is sold to a strategic investor.
What are the risks associated with pre-IPO investment
Rewards are proportional to risk involved. Pre-IPO funds also come with a risk factor. It is essential for investors to consider the risk factors involved before making an investment decision. Unlike a publicly listed company, a privately held company doesn’t disclose financial statements. So, it may not be easy to estimate the value of shares at the pre-IPO stage.
Following are the risks involved in investing Pre-IPO funds:
- Entry price
- Shift in the market sentiment
- Government and Regulatory roadblocks
- Profitability requirements
How to invest in pre-IPO funds
To invest in pre-IPOs, you need to find stockbrokers who manage pre-IPO funds. You can also contact pre-IPO experts at SBNRI to invest in a pre-IPO, know the companies accepting pre-IPO investments and know the price for each share.
After understanding the various aspects of pre-IPO funds, if you want to proceed with investment, there would be an application process and other formalities that you need to complete before you can start investing. Then you need to send the investment amount to the broker. After that, the shares will be transferred to your NRI Demat account. Purchase of shares will be considered complete once you can see the ISIN numbers of the pre-IPO shares in your Demat account.
You may also invest in a pre-IPO through the mutual fund route. Some AMCs have launched limited-subscription pre-IPO mutual funds to allow investors to purchase the shares of late-stage companies.
When investing in pre-IPO funds, you should keep the following points in mind:
- Risk involved
- Investment horizon
- Expected returns
- Profile of fund managers
- Holding period (the period after which you can get your money back)
- Prior returns of the fund
Tracking the investment and staying updated is as important as making the initial investment. So, keep tracking the activities of your investment on a daily basis.
Pre-IPO investment is gaining popularity in India on account of the evolving regulatory landscape and maturity of the VC industry. Because of the unprecedented rate of digital penetration, technology-based companies in India have attracted a significant amount of investment from Indian and NRI investors.
Pre-IPO investing is different from investing in other asset classes. It requires due diligence to make a decision regarding investment in pre-IPO funds. Before investing in such funds, NRI investors can take financial advice to understand their responsibilities, know the companies accepting pre-IPO investment and price of each share so as to make an informed decision.