HNIs target companies at pre-IPO stage

They can earn super-normal profits, but any delay in the offer would mean a longer holding period

They can earn super-normal profits, but any delay in the offer would mean a longer holding period. TINESH BHASIN writes

For high net-worth individuals (HNIs), getting the desired allotment in initial public offerings (IPOs) has become difficult. In Amber Enterprises India issue, for example, the noninstitutional category was subscribed 519.26 times. Consequently, many HNIs are actively looking at other places for hefty returns. One option, which has emerged in recent times, are companies which are planning to go for an IPO in a few months.

Getting shares in the unlisted companies at the pre-IPO stage means an investor can get a higher number of shares than in an IPO and at a lower price. “To get a higher exposure, wealthy investors they are happy to go up the risk curve and take an exposure at an early stage of the IPO cycle – even 12-18 months before the planned listings, at times,” says Prateek Pant, head of products and solutions at Sanctum Wealth Management.

Investment managers point out that there’s high demand for companies in banking, financial services and insurance (BFSI) space. At present, investors are scouting for opportunities in companies such as Hero Fincorp, UTI Asset Management Company, HDB Financial Services (a subsidiary of HDFC Bank), Metropolitan Stock Exchange of India, FINO Paytech and Smaaash Entertainment, according to industry sources.

While there’s potential to make higher returns to listed equities, it carries much higher risks compared to listed companies. Investors need to tread with caution. If they don’t have the time to evaluate the companies, they can look at a few Alternative Investment Funds (AIF) launched that focus on this space. Getting into the game: Most HNIs in the pre-IPO space acquire shares through intermediaries. The intermediaries can be stockbrokers or individuals who have acquired a significant number of shares from an existing investor or employees with stock options, and then sell them in parts at a profit. At times an existing investor wants to offload part of his stake and a group of HNI investors acquire them. Promoters selling a part of their stake is not common.

These deals can give investors high returns when markets are doing well. Investors, however, need to keep return expectation practical from the bouquet of investments they make. “These investments should give an alpha (risk-adjusted returns) over listed equities of threefive per cent,” says Nishant Agarwal, managing partner and head of family office, ASK Wealth Advisors. If investors expect to make 12-15 per cent in equities, return expectations from pre-IPO investment should be 17-20 per cent.

While there are could be many opportunities available, investment advisors say that they first look at the uniqueness of the sector. They usually prefer companies that don’t have many or no listed peers at all. “If there are many listed peers available, return expectation should be close to listed equities,” says Agarwal. At present, one can look at stock exchanges, small banks and so on.

Apart from doing the valuation and evaluating future earnings, analysts looking at such deals then look at other investors in the company. If there are well-known global institutions in the company, it gives them comfort.

Liquidity will be an issue:

There’s also the risk of the delay in IPOs due to regulatory clearance or the company calling off the fund-raising plans due to market conditions. Wealth managers point out the case of National Stock Exchange where the IPO got delayed due to its pending co-location case with Securities and Exchange Board of India (Sebi) has caused uncertainty. “Exiting companies whose IPOs are delayed can be difficult as there’s no formal mechanism to trade shares in unlisted companies,” says Abhijit Bhave, CEO at Karvy Private Wealth.

Bhave also suggests that when an investor gets into such deals, he should be willing to stay invested for at least three years. “Investors should treat these investments just like they would look at listed companies,” says Bhave. Sebi also mandates that shareholders cannot sell their holdings for one year after the listing date. Only specific category of shareholders, like employees with stock options, are permitted to sell before one year of listing. By the time an investor can sell there is a possibility that market starts correcting and so does the company’s stock.

As wealthy investors are eyeing this space in a big way there has also been proliferation if intermediaries. Investors need to be careful of the intermediaries they are dealing with. Investment management companies point out that such transactions are fraught with risk of fraud. There have been cases of unscrupulous intermediaries collecting money from investors and not delivering shares. Investors should stock to brokers known to them or their investment advisors.

Wealth managers also say that as more and more investors chase preIPO deals, the sellers are offering it at aggressive valuations. Going forward, it may get difficult to get a high discount to the listing price. Even at present price discovery can be a challenge for an investor if he doesn’t have professional help as little information is available about unlisted companies.

Spread risks though funds:

Those investors who don’t have the time and inclination to analyse the companies in depth, are better off with funds focussed on such deals. A few companies such as IIFL Asset Management and Edelweiss Group, have such AIF funds, where minimum investments as mandated by Sebi is ~10 million.

By investing in a fund, the investor can diversify across companies at a smaller amount. “Funds get better deals from institutional investors looking to sell a significant stake. Even their evaluation criteria are far superior to what individual investors can do,” says Prashasta Seth, CEO, IIFL Asset Management. Seth says that the fund looks at historical data, there are multiple rounds of discussions with the seller, view on industry experts are sought, there are meetings with the management, there are checks on the suppliers and so on.

Wealth managers do agree with the reasoning, they say that AIFs can have high fee and profit sharing that investors need to bear in mind.