The avenues available, the role of syndicates, private placement vs grey market, and SEBI’s warning to investors
Did you know that you can invest in shares of a company that are not yet listed on the stock exchange? It’s a common practice and one that has been gaining in popularity in recent years among investors. The startup boom and flurry of IPOs is driving the trend, with investors eager to get their hands on shares of plum companies in up-and-coming sectors.
While it is legal to purchase unlisted shares, invest in pre-IPO companies, and make investments in startups via syndicates/private placement, there are some things to keep in mind as an investor to safeguard your interests (and your money!)
At present, there are numerous “specialised” online brokers, who are not registered with India’s market regulator SEBI, offering shares in unlisted companies. These are typically small, independent outfits with no ties to established market intermediaries or brokerages. The shares they offer often belong to companies that have either announced or are planning to go public.
And this is why SEBI (Securities and Exchange Board of India) put out a statement cautioning investors and sounded the alarm on online platforms enabling transactions in unlisted shares of public limited companies. According to SEBI, such activities violate the Securities Contract (Regulation) Act of 1956 and the SEBI Act of 1992, putting these operations in direct conflict with established market regulations. The regulator also urged investors to stay cautious and avoid sharing personal information with unregistered platforms.
The December 9, 2024 press release stated:
- Some unlisted companies are luring retail investors by issuing securities including non-convertible and convertible debentures/ non-convertible and convertible preference shares/ equity shares in the garb of private placement, without complying with the provisions of Companies Act, 1956 read with the Companies Act, 2013, SEBI (Issue and Listing of Debt Securities), Regulations, 2008, SEBI (Issue and Listing of Non-Convertible Redeemable Preference Shares), Regulations, 2013 and SEBI (Issue of capital and Disclosure Requirements) Regulations, 2009.
- Any offer of securities made to 50 or more persons has to be construed as a “Public Offer” under the provisions of Companies Act, 1956.
SEBI has made it clear that only recognised stock exchanges and entities are authorised to facilitate fundraising and trading in securities of listed and soon-to-be-listed companies. And any offer to50 or more persons must be made as a public offer. To understand SEBI’s warning better, let’s look at the different kinds of investment outside of the bourses, and what they mean.
Primary vs secondary market shares
There are two main avenues to buy and sell listed shares: the primary market and secondary market. In the primary market, shares are purchased directly from the company, with the company receiving the proceeds from the sale. In the secondary market, shares are bought from existing shareholders, and the company does not receive any funds from these transactions.
The sale and purchase of shares in the private (or grey) secondary market means a current shareholder of a company has directly sold their shares to a buyer. Since these shares are not publicly traded on a stock exchange, these sellers could include the company’s promoters, family members, or former employees who acquired shares through employee stock ownership plans (ESOPs).
Unlisted shares
Unlisted shares are financial assets that don’t trade on traditional stock exchanges but instead change hands over-the-counter (OTC). Unlike listed stocks, which fall under the watchful eye of SEBI, unlisted shares operate in an unregulated space, making them a riskier investment.
However, they also present a unique opportunity: a chance to get in early on new-age, high-growth businesses that could deliver lucrative returns in the future. For savvy investors willing to take the plunge, unlisted shares could unlock significant potential.
Pre-IPO, PMS, AIF and startups
Other ways to invest in unlisted shares is through pre-IPO companies, PMS, AIF and startups.
Pre-IPO: Investing in pre-IPO companies gives you early access to promising companies before they go public. These unlisted companies plan to list on stock exchanges soon. The process is simple—shares are transferred directly to your Demat account, even though the trade happens off-record. But investors must choose a reliable and trusted intermediary to minimise risks.
PMS and AIF: Portfolio Management Services (PMS) provide a professional, hands-on approach to investing, with experts adjusting portfolios based on market trends to maximise returns. Similarly, Alternative Investment Funds (AIFs) pool money from investors to invest in high-growth opportunities like hedge funds, venture capital, or private equity.
Startups: Another option for investors is unlisted startups or innovative companies with high growth potential. While these businesses may not be widely known yet, they offer the chance for strong future returns and early access to the next big market disruptors.
So interested individuals who would like to diversify their portfolio can buy unlisted shares and invest in “valuable” startups and pre-IPO companies ahead of their listing.
Startup investments, syndicates, and what they mean
Startups are always on the lookout for funds to get their ideas off the ground and to grow their business. One among the many avenues available to them (like venture capital forms, angel investors, private equity firms etc) is a syndicate.
A syndicate is an investment platform that lets backers team up with seasoned, reputable investors or leaders to co-invest in some of the most promising startups in the market.
A syndicate leader is a business angel who has been in the industry for a while, has rich experience in investing, with exposure to multiple sectors and access to dealflows (the rate at which they receive investment offers). They are supposed to have a proven track record, a sound sense of judgement in making the right investment, and even receive exclusive dealflows. Think of them as seasoned pros who should know the ins and outs of startup investment.
A backer is an investor who either lacks significant experience in startup investing or opts to rely on a leader to manage investments and select the right startups to back. This approach allows backers to participate in the startup ecosystem without directly handling investment decisions.
This form of investment happens well-ahead of the startup goes public, so the syndicate gets a certain share of the startup before it is made public. So it’s a way for investors to “own” a share in the company before the general public does.
Investing in unlisted, innovative startups may offer strong future returns. Though these companies may currently operate under the radar, their high growth potential makes them attractive opportunities for investors.
But what you need to note, as an investor, is that when you invest in a portfolio company through a syndicate, you’re actually investing in a Special Purpose Vehicle (SPV), a separate entity created to pool funds for that specific deal. This means you’re not buying shares directly in the portfolio company but instead hold ownership in the SPV alongside other syndicate members. Think of it as joining forces with like-minded investors to collectively back a single opportunity. For instance, in an equity round, your investment goes into the SPV, which then purchases shares in the company on behalf of the group.
In India, (SPVs) are primarily governed by the Companies Act, 2013, as they are structured as companies under its provisions. However, the Securities and Exchange Board of India (SEBI) may regulate an SPV if it raises capital from the public or engages in investments subject to SEBI oversight, such as Alternative Investment Funds (AIFs). In such cases, the SPV’s fund manager must be SEBI-registered under the AIF regulations and adhere to specific qualifications and governance standards. Additionally, the SPV is required to provide investors with detailed disclosures on investment strategy, fees, risks, and performance.
Private placement
Another way in which unlisted Indian companies can offer shares to the public or in which listed companies can raise further capital, is through the practice of private placement.
Private placements are non-public issuances of securities to a specific group of accredited investors. It can be undertaken by both public and private companies, and syndicates can take part in private placements.
As per SEBI, the details of private placement are as follows:
SEBI further states that private placement of shares or convertible securities by a listed issuer can be of three types:
Preferential allotment: When a listed issuer issues shares or convertible securities, to a select group of persons in terms of provisions of Chapter VII of SEBI (ICDR – Issue of Capital and Disclosure Requirements) Regulations, 2009.
Qualified institutions placement: When a listed issuer issues equity shares or non-convertible debt instruments along with warrants and convertible securities other than warrants to Qualified Institutions Buyers only.
Institutional placement programme: When a listed issuer makes a further public offer of equity shares, or offer for sale of shares by promoter/promoter group of listed issuer in which the offer, allocation and allotment of such shares is made only to qualified institutional buyers.
Offer for sale or OFS isn’t used to raise new money, but rather to allow existing shareholders to dilute their interests. It is the transfer of ownership from one shareholder to another that does not result in any new capital being raised. Non-promoter shareholders who hold more than 10% of the stock may sell their shares.
The risks and SEBI’s clarifications to keep investors safe
So yes — there are many ways to purchase unlisted shares and invest without touching the bourses. But SEBI’s guidelines as per their December 9th statement are clear: these shares need to be sold by recognised sellers and platforms, and bought mainly by accredited groups/investors and qualified institutions/buyers. And any offer of securities made to 50 or more persons has to be construed as a “Public Offer” under the provisions of Companies Act, 1956.
Unlisted shares are typically acquired from existing shareholders, such as former employees holding ESOPs, current employees, or promoters. These transactions can occur directly between buyers and sellers or through SEBI-registered brokers. For trading to be legally facilitated, entities must register with SEBI. The market regulator has issued warnings against unauthorised websites and online platforms operating without its approval.
These platforms:
- Claim to have access to unlisted shares;
- Act as intermediaries and charge a transaction fee;
- Promise high returns;
- Claim to have thousands of investors;
- Issue shares to more than 50 persons at a time, which is above SEBI’s cap.
Since these platforms are not registered with SEBI, they may be considered illegal, since they are essentially operating without the approval or acceptance of the market regulator.
What next?
SEBI’s argument is well-meaning and simple: these online trading platforms that deal in unlisted shares are not registered with SEBI, not recognised by SEBI, and not authorised by SEBI. They are mere intermediaries that facilitate the transaction and purchase unlisted shares on the investors behalf, while promising guaranteed returns. They don’t follow the guidelines set out by the market watchdog and don’t come under SEBI’s purview.
And since most of these platforms offer shares to more than 50 persons, it’s technically a public issue that needs to follow the set route of filing an offer document or application within SEBI’s framework. With none of these guardrails in place, investors, essentially, are taking a big risk and there is very little SEBI can do if things go south.
Will SEBI take action against these platforms? We will have to wait and watch.
In the meantime here’s what you can do as an investor: visit SEBI’s website, look at the verified exchanges and brokerages listed, and invest via recognised entities. Always check whether someone who is intermediating your money is listed as a registered intermediary on SEBI’s website.
Sources
https://www.jordensky.com/blog/the-basics-of-startup-syndicate-funding
https://www.sebi.gov.in/sebi_data/commondocs/subsection1_p.pdf
https://www.sebi.gov.in/sebi_data/docfiles/33262_t.html