Unlocking hidden wealth: Why HNIs should explore secondary sales in the unlisted space

In the early days of Indian financial markets, investment opportunities were limited to public stocks, government bonds, and a narrow range of financial instruments. Venture capital (VC) and private equity (PE) players entered the market in the late 90s and early 2000s, and the space was dominated by large institutions and global players with limited opportunities for high-net-worth individual (HNI) investors. 

With limited access to the unlisted space, ultra-high-net-worth individual (UHNIs) investors and successful founders came together and formed angel networks to participate in the space and have played a key role in organising the startup ecosystem.

Some of these networks then branched out and started funds or joined existing large institutional players.

Post 2012, with the advent of Alternative Investment Funds (AIFs) in India, VC and PE funds started raising funds from large UHNI families and HNIs. HNIs had indirect exposure to unlisted companies and startups by investing in such funds but had no direct control over the investee companies.

When these funds failed to generate the expected return, investors wanted direct stakes, especially in their respective industries, where they could provide managerial inputs.

The allure of investing in unlisted stocks has become the topic of conversation among HNIs, often considered as social currency. While many investors have started investing in early-stage startups, pre-IPO or late-stage investments through secondary shares are on the rise.

The risk associated with early-stage startup investments is higher, primarily because the success rate of startups is significantly lower compared to established companies, which have gone through several funding rounds and offer lower risks and attractive returns.

Over the last few years, secondary deals in the unlisted space have been on the rise. A secondary deal is between existing and incoming investors, and the cash doesn’t go into the company.

With early and mid-stage investors looking for an exit in the company, several stockbrokers, wealth managers, and online platforms have sold shares of these companies to HNI and UHNIs and even retail investors. 

Many investors now believe that incorporating a multi-asset portfolio with a 5–10% allocation to the unlisted space can enhance diversification and offer potential upside through listing gains or subsequent funding rounds within the same company. However, some have faced challenges, such as entering at high valuations and navigating the complex share transfer process, which can take six to nine months to complete.

In the last few years, IPOs have given substantial returns to investors. However, due to IPO allotment being only a fraction of the number of shares applied for, investors have participated in the secondary sales of the shares they believe will give them outsized returns.

It is important to note that the IPOs of Paytm, LIC, and Delhivery did not do as well.

While unlisted shares offer the potential for diversification and high returns, they come with significant risks, including illiquidity and limited transparency. Unlike listed stocks, there is no mandatory requirement for these companies to disclose updates and quarterly results.

For example, Swiggy shares were sold in the secondary market without its annual results for the previous financial year published, primarily due to the hype created in the market by various intermediaries. 

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It is crucial to thoroughly research any company before investing and ensure you understand its financial standing and growth potential. Investors seeking to build unlisted positions through secondary market deals in their portfolios should evaluate the following:

Check for comparable companies in the listed space and assess premiums

Before investing in unlisted securities, evaluate whether a comparable company exists in the listed market. Analyse the financial metrics, growth prospects, and valuation multiples of such companies. Assess the premium at which the unlisted company is trading relative to its listed peers. A high premium may indicate overvaluation, which could limit future returns, especially in the absence of a near-term liquidity event like an IPO.

Visibility of an exit and liquidity in the unlisted space

A key aspect of investing in unlisted securities is understanding the potential exit routes. Investors should consider the likelihood of an IPO in the foreseeable future, as this can significantly influence the investment’s attractiveness. Additionally, analyse how liquid the stock is in the unlisted market—some unlisted stocks are traded actively in secondary markets, while others may be illiquid, making it difficult to find a buyer when needed.

Be prepared for exit opportunities if the IPO is delayed

The timeline for an IPO can often extend beyond initial expectations due to market conditions or company-specific challenges. Investors should monitor the market dynamics and identify opportunities to exit via secondary sales if the IPO timeline is delayed. Being proactive is critical to avoid being caught when market sentiment turns negative or if a bubble in the unlisted market bursts, leading to significant valuation corrections.

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Intermediary’s credibility and track record

The intermediary facilitating the transaction plays a crucial role. Investors should perform due diligence on the intermediary, assessing their reputation, experience, and track record in handling secondary market deals. Look for intermediaries known for completing transactions at fair valuations and providing adequate support, including potential exit opportunities, if required. An intermediary with a strong network, investment banking arm and expertise can be an asset in navigating the unlisted market.

Prudent allocation and investment horizon

Given the risks and illiquid nature of unlisted investments, it’s prudent to limit exposure to 5-10% of one’s financial assets. Additionally, only allocate funds that can be locked in for a medium-to-long-term horizon, typically 3-5 years. This ensures that other financial goals and liquidity requirements remain unaffected, and investors can withstand potential delays in achieving returns.

To maximise value in the unlisted market, it's essential to invest at the right time, avoiding overvaluation due to emotional investor sentiment.

Ankur Punj is the Managing Director and National Head of Equirus Wealth.