How to Trade in Unlisted Shares: A Complete Guide for Investors

Unlisted share trading refers to the purchase of equity in private entities, startups, or pre-IPO (initial public offering) businesses before they are listed on public stock exchanges such as the BSE (Bombay Stock Exchange) and NSE (National Stock Exchange).

Key Takeaways

• Unlisted shares are off-market transactions enabled through specific platforms, private brokers, or even ESOP (employee stock option) transfers. 
• Investors looking at ways to buy unlisted shares in India are driven by the growing popularity of pre-IPO investing. This is because it allows investors to capture large valuation increases before the company goes public.
• The rising startup ecosystem in India is another reason, with investors participating directly via venture capital syndicates or angel networks. They are also increasingly pooling funds through SEBI-regulated AIFs (alternative investment funds) or leveraging PMS (portfolio management services) to invest in unlisted shares.
• A key point worth noting is that investing in unlisted shares differs from investing in listed shares, which are directly traded on recognised exchanges and have higher liquidity.
• The minimum investment is often much lower for listed shares. 

What Are Unlisted Shares?

Before you buy unlisted shares, it is important to know what they really mean. These are shares of companies that are not listed on recognised stock exchanges such as the BSE or the NSE. They are bought and sold through private transactions rather than on a public exchange.

They primarily belong to private entities or pre-IPO startups, and transactions occur via OTC (over-the-counter) or direct placements rather than on public markets. 

This market is usually classified into three components: 

• Private companies: These are privately held businesses, subsidiaries, or startups that have never issued shares to the public. They raise capital directly from venture capitalists, angel investors, or private equity funds. 
• Pre-IPO companies: They are established private entities or startups which are highly valued. These are entities planning to launch an initial public offering (IPO) in the future.
  Early investors, employees, or founders may cash out on a portion of their company holdings in these cases, with new institutional investors buying in before the shares are publicly available. The price tag may be higher than early-stage private shares. 
• Delisted companies: They are companies that were publicly listed and traded on stock exchanges earlier but have now had their shares removed for one of two reasons.
  The first one is voluntary, i.e. the promoters buy out the shareholders to take the company fully private.
  The second one is involuntary, i.e., the company is penalised by the exchange for failing to meet financial requirements, failing to abide by regulatory disclosure requirements, or for poor corporate governance. 

Can You Trade Unlisted Shares Like Listed Stocks?

Is it possible to trade unlisted shares like listed stocks? Here are some key aspects worth noting in this regard. 

Listed Shares

• Exchange-based trading: Listed entities are traded on public stock exchanges, such as the Bombay Stock Exchange or the National Stock Exchange. Trades are electronically matched through the centralised order book. 
• Real-time liquidity: You can easily buy or sell shares during trading/market hours, with the trade settling swiftly and cash being readily available. 

Unlisted Shares

• Off-market transactions: Note that unlisted shares are not traded on stock exchanges. Trades are executed through specialised brokers, secondary market platforms, or peer-to-peer (over-the-counter) systems. 
• Liquidity constraints: Finding a buyer or seller may take a long day. There is no continuous trading stream or market liquidity, since these shares are not traded on exchanges. You cannot cash out when you want.
• Pricing negotiations: Listed stocks have their price set by the market. However, unlisted share prices are negotiated directly between buyers and sellers. 

How Unlisted Share Trading Works

Here is how you can trade unlisted shares: 

1. Identify an unlisted company:

The first step is researching private entities or pre-IPO startups. Since they do not publicly trade, you have to thoroughly check their growth prospects, financials, and corporate valuation through financial advisors or independent research. 

2. Find a buyer or seller:

Unlisted shares are illiquid. You will usually have to use OTC (over-the-counter) trading intermediaries or online platforms. They maintain an inventory of available shares and connect potential buyers with sellers (early-stage employees, ESOP holders, angel investors, etc.). 

3. Negotiate price:

There is no exchange-mandated or live market price for unlisted shares. Sellers and buyers (often with the help of intermediaries) have to negotiate mutually acceptable prices and the trade lot size. 

4. Execute off-market transfer: 

• Once the trade size and price are confirmed, both parties have to exchange their KYC documents (Aadhaar, PAN, and a client master report).
• The transfer is then initiated through the off-market mechanism.
• The seller will fill out the DIS (delivery instruction slip) or use a depository platform to debit shares from their demat account.
• The buyer will provide demat details and wire the funds to the seller’s account before or simultaneously with the transfer of shares.
• Note that off-market share transfers should comply with the Indian Stamp Act, which requires payment of the applicable stamp duty on the transaction value. 

5. Settlement through demat account: 

Both the depositories (CDSL and NSDL) supervise the electronic transfer of shares. After the transaction is verified and the seller confirms, the shares will be credited directly to the buyer's demat account, thereby concluding the transaction successfully. 

How to Buy Unlisted Shares

Here is how you can usually buy unlisted shares - 

Through Specialised Unlisted Share Dealers

You may approach SEBI-registered investment banks, brokers, or specialised unlisted share dealers. They function as intermediaries, maintaining an inventory of private and pre-IPO shares. They enable off-market transactions by linking buyers with current promoters or shareholders. 

Through Existing Shareholders

You may directly purchase from early-stage angel investors, promoters, and founders. It is usually a negotiated OTC (over-the-counter) private deal that often requires sizable minimum investments. 

Through ESOP Transactions

Employees holding ESOPs (employee stock option plans) may want to sell their vested shares for liquidity. Specialised platforms and brokers may link you to these employees for off-market transfers. 

Through Pre-IPO Platforms

If you were wondering how to invest in pre-IPO shares, there are opportunities available through specialised digital investment platforms that aggregate them. They streamline the entire KYC, discovery, and transfer procedures. 

Note that clear documentation is necessary for a clear title transfer, since these trades do not undergo standard exchange order matching.

Both buyers and sellers have to provide PAN cards, Aadhaar, and bank account details.

The client master report (CMR/CML) has to be issued by your DP (depository participant) and confirms your demat account, DP ID, Client ID, and linked bank accounts. 

The other documents include the SPA (share purchase agreement), DIS (delivery instruction slip), proof of payment, and the transfer deed (SH-4). 

How to Sell Unlisted Shares

The process to sell unlisted shares is not as complicated. It generally involves the following steps

• Finding buyers

There is no central order book that you can use in this case. Hence, you have to rely on specialised channels, including intermediaries and unlisted share platforms. 

• Pricing negotiation

Pricing is privately negotiated. Price discovery is usually driven by the company's recent private funding rounds, financials, anticipated IPO valuations, and the GMP (grey market premium). Once you and the buyer agree on the price per share, the broker will issue a deal sheet detailing the transaction. 

• Transfer process

The transfer is then executed via an off-market transfer between demat accounts. If your broker uses CDSL, it is done through the CDSL Easiest platform with an OTP.

NSDL also has a similar Speed e-system. If online transfer is not available, you will need to complete the DIS (delivery instruction slip) with the buyer's DP ID and Client ID before submitting it to the broker. 

• Settlement mechanism

Settlement usually uses an escrow-like system to mitigate counterparty risk. The buyer/platform will verify your shareholding, and you will then transfer the unlisted shares to the buyer's demat account or the broker's account.

Once the receipt is confirmed, the funds will be credited directly to your registered bank account through NEFT or RTGS. 

*Note: Unlisted shares are highly illiquid in comparison to their listed counterparts. Hence, finding a buyer to buy your targeted volume of shares at your chosen price may take a long time (sometimes weeks or months).

Also, you cannot immediately sell pre-IPO shares once the company files its Draft Red Herring Prospectus (DRHP) or goes public. There is a 6-month lock-in period from the date of listing. 

Step-by-Step Process to Trade Unlisted Shares

Here is a step-by-step process to trade unlisted shares -

Step 1: Open a Demat Account

Open a demat account with a Depository Participant (DP) to execute the trade. Standard retail brokers cannot execute them directly on their platforms, although they can securely hold unlisted securities once the transfer is done. 

Step 2: Complete KYC

Complete the standard Know Your Customer (KYC) verification at this stage. The seller and buyer must share documents such as Aadhaar cards, PAN cards, bank details, and a copy of the Client Master Report/List (CMR/CML) from their respective brokers. 

Step 3: Verify Share Availability

Unlisted shares lack public liquidity. Verify availability via SEBI-registered intermediaries, specialised pre-IPO platforms, or wealth managers. Review the minimum investment or lot size required and check the latest indicative prices. 

Step 4: Negotiate Price

Unlike listed stocks, prices are determined by private mutual agreements. Buyers and sellers negotiate final prices based on the latest deal values, company financials, and market demand. Once the agreement is in place, the deal note or SPA (share purchase agreement) is signed likewise. 

Step 5: Execute Off-Market Transfer

Since the trade does not go through the BSE or NSE, the transaction will be settled via off-market transfer. The seller will initiate the transfer from the seller's demat account to the buyer's demat account using the depository's electronic facility (CDSL Easiest or NSDL Speed-e). 

Step 6: Receive Shares or Funds

At this stage, the transaction will work through an escrow system. The buyer will transfer the funds to the seller/broker through secure banking channels. The shares are also credited to the buyer's demat account within T+1 to T+5 working days. 

Types of Unlisted Shares Available for Investors

Here are the common types of unlisted shares available to investors. 

Pre-IPO Shares

They are shares in private, usually well-established entities that have officially announced or are expected to launch an IPO (initial public offering) in the near future. These shares are bought early to get quick entry at a possibly discounted valuation before public trading starts.

Startup Shares

They indicate equity in early-stage entities and emerging startups that have not yet filed for IPOs. These startups issue shares to raise angel or venture capital to finance their growth and operations. While they come with high return potential, they also carry considerably higher risks. 

Employee ESOP Shares

Employee stock ownership plans (ESOPs) are unlisted shares issued to employees as a part of their benefits/compensation. They often liquidate these shares in the secondary market or via buyback programs before IPOs. 

Delisted Shares

Delisted shares are those of companies that were once publicly traded on recognised stock exchanges but were subsequently removed (either voluntarily or involuntarily). Delisted entities remain operational and retain value, while their shares can still be traded via specialised delisted-stock platforms or over-the-counter (OTC). 

How Are Unlisted Shares Priced?

Successfully trading unlisted stocks means being aware of the pricing mechanisms. Here are the valuation methods for your perusal. 

Revenue Multiple Method

This method calculates share value by comparing the company's annual revenue/sales figures with those of similar listed entities.

A revenue multiple is calculated from comparable publicly traded companies and applied to the unlisted entity’s revenues.

It is ideal for SaaS, pre-profit, and high-growth businesses, where revenue growth is the primary performance indicator. 

Earnings-Based Valuation

In this method, share values are based on the company's profitability, future earning ability, and historical income.

Metrics like the capitalisation rate or price-to-earnings (P/E) ratio are used to calculate the company value.

For example, if the peer group trades at a P/E of 20, the unlisted company’s earnings will be multiplied by 20 to determine the total equity value. This will then be divided by the total number of shares to get the per-share price. 

Funding Round Valuation

This is also called the last transaction price method, and the share price is based on the valuation the company received in its latest funding round from venture capital or private equity investors. It is ideal for growth-stage companies and actively-funded startups. 

Comparable Company Valuation

Also referred to as Comparable Company Analysis (CCA), it is a relative valuation method.

The unlisted company is benchmarked against its listed peers or even precedent transactions in the same sector.

This case examines EBITDA (profit margins), operating metrics, and business models. It is best for standardising valuations throughout an industry sector.

However, because unlisted sectors are illiquid, a liquidity discount is usually applied, typically 10-30% of the final comparative price. 

Factors to Consider Before Trading Unlisted Shares

There are some aspects that you should consider before trading unlisted stocks -

Business Fundamentals

You should cut through the buzz and understand how the company generates its revenue. Look for strong business fundamentals, i.e. a sustainable business model, competitive advantages, and scalable offerings that can capture market share. 

Financial Performance

Unlisted entities are not subject to the same public disclosure rules as listed firms. Hence, you should request 3-5 years of financial statements and check them for consistent revenue growth, manageable debt, operating margins (have to be stable), and positive cash flows. 

Management Quality

The company's execution ultimately depends on its management and leadership. Do your research on the track record, background, and ethical standing of the main executives and founders. Also, evaluate the company’s corporate governance systems, transparency, and the alignment of leadership interests with those of the minority shareholders. 

IPO Potential

For many pre-IPO investors, the IPO is the primary exit strategy. You should assess how ready the company is to go public, as well as regulatory compliance and market demand in the sector. Be aware of historical market trends regarding underpricing, and do not count on the IPO as your guaranteed exit. 

Liquidity Risk

Unlisted shares naturally come with liquidity risks, since there is no active, centralised exchange for them. You should commit your funds only if it is surplus money you do not require for any short-term goals. Verify that there are clear lock-in clauses or secondary market mechanisms before buying. 

Benefits of Trading Unlisted Shares

Here are some of the benefits of trading unlisted shares: 

Early-Stage Investment Opportunity

Investments in unlisted private entities may help you buy into or support a business in its initial or expansionary phases. Being part of promising ventures early on usually means getting shares at a comparatively lower valuation than entering at a later stage. 

Potential IPO Gains

Unlisted shares enable a pre-IPO entry benefit. When it finally launches its IPO and lists on the exchange, the valuation often increases, helping you capture sizable capital appreciation. 

Portfolio Diversification

Unlisted shares are not usually tied to daily sentiments in the stock market or other macroeconomic shocks or fluctuations (that otherwise affect the BSE or NSE). They have a low correlation with regular asset classes, which serves as a buffer and helps balance short-term portfolio volatility on your end. 

Access to High-Growth Companies

Many established, large companies in India, including popular startups, retail brands, and financial services players, often choose to remain private for extended periods. Trading in these unlisted shares gives you exposure to rapidly growing industries and exclusive businesses that may not always be available on public exchanges. 

Risks of Trading Unlisted Shares

Some of the risks of trading unlisted shares include: 

Low Liquidity

Unlisted shares are highly illiquid in nature. You cannot sell them immediately like public stocks. Finding a buyer for the same may take several years or months. If you wish to liquidate your position swiftly, you may be forced to accept steep discounts. 

Limited Public Information

Private companies are not subject to the same stringent reporting standards as their public counterparts. They are not usually required to file quarterly earnings or audited financial statements with regulatory bodies. This lack of transparency makes it quite hard to get the full picture of the company’s operations and finances. 

Valuation Uncertainty

Without a public market to determine the final share price, valuing unlisted shares is inherently subjective. You often have to rely on valuations from earlier funding rounds, which may be outdated or inflated. You may sometimes end up overpaying and find it hard to work out the actual market value of the investment as well. 

Regulatory Changes

Unlisted shares operate outside the stringent regulatory framework that safeguards retail investors in public markets. Changes in securities laws, i.e. amendments to accredited investor definitions or even private offering exemptions, may limit your ability to trade these shares or suddenly change the entire compliance environment. 

Delayed Exit Opportunities

Exiting an investment in an unlisted company usually depends on a specific liquidity event, such as an IPO (initial public offering), merger, or acquisition. In case the company delays its plans to go public eventually, cancels a merger, or struggles to find buyers, your capital may be locked up for longer durations than you initially thought. 

Taxation of Unlisted Shares

Here are the key taxation details for unlisted shares: 

Short-Term Capital Gains Tax

STCG refers to unlisted shares held for ≤ 24 months. They are taxed as per your applicable income tax slab (profits are added to your total income). 

Long-Term Capital Gains Tax

It indicates shares held for more than 24 months. They are taxed at 12.5% with no indexation benefits available. 

Taxation After IPO Listing

Once the company goes public, its shares become listed equity. The threshold for determining long-term status has been reduced from 24 months to 12 months for listed securities. STCG is taxed at 20% if the shares are sold within 12 months of listing, while LTCG is taxed at 12.5% if they are sold after 12 months. The listed shares will be eligible for the annual LTCG exemption of ₹1.25 lakh. 

Unlisted Shares vs Listed Shares

Here is a comparison of unlisted and listed shares for your benefit. 

Key Aspect	Unlisted Shares	Listed Shares
Trading Platform	Private market	BSE/NSE
Liquidity	Low	High
Price Discovery	Negotiated	Transparent
Information Availability	Limited	Public
Regulations	Comparatively lower	Stringent and extensive
Exit Opportunities	Hard	Easy

What Happens When Unlisted Shares Get Listed?

Here is what happens when unlisted shares get listed: 

• IPO Process

The company goes through the initial public offering (IPO) process. It files its DRHP (draft red herring prospectus) with the SEBI (Securities and Exchange Board of India).

Underwriters and investors evaluate demand to arrive at the issue price or price band through book-building.

Then the subscription period closes, and shares are allotted, with the unlisted shares being reclassified on the exchanges as listed equity. 

• Listing Gains

Listing gains take place when the opening trading price on the exchange is more than the IPO issue price (or the price you paid originally in the unlisted market).

However, there is also a risk that the shares list at a discount in the event of weak public demand. 

• Lock-In Implications (if applicable)

To combat immediate market share dumping and ensure price stability, SEIB mandates a lock-in period for pre-IPO investors. This is usually 6 months from the listing date.

You cannot sell your unlisted shares in this period on the exchange. Company promoters usually have an 18-month lock-in period. 

• Market Valuation Changes

The company's valuation changes dramatically when it goes public. Once listed, its valuation is continuously determined by open-market supply and demand.

The public market may assign a wholly different P/E ratio or multiple to the entity than the unlisted market. If this is lower than expected, your share value may also fall. 

Who Should Invest in Unlisted Shares?

Unlisted shares could be considered for investment by - 

• Long-term investors: Ideal for those looking to hold assets for extended periods without anticipating immediate market exits. 
• HNIs (high net-worth individuals): With high minimum investment sizes, high capital availability and financial strength are necessary. 
• Investors looking for pre-IPO opportunities: Ideal for those looking to tap into early-stage growth or pre-IPO valuations in robust private firms. 

They may be less suitable for the following categories - 

• Short-term traders: Prices are privately negotiated over the counter (OTC). This means no real-time price discovery or swift profit turnover. 
• Investors requiring liquidity: Funds will be locked-in for a long time, since finding buyers is hard and time-consuming. 

Common Mistakes to Avoid

Here are some common mistakes to avoid when trading unlisted shares - 

Investing Only for IPO Hype

You should not buy unlisted shares only because of hype on social media or other platforms. Do not buy on the anticipation of huge listing gains while ignoring the underlying business financials and other fundamentals. 

Ignoring Valuation

Do not blindly depend on the pitch deck or pay whatever price the unlisted platform or broker quotes. It may lead to overpaying in a late-stage private round, often resulting in post-listing price corrections. Always benchmark the valuation against listed industry peers. 

Overlooking Liquidity Risk

Do not treat these shares like regular liquid stocks that can be sold easily. Remember that your capital may be locked up for a long time. 

Not Verifying Share Authenticity

Do not purchase shares through any unregulated or informal networks or transfer funds to personal bank accounts. Verify the ISIN (International Securities Identification Number) and ensure that share credits are directly credited to demat accounts, while using only SEBI-authorized intermediaries or institutional funds for payment processing. 

Ignoring Tax Implications

Do not treat unlisted capital gains as you would publicly traded shares. They often have different tax rates and holding periods. LTCG of 12.5% only applies after a 24-month holding period. 

Conclusion

As you can see, unlisted shares offer access to some strong private companies before they list publicly, giving you possible high-growth opportunities for your portfolio. Yet, they come with higher valuation and liquidity risks as discussed. 

Before you invest, it is important to undertake thorough due diligence of the company. You should also analyse the long-term investment perspective without succumbing to any pre-IPO hype.