If your focus is long term wealth creation, then investing in pre-IPO companies (those that haven’t been listed on the stock exchange yet) is a great option. However, this doesn’t come without its own risks. There are a number of factors you have to take into account before investing in unlisted shares. Some of these are listed below:
1. Capital loss
In cases where the company’s IPO has not been tried and tested, you might face the risk of total capital washout. The company might go bankrupt in the future, experience operational failures, or face a lack of future financing. Even if it does not fail, there is a possibility that a partial loss can result in lower-than-expected returns in the future.
Always make sure to invest only the amount of money that you can afford to lose. You should also diversify your investment portfolio by investing small amounts in different companies. Tip: Sign up with an over-the-counter service like Unlistedkart, which offers detailed reports about pre-IPO company shares so that you have an understanding of what you’re getting into.
2. Lack of liquidity
Whether a company is listed or unlisted, there is no guarantee about the liquidity of your investment. A lack of liquidity essentially means that there will be a difficulty in selling or trading the securities. With unlisted companies, the chances of selling shares in the future can look grim as there might be a lack of buyers interested if the company fails to generate a positive pulse in the market. Moreover, investing in unlisted shares ensures that you cannot count on a quick, short-term exit.
3. Scarcity of dividends
Most pre-IPO companies would rarely pay dividends since their shareholders world prefer that that money be reinvested in the company. Bear this in mind, and remember that if you are seeking recurring revenues derived from dividends, these might fluctuate or even be non-existent.
Any investment in pre-IPO shares could be subject to dilution. For example, a company might additional funds at a later date by issuing new shares. When new investors subscribe to these, the percentage stake in the issuing company held by investors who do not subscribe to this capital increase will fall.
5. The company may never go public
The IPO of a company, even if scheduled, is never guaranteed and liquidity could only develop over the long term. There is no guarantee about how long this will take. This may affect the value of the unlisted shares. You also may not be able to sell your shares and get back your investment.
6. Buying price
Given its illiquid nature, your buying price may be high as different pre IPO brokers charge different rates. If you research properly, it may cost you a lot. Make sure to check the valuation of the company at your buying price and compare with listed peers to check if the price you are paying is over or under the valuation.