What Are Unlisted Shares? A Complete Guide for Indian Investors

What are Unlisted Shares? Any shares of a company which are not traded on any of the recognized stock exchanges like the NSE or BSE, are known as unlisted shares. A large number of companies in India are unlisted. These may include private companies, companies which are about to be listed, or companies in which the equity is not available through the stock markets. Like listed stocks, unlisted stocks are also purchased and sold. However, unlisted stocks do not have an order book, and there is no centralized location from which the buy and sell prices can be determined.

The lack of an order book is only one of many differences between listed and unlisted stocks. There are differences in the way these stocks are valued, how they are transferred, and how they are held in a Demat account. Unlisted stocks can provide an investor an opportunity to purchase shares of companies which are not otherwise available for trade. However, unlisted stocks can be extremely illiquid, and there may be significant risks associated with valuation and price appreciation.

This article provides a beginner’s guide to unlisted shares in India, and provides a risk adjusted framework for investing in unlisted stocks, including stocks of companies which are being offered to the public for the first time.

What Are Unlisted Shares?

Equity shares that are not listed on any stock exchange are referred to as unlisted shares. Shares listed on a stock exchange are freely tradeable, while shares listed on other exchanges are not.

Let us consider Company A, which is a private company and has not listed its equity shares on any stock exchange. Hence, equity shares of Company A are unlisted shares. Equity shares of Company A may be listed and traded on a stock exchange after Company A has completed its Initial Public Offer (IPO).

Pre-IPO shares mean the unlisted shares of a company which intends to or is expected to list its shares on a stock exchange. Not all companies in the market are planning to go public and therefore not all unlisted companies are expected to be listed in the stock exchange. Hence, it is erroneous to assume that each and every company has a liquidity event in the near term.

Listed shares and Unlisted shares

The main difference between listed shares and unlisted shares is the presence of a regulated and developed market. Listed shares are tradeable shares which have their prices quoted on the stock exchange, and therefore have a large number of potential buyers and sellers. Unlisted shares do not have an organized market, and therefore, their prices are not determined.

The absence of exchange trading does not mean that an unlisted share has no value. It means that the investor should understand the valuation and exit process before investing.

How do unlisted shares work in India?

The investment process for unlisted shares is split into different steps such as identifying an opportunity, evaluating the company, completing the purchase, and holding and later transferring the shares.

1. Identifying an opportunity: Investors learn of unlisted company shares through a number of channels including, existing shareholders, eligible intermediaries, private deals and/or platforms that facilitate deals in unlisted securities. Shares of companies listed on these channels can vary from time to time.

2. Evaluating the company: A potential investor must evaluate the financial and operational aspects of the business including but not limited to the company’s financial statements, ownership structure and governance, as well as the company’s liabilities, capital structure and potential avenues for an exit.

3. Closing the deal: An agreement between the buyer and seller on the price and volume is reached after the buyer and seller satisfy themselves on the legal and regulatory issues as well as the terms and conditions set by the company and the intermediaries involved.

4. Receive and hold the shares: Where the security and issuer are eligible for dematerialisation, shares may be held electronically through a Demat account. The exact process depends on the security, issuer and applicable requirements.

5. Selling or Transferring Shares: Shares are sold if the investor is able to find a buyer and legal and other restrictions on transfer are satisfied. Possession of shares does not guarantee an exit.

How do Investors Buy Unlisted Shares?

Purchasing unlisted shares is not the same as placing a buy order for shares of companies listed on the NSE or BSE. Investors cannot post orders on an order book for an unlisted share.

Investors have to find alternative ways to purchase unlisted shares depending on the company. Some ways of purchasing unlisted shares include purchasing shares from current shareholders or using a broker.

Investors should examine the party selling the shares, the party facilitating the transaction, the title to the shares, and the documents provided.

Before paying for the shares, investors should check the company is authentic, the seller or broker is legitimate, the share price and quantity, bank account details, charge for the transaction, and how the shares will be transferred to him/her/them. Investors should be careful to not fall for offers for shares of companies which are known to list their shares, or share offers which look too good to be true.

SEBI has previously warned investors about shares offered through unauthorized private placement, and has other mechanisms to hear investors complaints about unlisted companies. As such, investors should make their own due diligence about companies and shares offered, and not take company promoters' or agents' assurances at their word.

Can Unlisted Shares Be Held in a Demat Account?

Yes, unlisted shares can be held in a Demat account. Depositories have the authority to establish guidelines and determine eligibility of unlisted securities for dematerialization. Further, specific companies can set conditions on the securities to be eligible for dematerialization. The entrusting depository, e.g. CDSL, can also establish guidelines to allow eligible unlisted companies to be listed on the depository for dematerialization.

As a result, not all unlisted securities are processed similarly. Prospective investors are encouraged to confirm the following details prior to investing: Is the security or issuing company sponsored by a depository? How will the share be transferred? How will the share be credited to the investor?

Further, having a Demat account does not guarantee that an unlisted security will be listed and traded on an exchange. Unlisted shares, regardless of their electronic form, will remain unlisted.

Determinining the Price of Unlisted Shares

The main difference between listed and unlisted shares is how their prices are determined. With listed shares, their prices are determined by the shares’ exchange listings. Transactions for a company’s unlisted shares are done over-the-counter. Thus, unlisted shares do not have continuously listed prices.

Prices of unlisted shares are determined by:

• Recent transactions involving the same company's shares.

• The company's revenue, profitability and cash flows.

• Assets, liabilities and net worth.

• Growth expectations and the quality of the business.

• Shareholding structure and rights attached to the shares.

• Comparable listed and unlisted companies.

• Demand and supply among potential buyers and sellers.

• Expectations regarding a future funding round, strategic transaction or listing.

• Valuation methods used by investors, advisors or transaction participants.

An indicative or quoted price from an intermediary should not automatically be treated as the company's intrinsic value. Two transactions can occur at different prices because the timing, quantity, buyer, seller, liquidity and transaction terms may differ.

What Causes a Single Unlisted Security to Trade at Multiple Prices?

Without an exchange to provide transparency and address information asymmetries in the market, sellers and buyers of unlisted securities often transact at prices that reflect their own individual assessments of a security’s worth. Transactions of larger sizes may contain different terms from smaller transactions.

Therefore, it is prudent for the investor to analyze the terms of the trade to understand the rationale for the trade, assess the level of recent activity in the security, analyze the extent to which the quoted price represents the company’s most recent financing, and examine the company’s fundamentals to determine if the quoted price represents value.

How Are Unlisted Companies Valued?

Although the procedures to value unlisted companies and listed companies differ, the conceptual differences are not very dramatic. An unlisted company's valuation rests more on judgment than an listed company's valuation.

Revenue and earnings multiples, price to book value, enterprise multiples, and discounted cash flow are the main valuation metrics. Among the above metrics, cash flow multiples and discounted cash flow are prevalent in the valuation of listed companies.

Valuation also depends on the rights attached to the shares being sold. Different classes of shares may have differential voting or economic rights. An investor may need to study the company's articles of incorporation and other legal documents in order to understand the valuation fully.

This article has focused on the valuation of unlisted companies. For a general guide on the valuation of listed companies, see how to value a stock in India.

Some Potential Benefits of Owning Unlisted Shares

There are potential benefits of investing in unlisted shares; however, these need to be assessed against the risks.

• Access to private businesses: Investors may gain exposure to companies before they become publicly traded.

• Potential diversification: Unlisted equity can represent a different part of the market from an investor's listed portfolio, although it remains equity risk.

• Long-term participation: Some investors may be interested in holding a business through a longer development period rather than trading it frequently.

• Opportunity around corporate events: A future IPO, strategic investment, merger or other transaction can change the liquidity or valuation profile of an unlisted company. However, such events are uncertain.

These potential benefits should not be interpreted as a prediction of returns. An unlisted company can also remain private for many years, require additional capital, face business difficulties or become harder to sell.

Most Important Risks Related to Investing in Unlisted Shares

1. Risk of Loss of Capital (or Liquidity Risk)

This is the most important risk in practice. An investor may wish to sell his shares, but there may be no buyer. An investor of unlisted shares cannot put a sell order on an exchange and wait for a buy order.

2. Risk of Unjustified Value (or Valuation Risk)

Without quoted prices of shares, it may be difficult to determine whether shares of a company are overvalued or undervalued.

3. Risk of Information Asymmetry (or Information Risk)

Generally unlisted companies do not provide regular disclosures. Consequently, investors may need to do more work to gather information than they are used to.

4. Risk of Business Failure (or Business Risk)

All businesses face risks of loss of customers, insolvency, competition, regulation, management, etc. Just being a good prospective IPO company does not shield a business from these risks.

5. Transfer and Legal Restrictions

Some unlisted shares, particularly shares of private companies, can be subject to restrictions under applicable law, the company's articles, shareholder agreements or transaction documents. Investors should verify whether there are rights of first refusal, approval requirements, lock-ins or other restrictions before purchasing.

6. Risk of IPO (or Listing Risk)

A common misconception is that buying pre-IPO shares guarantees participation in an upcoming IPO. A company may delay, change or abandon a proposed listing, and an eventual listing does not guarantee a particular market price.

7. Fraud and Counterparty Risk

Be wary of faked documents and fraudulent payment requests. Be wary of any offers for guaranteed listing profits. All investments are risky, and investors should conduct their own due diligence, including verifying the counter-parties to the transaction.

Unlisted Shares and Taxation in India

There are several situations in which the taxation of capital gains from the transfer of shares is dependent on the nature of the shares, the period of holding, the terms and conditions of the transfer, and the applicable provisions of the Income Tax Act. As per the Income Tax Department, the holding period of unlisted shares to qualify as a ‘long-term capital asset’ is generally more than 2 years, unless otherwise provided in the statute.

It is not correct to presume that unlisted shares would be taxed like listed shares. The reasons for the same include the nature of the shares, the terms and conditions of the transaction, and the provisions of the Income Tax Act that would be applicable to the transaction.

Investors should consult the Income Tax Department’s website and/or a tax accountant for the latest information on taxation and compliance, as the case may be.

What Should You Check Before Buying Unlisted Shares?

A practical due-diligence checklist can help prevent investors from focusing only on the possibility of a future listing.

1. Company identity: Verify the legal name, CIN and registered details of the company.

2. Business fundamentals: Review revenue, profits or losses, cash flows, debt and business model.

3. Share capital: Understand total shares outstanding, recent issuances and potential dilution.

4. Ownership: Review promoters, major shareholders and material changes in ownership.

5. Valuation: Understand the basis for the asking price and compare it with relevant financial metrics.

6. Share rights: Check voting rights, class of shares and any special rights or restrictions.

7. Transferability: Confirm whether the shares can be transferred and whether company or shareholder approvals are required.

8. Demat details: Verify ISIN and the process for receiving the shares in Demat form where applicable.

9. Exit route: Ask who could potentially buy the shares later and whether there is any realistic secondary-market route.

10. Transaction documentation: Review the agreement, payment instructions, charges and supporting documents before committing funds.

11. Listing assumptions: Treat any expected IPO or corporate event as uncertain unless formally announced and supported by reliable documentation.

For the next step in understanding the process, investors can refer to How to Buy Unlisted Shares in India: Step-by-Step Guide once that supporting guide is published.

Unlisted Shares: A Practical Investor Framework

Considering an investment in unlisted shares? Breaking your case down into the four questions: What am I buying? What am I paying? What can go wrong? How will I sell? is a good place to start.

You first need to understand the business and the nature of your investment. Next, understand the price and move away from the IPO narrative. Next, think about the risks. Will the business change for the worse? Will the share be diluted? Will there be more information disclosed? Will there be other shares created? Will you be able to sell? You need to have an answer to all of these before you invest.

Always consider the worst case scenario. Be prepared to not have the share be worth anything. You need to prepare to hold the share indefinitely. You may not have the means to easily sell the share if you need to.

Are Unlisted Shares Right for Every Investor?

No single investment structure is appropriate for every investor. Unlisted shares require more due diligence and generally involve greater uncertainty around liquidity and price discovery than actively traded listed shares.

Beginners should first understand basic concepts such as equity ownership, Demat accounts, fundamental analysis, valuation and investment risk. The stock market basics in India guide can help build that foundation.

Investors who are considering an unlisted opportunity should also avoid committing money solely because a company is described as a future IPO candidate. A sound investment process starts with the underlying business, valuation, ownership structure and exit possibilities.

InvestEdge360 provides educational information to help investors understand market concepts. Investors should independently verify transaction documents, applicable regulations, taxation and intermediary credentials before making any investment decision. You can also Explore Unlisted Shares in India to understand the available information and opportunities on the InvestEdge360 platform.