Reasonable valuation makes unlisted stocks attractive, say experts

However, investors have to deal with counterparty risk

Rakesh Jhunjhunwala recently said that his portfolio of unlisted shares has given him higher returns over the years compared to listed shares. If, after the ace investor’s view, you too are keen on a slice of the action in this market segment, first acquaint yourself with the potential upsides and risks.

Recently, Barbeque Nation listed on the bourses through an IPO. Investors, who had been holding the shares of this company for years, may decide to offload them, depending on how the market values their holdings.

A large number of other privately-held companies, too, have issued shares to investors and employees.

OTC transaction

Investing in unlisted shares is not difficult. “Any investor with a demat account can invest in them. He can decide the shares he wants to invest in, get in touch with sellers, and execute an off-market transaction. The shares will be transferred to his demat account directly or through well-established intermediaries via an over-the-counter (OTC) trade,” says Krishna Raghavan, deputy chief executive officer, unlistedkart.com, a market place for pre-IPO equity.

At any given point, many investors and employees are willing to sell their holdings because they need money. Buyers can negotiate a price with them.

High counterparty risk

When you buy a listed share, the procedure is well-defined. You place an order through a broker, the deal goes through, and the stock gets credited to your demat account on T+2 basis. But an unlisted share purchase is a transaction between two private parties with no exchange in between. So, counterparty risk is high. You pay in advance and then the shares get credited into your demat account. It is advisable to involve a broker or a mediator. If the transaction is large, enter into a formal agreement with the counterparty.

Liquidity can be an issue

To exit unlisted shares, you need to find a buyer and then transfer the shares either electronically or by submitting a delivery instruction slip to your broker.

“Liquidity depends on current demand and supply. Liquidity was a concern earlier. But with the unlisted segment growing, this challenge has become easier to meet. In the case of frequently-traded stocks, liquidity is immediate. You may have to sell at a discount of 2-3 per cent to the current market price,” says Raghavan.

Upside

If the management is sound, the company is into a new business and addresses a large market opportunity, enjoys leadership position, or has a moat in the form of intellectual property rights or a monopoly, its earnings can grow multi-fold and the share price can follow suit.

“You can get shares at reasonable valuations and benefit from the company’s early-stage growth. Retail investors get access to the same opportunities that are otherwise available only to large private-equity firms,” says Nitin Rao, founder, alphaideas.in. 

Risks

Investors must, however, be fully aware of the risks in such investments. Offloading these stocks at will could be difficult due to lack of liquidity. There is also counterparty risk. “Follow the right payment protocol while dealing with a buyer or seller,” says Raghavan. The price versus intrinsic value evaluation is also harder.

Limit your exposure

Not everyone is equipped to handle the higher risks in unlisted shares. The market is less transparent. Take expert help to understand the company’s prospects and the right price for the stock, or do rigorous homework yourself. If you do invest, keep exposure to this segment limited.