- Long-term average return from private markets could be substantially higher
Until recently, investment opportunities in private companies have only been available to large institutional investors. There is high demand for participation in well-known private companies and scope for generating a higher alpha, and so the investor landscape is now changing to include a broader set of audiences in the pre-IPO (initial public offer) investment universe.
Investing in private markets is a lot different and complex from investing in public markets. Pre-IPO investment has its own pros and cons. The long-term average return of private markets is substantially higher than traditional asset classes. Investment in alternatives is also gaining traction because of the diversification factor. Adding a portion of alternatives to the portfolio helps reduce the overall risk due to the volatility in the public markets.
While the opportunity to own a share of a promising business seems quite lucrative, it carries a significant amount of risk. Here is a list of a few key risks of investing in any pre-IPO company.
Private companies aren’t required to publicly disclose financial statements ; this makes it difficult to get clarity about the company. There is also no way to validate how well the company is doing.
There are many layers between the investor and the company in which you are investing, and it is often difficult to understand what the investment process can look like from an investor’s standpoint. For example, understanding the process of investing directly in a company versus investing via a single layer or dual layer special purpose vehicle (SPV) can be difficult for an individual. Different assets are located in different jurisdictions and, so, governed by different laws; it is important to understand this as these laws impact your exit.
Since the shares of private companies aren’t traded publicly, it is difficult to find sellers and also relevant information about them. Since investments in private markets are generally seller-driven, shares trade at different prices with different sellers. This makes it difficult to ascertain the right price or to value the investee company. Thus, one has to do extensive research before finalizing a deal.
Investment tenure and liquidity timelines
An investor also needs to be aware of before investing in the private market space is the liquidity aspect. Exit options in case of such asset classes is not as simple as with public market investments. Usually, exit options are available when the company goes public (either via a SPAC [Special Purpose Acquisition Company] or an IPO ) or when a big investor comes in or through secondary liquidity via some wealth management platform.
Larger cheque size
The quantum of investments required to qualify for this type of investment has been pretty high and has until now only been available to institutional investors. The investment size may not be much of an issue if you are looking for pre-IPO investing via unlisted shares from an unlisted shares dealer. Most brokers are providing the investment opportunity for a few thousand rupees. But, if you choose a wealth management firm facilitating pre-IPO investments, note that only accredited investors under financial regulation laws can participate in such investments. The minimum ticket size varies from one to another (it is $10,000 – 25,000 on Kristal.Ai for single-asset deals).
The key is to have a good understanding of the asset class before making any investment decision. The risk-reward ratio might be higher in case of private markets investing. This also bolsters the case for extensive research.
If you are investing in unlisted shares through a broker, make sure you do a thorough research of all the points mentioned above. If you are investing using a wealth management platform, make sure the one you select does extensive research by seeking additional information about the company and ensuring a due diligence process that is usually followed by an approval by the internal investment committee for further screening of the asset.
Manmohan Mall is the head of private markets, Kristal.AI.
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