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IPO vs pre-IPO: Which companies should you invest in?

IPO vs pre-IPO: Which companies should you invest in?

Calendar year 2021 has been a record year for initial public offerings (IPOs). Investing in IPOs can be an exciting proposition. You get to invest in new-to-market companies, some of which belong to categories that previously did not exist in the listed universe. And you could have listing gains.But what if you decided to take a step back, and invested in companies that are yet to reach the IPO stage? While this is not an either-or scenario, let's see how investing in IPO companies and pre-IPO companies compare as strategies.

Investing in IPOs

There are two reasons why investors subscribe to IPOs. For listing gains and as long-term investments.Let’s look at the first one first: listing gains.You will notice that the number of IPOs that hit the market every year is not consistent. Companies tend to list their shares when the market is doing well. That is because they expect to get good valuations. And during such times, companies often list with a premium. Many investors subscribe to public issues with the hopes they can make quick money, with the “listing pop” and exit soon after.The strategy does largely seem to work for the duration when the IPO market is hot. For instance, out of a total of 43 IPOs in 2021 so far, only 12 failed to make money on listing day, with the worst loss being 13.4%. Among the gainers, the best listing gain stood at 185%.But this strategy has limitations. The biggest being such IPO booms can be short-lived. Besides, since IPO allocations happen on a lottery basis, investors are not guaranteed to get subscription.What about investing in IPOs for the long term? There the record is not inspiring.For instance, since its launch in 2006, the BSE IPO index underperformed the Sensex consistently till March 2020. It is only since the IPO boom of the past one year that it has inched up ahead.

Source: Trendlyne

What to look out for before investing in an IPO

If you would like to invest in IPOs, here are a few rules to keep in mind.It is critical to keep an eye on the fundamentals of the company and analyse how it may perform in the future before you decide to invest. This is not just limited to the financial performance of the company. You should take into account aspects such as the company’s promoters and their credibility, valuations, existing institutional investors, underwriters, and many other such factors.It is also important to do a comparative study of the company against its peers. This review will help to understand other listed companies in the sector, their growth curve and also to compare their PE ratio.You should always read the draft prospectus to the issue which lays out the company’s strengths and opportunities, risks and challenges. Another important pointer to check before considering an IPO is to check how the proceeds from the IPO will be used.Always bear in mind that companies come to the market when they are sure to get a very good price for their shares. This typically translates into pricey valuations for investors. So the onus of due diligence falls on them even more.

Alternatives to IPO investing: Pre-IPO opportunities

IPOs are a good option because they allow you to invest in themes that may not have been investible before. To extend that argument further, investors can look at pre-IPO companies to gain such exposure. The advantage with investing in unlisted shares is that you may get to invest in companies before they become large -- so the price upside may be higher.India, like many countries globally, is in the midst of a startup boom. In fact, the current IPO mania is in large part driven by startups.Traditionally, investing in pre-IPO companies has not been easy to do, both from a process and due diligence standpoint. However, the advent of digital wealth managers such as Kristal has brought about a sea change in the way this is handled (more on which below).

Pre-IPO opportunities: Risks vs benefits

Investing in pre-IPO companies, especially early-stage startups can be a risky proposition. Many companies may have revenue growth but no profit while others may change their business strategies midway. Such companies also may not have a long track record, or their financials may also be difficult to assess, given that they are not subject to strict regulatory disclosure requirements that listed companies do.But these risks can be commensurate to rewards that can follow by successfully navigating these challenges. Which is why cases where investors have been rewarded 10x to 100x on such investments are not unheard of.This is why investing in pre-IPO companies is generally the reserve of sophisticated institutional investors.At Kristal, we mitigate most of these risks for investors. As part of our pre-IPO product offering, we invest in such companies where we have already done due diligence and shortlisted the most exciting options. If you wish to understand more about how we do this, contact us. Kristal invests in pre-IPO companies not just in India but also globally, which gives investors exposure to themes not available in Indian markets.

Conclusion

The IPO market periodically becomes an exciting investing prospect. However, long-term investors may be better off in either secondary markets or even the unlisted market to generate wealth.

By

Kristal Advisors

August 21, 2021

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