WHAT IS PRE-IPO INVESTING

INTRODUCTION

Pre IPO investing refers to buying shares in a company before the issue actually opens. Pre IPO investing in India is common among certain institutional investors, HNIs and family offices. The pre-IPO stake may be at a slightly higher price, but the allotment is assured and known in advance, so the investors don’t have to worry about the uncertainty. Here let us look at what is pre IPO investing and the pros and cons of doing the same.

UNDERSTANDING PRE-IPO INVESTING

An initial public offer (IPO) is the raising of capital by a company from retail and institutional shareholders. However, this is a public offer in which any eligible investor can bid. Oversubscription is a major challenge in many public issues, which means you don’t get the desired quantity. That is why many of the investors prefer to adopt the pre-IPO investing route. A better way to get good returns is the pre-IPO market where investors can get shares ahead of the IPO. Pre-IPO solves the problem of under allotment or inadequate allotment. You can apply for shares in a potential company even before the opening date of the IPO. Quite often, the pre-IPO is done at a premium pricing, since it is an assured allotment mechanism.

Let us look at how the pre-IPO investing works in practice. In pre-IPO investing; even before the stock is offered to the public via IPO, a good chunk is sold privately through a pre-initial public offering (IPO) placement. Normally, the company sets a base minimum qualifying limit which may be Rs5 crore or Rs10 crore depending on the size of the pre-IPO portion. Since the size is significant, the risks involved are also significant. Depending on the demand, the price may be discounted or offered at a premium to the indicative value. Pre-IPO stocks are demanded by PE investors, hedge funds, HNIs and family offices.

Today, retail investors can also participate in the pre-IPO market. It is not just via direct participation, but there are several PMS (portfolio management services) that allow the investors to subscribe to their pre-IPO PMS with the sole condition that the funds would only be invested in pre-IPO allotments. This is an indirect way to participate in pre-IPO.

HOW DO INVESTORS MAKE PROFITS OUT OF PRE-IPO INVESTING?

At the outset, let us be clear that the profitability of the pre-IPO investment depends on how early in the stage of the company you have entered. Normally, the pre-IPO has a lock-in period of 1 year and cannot be sold during this period. Even pre-IPO shares cannot be held in physical form but only in demat form, otherwise they are not ready to be sold when due. Once you get the pre-IPO shares and the lock-in period is completed, there are several options in front of the investor. Here are a few of them.

1) You can do a private off-market transfer of such unlisted shares to a potential buyer. This can directly be done from one demat account to another and this is not through the market mechanism. This is a private deal between two investors where the price is negotiated and the transfer and payments are executed accordingly. This can only be done if the shares are already in demat mode.

2) The second option for the pre-IPO investor is to take exit in the IPO of the company. For instance, the pre-IPO allotment may have happened at Rs180 and the IPO after a year may be priced at Rs270. That is a return of 50% in a year and most institutions and HNIs would consider that as an extremely attractive level of return in a one year period. In such cases, they would directly offer their shares got through pre IPO allotment in the IPO as part of the offer for sale (OFS). This is one way of getting exit once  you have got pre-IPO allotment of shares.

3) Quite often, if the pre IPO investor is convinced with the story behind the company, they may prefer to hold on. Their argument would be why to stop at 50% returns in 1 year if the listing and the benefits can result in price discovery. If the stock has the potential to go up 4-5 times in 3 years, then it makes a lot of business sense for the pre-IPO investor to hold on to the stock. Quite often, most investor do a mix. They partially sell some of their pre IPO shares in the IPO and then hold on to the balance to get the best deal.

Having seen the exit methods, let us turn to the pros and cons of pre IPO investing.

MERITS OF PRE-IPO INVESTING

Clearly, pre IPO investing would not be an unmixed bag. Here we first look at the major advantages of investing through the pre IPO route.

• Pre IPO investing can generate higher returns, especially in new age sectors like IT, digital, ITES, biotechnology, CRAMS, AIML etc.
• In the pre IPO market, the role of market volatility is very limited and the pricing is negotiated across the table. Hence there is scope for in-depth research here.
• Quite often pre IPO investors get a discount for offering bulk investments. Hence, they get a safety buffer, even if the value of the stock was to see some volatility later.
• In any pre IPO market you can judge its quality by the kind of family offices and institutions participating in the pre IPO offer. This is indicative of the fundamental strength of the company and you can take a decision accordingly.

Let us now turn to some of the downside risks of pre IPO investing

DEMERITS OF PRE-IPO INVESTING

• Any pre IPO investing is like a blind date. Despite your best research, you are getting into unknown territory and cannot be too sure of what the outcome would be.
• The bet in any pre IPO investment is that the company will come out with an IPO and give you an exit. Quite often, the IPOs get held up or delayed due to bad market conditions or due to delays in SEBI approvals. That is a risk for your exit plan.

To sum it up, pre IPO investing is a great way to get exposure to quality companies early. You can decide whether you want initial-stage companies or late stage companies. The former holds more potential, but the latter is less risky.

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