The Pros and Cons of Investing in Unlisted Stocks

Unlisted stocks—shares of companies that are not traded on public exchanges—present unique investment opportunities. These investments span early-stage angel investing & venture capital (VC) deals to established private equity (PE) opportunities. While the potential rewards can be substantial, the risks are equally significant. This article explores the benefits and drawbacks of investing in unlisted stocks and compares them with listed stocks.

Pros of Investing in Unlisted Stocks

1. Potential for High Returns

Unlisted stocks often present opportunities for significant returns. Many successful companies start as private entities and achieve impressive growth before going public.

One notable example is the investment in Facebook before its IPO. Early investors such as Accel Partners invested in Facebook during its early rounds of funding. When Facebook went public in 2012, these early investors saw substantial returns. For instance, Accel Partners invested around $12.7 million in 2005 and saw their stake valued at around $6.6 billion at the IPO.

2. Diversification of Investment Portfolio

Investing in unlisted stocks allows investors to diversify their portfolios beyond publicly traded equities. This diversification can be beneficial in mitigating risk and accessing different sectors.

According to the Cambridge Associates U.S. Private Equity Index, private equity produced average annual returns of 10.48% over the 20-year period ending on June 30, 2020. In contrast, the Russell 2000 Index, representing small-cap companies, averaged 6.69% per year, while the S&P 500 returned 5.91% over the same period.

3. Early Access to Innovative Companies

Investing in unlisted stocks provides early access to innovative and high-growth potential companies. These companies may be working on groundbreaking technologies that are not yet available to the public.

For instance, consider SpaceX, founded by Elon Musk. SpaceX is a privately-held company that has revolutionized space travel and satellite technology. Draper Fisher Jurvetson, an early investor, saw massive gains as SpaceX advanced its technology and expanded its operations.

4. More Control and Influence

Private companies often offer investors more control and influence over the company’s operations and strategic direction compared to public companies. This can be appealing for investors who want to have a say in the company’s development.

For example, Slack Technologies, a workplace communication platform, began as a private company. Early investors like Accel and SoftBank had a voice in shaping Slack's business strategy, product development, and expansion. When Slack went public in 2019, it was valued at $23 billion, reflecting the success of early investment and the influence those investors had on the company's trajectory.

5. Less Market Volatility

Unlisted stocks are generally less susceptible to the daily fluctuations and volatility that characterize publicly traded markets. Because these stocks are not traded on public exchanges, their prices do not react as strongly to short-term market events or economic news. The reduced volatility can help investors maintain a long-term perspective.

Cons of Investing in Unlisted Stocks

1. Higher Risk of Failure

The risk of investing in unlisted stocks, especially in the VC space, is higher. Many startups fail, and investors in these early stages face significant risk. Not all investments will see the same level of success as Facebook or SpaceX.

2. Limited Information and Transparency

Information on unlisted companies is less accessible compared to listed companies. This can make it challenging to assess the company’s management and operations effectively. While some unlisted companies like SBI Fund Management and Care Insurance provide transparency, many do not.

3. Illiquidity

The lack of a public market means that selling unlisted stocks can be challenging. Investors may face difficulties finding buyers, and the liquidity risk must be considered.

However, one must also note that this illiquidity of unlisted stocks, at the same time, can prevent investors from making impulsive decisions based on market hype or panic, potentially avoiding common behavioural blunders.

4. Valuation challenges

Unlisted stocks are often valued lower than their listed counterparts due to illiquidity. This discount reflects the higher risk and lack of marketability associated with these investments.

5. Limited Access for Average Investors

Many unlisted stocks are only accessible to institutional investors or high-net-worth individuals, making it difficult for average investors to participate.

Comparison with Listed Stocks

In the sections that follow, we provide a detailed comparison of unlisted stocks versus listed stocks. We also break down the specific characteristics of angel investing, venture capital, and private equity to help you understand how each type of unlisted investment stacks up against the others.

Angel, Venture Capital (VC), and Private Equity (PE) Investment Types

Summing up

Investing in unlisted stocks offers unique opportunities but also comes with its own set of challenges. While the potential for high returns, diversification, and early access to innovation are attractive, investors must weigh these benefits against the higher risks, limited information, and illiquidity.

For those interested in exploring unlisted stock investments, consulting with a financial advisor or investment professional can provide valuable insights and guidance tailored to individual investment goals and risk tolerance. Fincart is here to help. Our team of experts can offer personalized recommendations to help you navigate the complexities of investing in unlisted stocks.

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