How to Buy Unlisted Shares in India

For investors looking beyond traditional stock market opportunities, unlisted shares represent an exciting alternative investment avenue. These pre-IPO investments have the potential to offer substantial returns, but they also come with unique challenges and considerations. This comprehensive guide will walk you through everything you need to know about buying unlisted shares in India.

What are Unlisted Shares?

Unlisted shares are equity shares of companies that aren't listed on any recognised stock exchange, such as the National Stock Exchange (NSE) or Bombay Stock Exchange (BSE). These companies haven't gone through the Initial Public Offering (IPO) process yet, but may be planning to do so in the future.

Unlisted shares typically belong to:

• Private companies with no immediate plans for public listing

• Companies preparing for an upcoming IPO

• Delisted companies that were previously traded publicly

• Shares held by employees through ESOPs (Employee Stock Ownership Plans)

• Shares of subsidiaries of listed companies

The key difference between listed and unlisted shares lies in their trading mechanisms. While listed shares can be bought and sold easily through stock exchanges with transparent pricing, unlisted shares are traded privately between buyers and sellers through intermediaries, with less price transparency.

Why Do Investors Buy Unlisted Shares?

Investors are drawn to unlisted shares for several compelling reasons:

1. Early-Bird Advantage: By investing before a company goes public, you might secure shares at significantly lower valuations compared to post-IPO prices. Historical examples like Reliance Retail and DMart have delivered extraordinary returns for early investors.

2. High Growth Potential: Many unlisted companies are in their growth phase with substantial expansion plans, potentially offering higher returns compared to mature listed companies.

3. Portfolio Diversification: Unlisted shares typically have a low correlation with public markets, providing genuine diversification beyond traditional asset classes.

4. Access to Unique Business Models: Some innovative companies remain private for longer periods, offering investors access to novel business models not yet available in public markets.

5. Lower Volatility: Unlike listed shares that experience daily price fluctuations, unlisted shares are generally less vulnerable to market sentiment and short-term volatility.

How to Invest in Unlisted Shares?

The process of buying unlisted shares differs significantly from purchasing listed stocks. Here's a step-by-step approach:

1. Identify Reliable Intermediaries

Since there's no centralised platform for unlisted shares, you'll need to connect with registered intermediaries who specialise in this market. Look for:

• Merchant bankers with pre-IPO departments

• Authorised stockbrokers who deal in unlisted shares

• Specialised unlisted share dealers with a good market reputation

• Investment platforms that offer unlisted equity as an investment option

• Portfolio Management Services or Alternate Investment Funds that invest in unlisted shares.

Make sure to verify their credentials, registration status, and track record before proceeding.

2. Complete Required Documentation

The paperwork for buying unlisted shares typically includes:

• Demat account details

• PAN card

• KYC documents (address proof, identity proof)

• Bank account details for payment transfers

• Share transfer forms (when purchasing from existing shareholders)

3. Select Target Companies

Research companies based on:

• Financial performance

• Management quality

• Growth prospects

• Industry potential

• Valuation metrics

Look for companies with solid fundamentals, transparent operations, and clear business models rather than chasing potential "unicorns" without substance.

4. Conduct Due Diligence

This critical step requires gathering and analysing:

• Latest financial statements

• Management background and reputation

• Business model and revenue streams

• Competitive landscape

• Exit opportunities (potential IPO plans, acquisition targets)

• Regulatory compliance status

Since information about unlisted companies isn't readily available, you might need to request these details directly from the intermediary or the company itself.

5. Negotiation and Transaction

Once you've selected a company:

• Negotiate the share price with the seller through your intermediary

• Transfer funds to the seller's designated account

• Complete share transfer documentation

• Ensure shares are transferred to your demat account

6. Record Keeping

Maintain comprehensive records of:

• Purchase price and date

• Share transfer documentation

• Communication with intermediaries

• Company information and financials

These records are crucial for future reference, tax calculations, and potential dispute resolution.

Things to Check Before Buying Unlisted Shares

Investing in unlisted shares can be profitable, but it comes with higher risks and lower liquidity compared to listed stocks. Before making any investment, consider the following key factors:

• Company Fundamentals

Assess the financial health and long-term viability of the business. Review audited financial statements, revenue trends, profit margins, debt levels, and cash flow. Understanding the company’s market position and growth potential is crucial.

• Promoter and Management Track Record

Research the background of the promoters and top executives. A credible and experienced management team with a history of sound business practices and ethical governance adds significant value.

• Valuation and Pricing

Evaluate whether the share price justifies the company's current performance and future potential. Compare it with valuations from recent funding rounds and with industry peers, if available.

• Liquidity and Exit Options

Unlisted shares are illiquid, and exiting your investment may take time. Check for potential exit strategies such as IPO plans, mergers, or acquisitions. Be prepared for a long holding period.

• Regulatory and Tax Considerations

Understand the taxation rules applicable to unlisted shares. Long-term capital gains (after 24 months) are usually taxed at 20%. Also, ensure the transfer process complies with SEBI regulations and is legally documented.

• Platform or Broker Credibility

Only buy through SEBI-registered intermediaries or trusted private equity platforms. Verify whether the platform performs due diligence on the companies they offers to investors.

• Shareholder Rights and Legal Agreements

Ensure that proper legal documentation, like a Share Purchase Agreement (SPA), is in place. Clarify your rights as a shareholder, including voting rights and entitlement to dividends.

• Risk Assessment

Unlisted investments carry high risks. Consider business viability, market volatility, the possibility of share dilution in future funding rounds, and the lack of regular disclosures.

Benefits of Investing in Unlisted Shares

Investing in unlisted shares offers several distinct advantages:

• Potential for Outsized Returns

Pre-IPO investments can deliver exceptional returns when companies successfully go public. For example, early investors in Zomato before its 2021 IPO saw their investments multiply significantly when the company listed.

• Lower Entry Valuations

Unlisted shares typically trade at discounted valuations compared to their expected market value post-listing, providing a margin of safety for patient investors.

• Strategic Investment Allocations

For sophisticated investors, unlisted shares can form a strategic portion of their portfolio (typically 5-15%) focused on higher-risk, higher-return opportunities.

• Access to Future Unicorns

Many fast-growing technology companies remain private for longer periods today, allowing private investors to participate in their rapid growth phase before public listing.

• Long-term Wealth Creation

With appropriate research and patience, unlisted shares can become significant wealth creators in a diversified portfolio. Companies like Asian Paints, HDFC Bank, and Bajaj Finance have created enormous wealth for early investors who got in before these companies became household names.

Taxation on Unlisted Shares in India

1. Taxation of Unlisted Equity Shares

The taxation rules for unlisted equity shares in India are similar to those for listed shares, but with a few important distinctions, particularly in the holding period criteria:

• Short-Term Capital Gains (STCG):
  Gains from the sale of unlisted shares held for 36 months or less are classified as short-term capital gains. These are taxed at 15%, along with applicable surcharge and cess.

• Long-Term Capital Gains (LTCG):
  If the unlisted shares are held for more than 36 months, the resulting gains are treated as long-term capital gains and taxed at 20% with the benefit of indexation.

• Dividends
  Dividends received from unlisted shares are taxed at the Income tax slab rate of the individual.

This contrasts with listed shares, where the short-term threshold is 12 months, and LTCG is taxed at 12.5% without indexation for gains exceeding ₹1.25 lakh.

2. Tax Deducted at Source (TDS):

• For resident Indians: No TDS on sale proceeds

• For non-residents: TDS applicable as per relevant tax treaties

3. Important Tax Considerations:

• The cost of acquisition must be properly documented

• Indexation benefits significantly reduce tax liability for long-term holders

• Gift tax implications may apply when transferring unlisted shares

How to Sell Unlisted Shares?

Selling unlisted shares requires planning and patience:

1. Identify Potential Buyers

• Other high-net-worth individuals interested in pre-IPO investments

• Family offices and small private equity firms

• Dedicated pre-IPO funds

• Existing shareholders of the company

2. Work with Intermediaries

• Re-engage with the intermediary who facilitated your purchase

• Connect with specialised unlisted share dealers

• Explore online platforms that facilitate unlisted share transactions

3. Pricing Considerations

• Determine fair value based on the company's current financials

• Consider recent transaction prices for the same shares

• Factor in any major developments since your purchase

• Be prepared for price negotiation

4. Transaction Completion

• Share transfer forms (duly signed)

• Demat account transfers

• Consideration receipt

• Tax implications documentation

5. Timing Your Exit

• Pre-IPO announcements often create liquidity and price appreciation

• Major funding rounds might provide exit opportunities

• Company buybacks can offer liquidity windows

Risks Involved in Buying Unlisted Shares

Despite their potential, unlisted shares come with significant risks:

• Liquidity Risk The biggest challenge with unlisted shares is finding buyers when you want to sell. Unlike listed shares with immediate liquidity, unlisted shares might require months to find suitable buyers.

• Valuation Uncertainty Without market-determined prices, valuations are often subjective and negotiable, creating uncertainty about fair value.

• Information Asymmetry Limited disclosure requirements mean investors often operate with incomplete information compared to company insiders.

• Regulatory Changes Changes in regulations governing unlisted shares can impact your investment, particularly around holding requirements and tax treatment.

• Corporate Governance Issues Private companies may have less stringent corporate governance standards, potentially leading to issues that could affect shareholder value.

• IPO Delays or Cancellations Companies may postpone or cancel planned IPOs due to market conditions or strategic changes, extending your investment horizon indefinitely.

• Counterparty Risk When dealing through intermediaries, there's always risk associated with the reliability and integrity of the parties involved in the transaction.

• Market Cycles Economic downturns can significantly impact private company valuations and their ability to raise further capital or achieve successful exits.

Conclusion

Buying unlisted shares in India can be a rewarding investment opportunity if approached with due diligence and a clear understanding of the process. By following the right steps—identifying credible sellers, conducting thorough research, verifying compliance, and using trusted intermediaries—you can tap into high-growth companies before they go public. Always be mindful of the risks, taxation implications, and legal aspects to make informed decisions and safeguard your investments.