The good, bad, and ugly of India’s pre-IPO market

The recent surge in NSE’s share price in the pre-IPO market has reignited public interest in India’s fast-evolving alternate investment ecosystem. But this is only the surface. What lies beneath is a deeper, complex and risky world of pre-IPO investing.

The Good

The last three calendar years have seen an aggregate of over 200 mainboard IPOs and over 530 SME IPOs in India. In anticipation of making listing-day gains, the majority of these IPOs saw significant oversubscription from retail investors.

With allotment probability declining over the years, a certain class of retail investors have taken a liking to pre-IPO markets for getting in early in anticipation of mega-wealth creation post listing. An important point to note here is that shares bought in the pre-IPO market typically have a lock-in of six months from the date of listing. Historically, this strategy has delivered with marquee names like the BSE, Avenue Supermarts, etc., generating astronomical returns for investors.

The Bad

That said, pre-IPO investing is far from foolproof. The low barriers to entry, combined with a herd mentality and lack of due diligence, have led many retail investors into murky waters. The result? Meaningful capital destruction.

New-age start-ups like Paytm and Pharmeasy and even legacy names like Reliance Retail and Tata Technologies, have left such investors nursing losses due to poor entry valuations and improper exit timing. This clearly highlights the amount of risk involved and why counter-intuitive thinking and caution are not optional, but rather critical to succeed in this space.

The Ugly

Then there’s the “grey” zone, quite literally. Pre-IPO investing lacks formal regulatory oversight. Sebi’s current regulatory framework revolves around listed securities, which leaves the pre-IPO space in a regulatory vacuum. In this grey area, deal re-negotiations, back-outs, and delivery failures are alarmingly common.

From fringe brokers to established FPIs, the absence of a signed share purchase agreement or reliance on loosely worded letters of intent is often exploited as an excuse to walk away from commitments, turning these documents into tools of convenience rather than accountability.

How to deal with the bad and the ugly?

Like with any other investment, it is paramount to evaluate opportunities through the lens of underlying business strength demonstrated through reported financials. Another critical aspect to consider is the visibility of an IPO, which can be evaluated through management commentary on the IPO timelines.

Lastly, it is prudent to consult an investment advisor from an allocation as well as investment evaluation perspective as pre-IPO investments can have a highly illiquid nature in certain cases. For the transaction execution, it is imperative to maintain a communication trail and have signed documentation in place.

In such a nuanced market, it’s wiser to pay a premium and work with institutions that live and breathe pre-IPO investing. Cutting corners with fly-by-night operators to save a little can lead to costly errors in judgment, and this is one space where being penny-wise often turns pound-foolish.

Taxation of pre-IPO shares

Short-term capital gain: If sold within 24 months of acquisition of shares, gains taxed as per the investor’s slab rate

Long-term capital gain: If sold after 24 months of acquisition of shares, gains taxed at a rate of 12.5% without indexation benefit

Sale of shares to Non-Resident Indians (NRI)

NRIs having a demat account can purchase pre-IPO shares unless expressly debarred by investee companies to maintain foreign investment limits

The domestic seller in transaction needs to file foreign currency transfer of shares (FCTRS) form with the RBI within 60 days of the completion of trade.

Where does the pre-IPO market go from here?

Despite its challenges, the pre-IPO market continues to mature, as evidenced by the shareholder count for NSE going over 1 lakh investors. Improving governance, rising professional intermediaries and potential Sebi regulations, all will lead to a more structured pre-IPO market.

Follow a disciplined philosophy, evaluate each investment on merit and avoid the market noise. Because while the good may be exciting, the bad instructive, and the ugly cautionary, the opportunity, when chosen wisely, is very real.

Smit Jhaveri is the co-founder of Ekvity.