Unlisted Shares – Concept, Trading Process, Market Functionality & more
In this article, we will talk about unlisted shares in detail. We will include everything about Pre-IPO shares which you can trade over the counter (OTC) and their benefits.
The regulations pertaining to the unlisted stocks, taxation rules, and other legalities will also be there in the article.
A stock market is a place where you need to find the best stocks which can earn the profit you desire.
There are hundreds of stocks on the exchanges which traders trade on a daily basis. Long-term investors invest in the stocks if they find the stock is undervalued.
However, there are another set of investors in the market who invest in stocks that are yet to be on the stock exchanges’ list.
If you are wondering how that is possible, then you must know that there is a parallel market where investors can invest in unlisted stocks as well.
What are Unlisted Shares or Pre IPO Shares?
Unlisted shares are the shares of companies that are not yet listed on the stock exchange. The companies that haven’t gone public yet are known as unlisted companies.
For instance, there is JIO, OLA which are premier business houses in the country but they are private ventures.
These shares unlike listed shares, do not trade in the exchanges. However, some investors invest in these stocks as well by buying them over the counter.
Thus, these stocks are often referred to as OTC securities as well. There is a huge market for unlisted shares in the country and these shares are known as ‘hidden gems’.
Shareholders in these shares may not enjoy the benefits like the normal shareholders of listed shares, but if they can find the right share, and if that share gets listed in the future, and the price surges, the shareholders can earn great profits.
The unlisted stocks can be divided between shares of known or popular companies and novice or new-age firms in the business.
For instance, unlisted shares of Reliance Retail or Reliance JIO are already popular even without being listed.
While on the other hand, there are new-age tech-first companies like One97 communications, OLA, OUO, and others that are making their mark in the industry.
The basic difference is about the risk involved in investing in these two types of unlisted shares.
While the popular companies’ pre IPO share can easily get the limelight, the new-age companies will need time.
This in turn also tells about the risk being higher in the new-age companies than the popular unlisted companies.
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How Unlisted Stocks are traded?
Unlisted stocks in India and across the globe are traded over the counter (OTC).
OTC trading is a process where both buyers and sellers of the share execute the transaction out of a formal stock exchange.
These transactions are not regulated by any stock exchange in the country. Both the parties involved in the deal carry it on via an intermediary.
Since it is not regulated by any stock exchange or regulatory body, there is credit risk which both parties have to carry along.
Moreover, the OTC market is a decentralized market with no physical presence. It is a network where different brokers/dealers are present.
These brokers buy and sell the unlisted stocks/debentures/commodities and other instruments from the seller and further sell them to the buyers.
The dealers and the buyers of unlisted stocks communicate directly unlike in exchange trading. They present their offers and requirements and then if everything falls into place, the deal happens.
In the next sections of the article, we will discuss in detail how unlisted shares are bought and sold.
How to find Unlisted Shares?
Before you buy unlisted shares, you need to find the one that suits your investment portfolio and would help you increase your wealth.
Since, Pre IPO shares are not there on the exchange, finding its details is pretty hectic. However, you can find the details of the unlisted stocks with the brokerage house you choose.
Different brokers deal in unlisted shares. You can reach out to them and check which all Pre IPO shares they are dealing in.
After that, You can then compare and choose the one that suits your investment purpose and goal.
You must compare the price of the unlisted stock on at least 3-4 brokers’ websites as every broker charges differently for different unlisted shares.
The price of the unlisted shares also differs from broker to broker because of the demand and supply of the share under that particular brokerage house.
Since these stocks are not traded in public, the prices move based on demand and supply generated within the brokerage houses.
How to buy Unlisted Shares?
The process of investing in unlisted shares includes the following steps –
Demat and Trading account requirements
The first step is to open a Demat and trading account. If you already have a Demat account with NSDL or CDSL, then you do not have to do anything further.
Choice of intermediary
For buying unlisted shares, you would need an intermediary or brokerage house that deals in unlisted shares.
You can choose the one that suits your pocket after screening the best ones in the market and comparing their charges.
Evaluation of stocks
Once you select the intermediary, the next step is to evaluate the stocks. As mentioned above, you can find the stocks with the brokerage house only that are available for investment.
Compare the stocks, evaluate their fundamentals and then select which one you want to buy.
Placing of the order
Once you have decided on the stock, call the brokerage house. You have to tell them about the unlisted stock you want to purchase.
Then you share the details of the stock – price, and volume that is available for purchase.
Then comes the negotiation part if you are not satisfied with the offer made by the broker. For instance, they are asking for Rs.75 for XYZ shares.
However, you do not want to buy the share above Rs.65, then you can tell them the same and wait. Once and if the price drop to Rs.65 or around, then the broker will inform you the same.
Then you can buy the shares you were waiting for. Often unlisted stocks volume is monitored by the issuing company and thus you cannot buy as many as you want.
They issue a certain amount of shares only.
Submission of documents
You need to submit or upload four documents to the broker for completing your deal.
- Client Master Copy – given by the broker
- PAN Card
- AADHAAR Card
- Canceled Cheque
Transferring the amount
After submission of the documents, you need to transfer the amount to the bank account of the broker.
Credit in Demat account
Once the broker receives the money in their account, they transfer the shares to your Demat account.
How to sell unlisted shares?
The selling process includes –
Finding an intermediary
If you are satisfied with the intermediary from whom you bought the shares, it is better to stick to them.
However, if you got the unlisted shares via ESOP or in demerger, then you need to find an intermediary for selling those shares.
The broker would want to buy the shares from you at the least price prevailing in the market to make a profit. You need to put forward your offer. Once they agree, they will intimate you.
You have to submit the following documents for buying unlisted shares –
- PAN Card
- CMC or Client Master Copy
- AADHAAR Card
- Canceled Cheque
Delivery Instruction Slip
This is provided by the intermediary and contains all the information about the deal
Submission of the shares
The shares are submitted and transferred to the Demat account of the broker once you submit the documents.
Sale proceeds credited
The proceeds from the sale of unlisted shares are credited to your bank account by the intermediary.
How does Unlisted Stock Market work?
The unlisted stock market works privately and is not available to everyone in the public. The unlisted companies issue their shares to the limited number of shareholders for availing funds.
In this section, we will talk about the different people and organization involved in this market –
- The unlisted stock market is a playground for private financers. There are angel investors, venture capitalists, private equity financiers, seed capital providers, and others who provide finance to the unlisted company before it goes public. The funds are allotted against a contract that once the company goes public, these financers will have a share of the equity in most scenarios. They might opt for profit percentage or interests as well but that is rare.
- Secondly, the intermediaries are involved who buy shares from the unlisted company. Then sell the shares to the interested buyers. Similarly, buy pre ipo shares from investors as well who hold such securities and sell them to other buyers.
- There are promoters of the company who are appointed before the company goes public. The promoters often sell the pre-IPO shares to a limited number of investors.
- Finally, there are Portfolio management services that buy and sell these shares on behalf of their clients.
How Unlisted Company issue shares?
Unlisted companies in India can issue shares to a maximum of 200 people and not out in the public. It can issue its shares via –
- Intermediaries: The unlisted companies can choose some of the intermediaries and allocate the unlisted shares to them. The intermediaries on the other hand can try to sell these shares to the clients it has.
- ESOP: The unlisted shares can be allocated by the company using its ESOPs as well. An employee Stock option plan is a unique plan where employees are allocated the shares of the company. The employees thus get an ownership position in the company and at the same time company can reduce its expenses.
- Private placements: Finally, the promoters of the company like investment banks, underwriters help in the private placement of the unlisted stocks.
How Retail Investors can invest in Unlisted Stocks?
The retail investors can buy unlisted shares of companies from any one of the medium listed below –
- Brokerage houses dealing in unlisted shares
- Portfolio Management Services offering unlisted stocks
- Purchase from the existing employees of the unlisted company who have stocks of the company allocated via ESOPs
- Equity crowd funding platforms
- Promoters and private placement.
The retail investors must evaluate the company thoroughly before investing in the unlisted shares. Pre IPO shares might look lucrative but they bear a huge risk quotient as well.
It is advised that the retail investors should talk to an investment planner before investing in unlisted stocks to have a better idea.
How to choose the Right Broker for investing in Unlisted Shares?
In the previous section, we talked about choosing an intermediary for investing in unlisted shares is crucial. It is because the unlisted shares are not available directly to the retail investors.
However, not all brokerage houses deal in unlisted stocks neither all who deals are good in the service they offer.
So, choosing the right intermediary or broker is highly important. Here are few things you need to see while choosing the broker for unlisted shares investment.
- Firstly, you need to see whether the brokerage house is a trusted one in the market or not. You can read the reviews about the brokers dealing in unlisted shares in India. You can also check on financial news platforms like ET, MoneyControl, and others.
- There must be no hidden costs or charges. The broker must keep everything very transparent.
- The transaction time must be minimized.
- There must be adequate safety of the assets and funds transferred.
- The brokerage house must provide excellent customer service.
All these qualities are necessary for dealing with pre ipo shares. Some of the top brokers who deal in unlisted shares are –
- Unlisted Zone
- Babli Investment
- Enrich Advisors
Valuation of Unlisted Share
The unlisted shares of the unlisted companies are valued as per the following –
Fair Market Value
Fair market value as there is no actual market price available. The fair market value is calculated by the investment bankers or the underwriters of the company.
When the existing employees with ESOPs of unlisted companies, sell their stocks, they find the valuation of the shares based on the fair market value of the company.
The Fair Market value of the company is derived by deducting the book value of the liabilities of the company from the book value of the assets of the company.
To get the value of the unlisted shares of this company, the FMV is further multiplied by the total paid-up capital of the paid-up equity shares and then divided by the total amount of paid-up equity share capital as per the balance sheet.
Discounted Cash Flow
Another way of deriving the value of the unlisted shares is using the ‘Discounted cash flow’ method.
In this method, the future cash flows are assumed and then they are discounted at a certain rate.
Using this method, valuation of the unlisted share is difficult than valuing listed shares as everything is on assumption.
However, this is the method that is mostly followed in the market as well.
Regulation related to Unlisted Shares
Though unlisted shares are not regulated by SEBI or are not traded on the stock exchange, there are certain regulations pertaining to them.
- The Pre IPO shares of the unlisted company cannot be issued to more than 200 members.
- Tax will be charged on the gains from unlisted shares.
- The unlisted shares can only be allotted in dematerialized format.
- The valuation of the unlisted stocks must be done by a merchant banker/investment banker and not a chartered accountant or a firm.
Taxation regarding Unlisted Shares
The capital gain tax is levied on the gains from unlisted shares. There is no STT as these securities are not transacted over the stock exchanges. The gains from unlisted shares categorized as –
- Long-term capital gain if the investor holds the shares for more than 24 months and then sells them. The profit or loss is then categorized under long-term capital gain/loss.
- A short-term capital gain or loss if the duration of holding the securities is lesser than 24 months.
In the case of long-term capital gain, the tax rate is 20% along with indexation. While for the short-term capital gain, the rate of tax varies as per the slab.
Why invest in Unlisted Stocks?
If you are an investor especially a long-term investor, then unlisted can fit into your investment portfolio.
These stocks are traded over the counter and mainly high net worth investors invest in these stocks. The reasons for buying unlisted stocks can include –
- The exceptional growth of the share value. The share prices can sky-rocket if the shares are listed on the exchange with a full-proof business plan, and demand in the market.
- If you are a risk-taker when it comes to investments, then you can buy these shares and if it clicks, you can earn huge profits.
- You do not need to keep a continuous watch on the price movement as the price moves very slowly for these shares. Moreover, the intermediaries keep in touch with you for buying and selling these shares.
Risks of Investing in Unlisted Shares or Pre IPO Shares
Multiple risks are there in unlisted share investment.
- To start with, there is the risk of losing the capital you invested in these shares if the company fails to thrive in the market.
- There is no possibility of trading these shares in the open market so the liquidity is too less.
- There are no dividends to the shareholders of unlisted shares.
Difference between Listed Shares and Unlisted Stocks
The differences between the listed shares and the unlisted ones are pretty visible and crucial for an investor to be aware of. The differences include –
- Taxation is different for both types of shares. While for listed shares, it is categorized as LTCG if the shares are held for more than 1 year whereas for unlisted shares, it is 2 years. The tax rate is also double for unlisted shares – 20% while it is only 10% for the listed shares.
- Listed shares are available on the stock exchange, unlisted stocks you can buy from intermediaries and thus these are OTC securities.
- Shares of listed companies are traded daily and thus liquid, while the liquidity in unlisted shares is very less.
- The risks associated with the unlisted shares are more than listed shares. However, the return can also be huge in the case of pre ipo shares than in listed shares.
Unlisted Shares or Pre IPO Shares – Conclusion
To conclude, we can say that unlisted shares are for those investors who want to be there in the market for the long-term. These investments are not at all for stock market traders but the investors.
There is the possibility of making exponential gains from these stocks and you can also lose everything invested in unlisted stocks if the company falls straight on its face and couldn’t survive in the market.
FAQs – Unlisted Stocks
Here are the various FAQs related to Unlisted Stocks –
Ques – What are unlisted companies?
Answer: Unlisted companies are those companies that are not listed on any stock exchange of the country. These companies’ shares are known as unlisted shares.
Ques – How many shareholders can unlisted companies have?
Answer: The maximum number of shareholders that an unlisted company can have is two hundred. These companies cannot issue shares in public.
Ques – Is investing in unlisted shares safe?
Answer: The unlisted shares are a safe investment if you invest after proper research and analysis. There are anyhow risks involved in investment and unlisted shares are no exception.
Ques – How long does it take to get the unlisted shares transferred into my Demat account?
Answer: It generally takes a maximum of 24 hours to transfer the shares to your Demat account post the money is received by the intermediary.
Ques – Who are the intermediaries?
Answer: The intermediaries in the unlisted stock market are referred to as the brokers who deal in unlisted shares.
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