India’s private capital markets have undergone a meaningful transformation in the last few years. More retail investors, family offices, and high-net-worth individuals have begun to look beyond the stock markets and join in the growth story of companies prior to a public listing. The increasing interest has led to unlisted share markets being discussed among investors who wish to join in earlier value creation.
Increased interest raises the question of how these shares are actually assigned a value.
Unlisted shares do not trade on any exchange; therefore, a price is discovered within the confines of unlisted share valuations through market activity, company fundamentals, the macroeconomic environment, and is subject to the sentiment of the investors. Anyone seeking to value unlisted shares must have an understanding of how these elements coexist and interact.
This is an attempt to answer unlisted share valuation discussions by considering what the factors are, what limitations or complexities may exist when they are discussed, and why market activity is only one of an extensive range of factors.
Understanding the Unlisted Share Market
Unlisted shares are shares of equity that have not yet completed a listing on any public register.
They comprise pre Initial Public Offer Companies (pre-IPO), Start-Ups, private financial intermediaries, and private sector companies that remain outside the public investment market.
The listing status of shares isn’t the only difference between listed and unlisted shares. Listed shares have a level of consumer protection that comes from governing bodies and the regulation of mandatory disclosures, standardized accounting, and continuous price discovery.
For unlisted shares, the regulation and the integrity of the market are far lower, meaning information is often asymmetrical, trades are done bilaterally, and price signals are derived from informal sources and not from a centralized exchange.
Due to the lack of regulation, unlisted shares are much more difficult to evaluate. In fact, there is no order book to view, and there is no active market for buyers and sellers to dictate valuation.
Because of this, share price is often determined by the different levels of information that one party can verify, while the other party must assume.
Key Market Activities That Influence Valuation Discussions
Demand and Supply
The pressure to value unlisted shares is largely determined by supply and demand. If the demand for unlisted shares rises, often due to an upcoming IPO, the supply of shares available for trade often causes an increase in price. This is driven by the prevailing interest in the company and the expected listing on the stock exchange.
This effect can be readily seen in shares of companies that are anticipating an IPO, as institutional and retail investors usually generate a trading price that is greater than the book value of the share.
Unlisted shares are often traded directly, and the unlisted share exchanges that operate in India highlight the effect that demand for individual companies has on the value of the unlisted share market as a whole.
Liquidity and Transaction Activity
Markets that lack liquidity have wider bid-ask spreads. In the case of low transaction volume of a specific unlisted stock, one large trade can significantly impact the price expectations. A greater volume of transactions typically leads to a narrowing of the spread, as well as a greater validity to the price signals.
As a result, discussions around the valuation of actively traded unlisted shares tend to be more precise and reach a consensus quicker compared to shares that are infrequently traded.
Company Announcements and Business Developments
Significant pieces of news such as the formation of a new partnership, a new product, a new regulatory announcement, or the onboarding of new members of the executive team can quickly initiate a renewed interest in valuation.
Since there are no scheduled earnings calls or mandatory listings for the traded unlisted shares, these news items serve as a substitute and increase the market focus.
Fundraising Rounds and Corporate Actions
The clearest and most obvious event that triggers valuation discussions is a new fundraising round. When a company raises funds through a new round with a credible strategic partner or institutional investor, the funding round provides a new valuation reference for unlisted shares.
Other transactions like offer-for-sale, employee stock option plan exercises, and transactions of secondary market blocs provide new reference points for other traded unlisted shares.
The Role of Market Sentiment in Valuation Discussions
Sector Trends
Market sentiment directly informs how investors negotiate prices for unlisted assets. Interest in certain sectors (e.g., technology, consumer brands, defence, fintech, clean energy, etc.) causes companies that operate in those sectors to become listed more quickly.
Valuation estimates for those companies grow. The reverse is also true. When public companies that operate in a sector experience a correction, companies that are unlisted in that sector also become less attractive to investors, regardless of unlisted companies’ fundamentals.
Investor Participation
Who the buyers are also matters. If major family offices and large institutional investors are known to hold positions in a certain unlisted company, retail investors often view this as a good sign for the company.
The company receives a valuation boost and more growth-oriented estimates, even when the company’s fundamentals have not changed.
Market Sentiment and Valuation Estimates
In any market, listed or unlisted, the stories that people tell are important. The story that people tell about a company’s competitive advantage or even its potential to become listed can shape its valuation just as easily as any analysis of the company’s financial position.
There is an important balance of analysis and market sentiment in the valuation estimates of stock exchanges like the MSEI unlisted shares and NSE unlisted Shares market.
How Growth Narratives Shape Unlisted Share Valuation
Consumer-Focussed Companies
Growth-oriented valuation narratives tend to focus on consumer-centric companies. The perceived size of the market that companies can serve and the likelihood that the consumer company can serve large segments of that market become key to the conversations people have about a company’s price.
For instance, conversations around OYO unlisted share prices have shown the challenges of balancing the company’s ambition of large scale versus the company’s ability to be profitable. This is what investors talk about for consumer-tech deals everywhere.
Tech Companies
Unlisted tech companies that utilize the power of their platforms, network effects, or data are more often valued based on revenue multiples or metrics of user growth as opposed to being valued based on earnings. There is a ‘valuation narrative’ that presumes the losses of the company today will mean profit in the future. Sometimes, this presumption is valued very optimistically.
This is also true for a number of on-demand platforms. For example, conversations about the Zepto unlisted shares are centered around the company’s ability to create a new market category and capture it, rather than the company’s ability to generate profit in the near future.
Manufacturing and Related Sectors
When talking about companies in the manufacturing sector, the semiconductor sector, or capital-intensive businesses like Polymatech unlisted shares that are the topic of discussion in the unlisted share market, the conversations around the value of the business are a lot more about the future growth of the business and a lot less about how the business will be able to operate profitably.
Price Discovery Challenges in Unlisted Shares
Limited Public Information
A major challenge that investors face when trying to determine the value of unlisted shares is the lack of public information. For listed companies, the stakeholders are required to make frequent disclosures about the details of the company.
This is not the case for unlisted companies. For unlisted companies, the investors have to rely on Draft Red Herring Prospectus, news articles, and other informal sources to make investment decisions.
Broader Valuation Spectrum
Due to gaps in data, two people with the same knowledge of the unlisted company may come to very different conclusions regarding the company’s valuation. The same is true with private markets around the world.
Without having a centralized, clear order book, the “price” of an unlisted share will likely be best interpreted as a range of values.
Valuation and Comparable Companies
In valuation, unlisted shares are typically compared to similar, publicly traded companies. Unlisted shares of financial infrastructure companies, such as NCDEX, may be compared to publicly traded commodity exchange companies to arrive at a value.
Although no two companies are exactly alike, and this method of valuation is often critiqued, it is a useful starting point.
Components Beyond Market Activity
Financial Performance
Revenue and growth, as well as the level of debt, will affect the speaking points of a company’s valuation. Strong company performance will foster healthy and reasonable valuation discussions; vice versa, if company performance is lacking. This remains true, even if there are fleeting periods of market enthusiasm.
Business Model
How a company earns revenue, e.g., predictability, and customer concentration and churn, as well as pricing and scalability, will impact a company’s long-term valuation. Companies with more predictable revenue and low churn will typically have a different valuation discussion than those companies whose revenue is transactional.
The discussion regarding the unlisted market involves factors such as management quality, board composition, and the company’s record and policies regarding minority public shareholders. Investors have the right to be concerned about lax governance.
Visibility regarding the company’s future growth is important. Near-term growth of a company can be attributed to growth in the company’s product pipeline and distribution networks, the company receiving pending regulatory approvals, and/or the prospect of the company going public.
All of these factors provide market investors with more substance in a valuation discussion than speculation.
Why Market Activity Alone Does Not Define Valuation
Transaction activity in the unlisted market is very low; therefore, a few motivated buyers or sellers can move the market to a particular price range without it having any significant effect on the company or its prospects.
In the long term, the fundamentals of the business are the key drivers of value, while in the short run, the market activity and investor sentiment are the key drivers. The valuation of a corporation should consider both the short-term market activity and the long-term business fundamentals.
The unlisted market rewards those market participants who strike this balance. The market participants should be attuned to the market signals while not losing sight of value.
Conclusion
Sophisticated conversation about valuations has emerged with the maturity of the unlisted stock market in India. Demand-supply dynamics, trading volume, fundraising, and expression of interest are some of the market phenomena that affect the price discovery mechanism, but they are complemented by financial performance, quality of business models, governance standards, and growth prospects.
For prudent investors operating in the market, the best strategy is likely to be the one that balances both. Understanding the market phenomena that create price discovery is important, and equally important is the timing to look beyond the value of the activity, as this will elevate investors from the reactive approach.
Frequently Asked Questions
What are unlisted shares?
Unlisted shares are shares of a company that are not available on any of the stock exchanges. Generally, these shares are of private companies, companies before an initial public offering (IPO), companies in their infancy (start-up companies), and companies that are financial institutions and have not gone public.
What are some of the common methods of valuation of unlisted securities?
The unlisted share valuation methods may involve consideration of the company’s financial reports, recent market activity, the latest capital raising activities, the company’s growth and the nature of the business, sector trends, and perceived value of similar companies.
What is the reason for the correlation of demand and supply with unlisted share price?
If there is an increase in the demand for the company’s shares due to the prospect of an IPO, because of the limited offer of unlisted shares, negotiations on the value of the shares become more frequent, and the prices become more volatile.
What is the impact of liquidity on the valuation of unlisted shares?
The liquidity of unlisted shares refers to the volume of trading activity of the shares. Unlisted shares that are traded more frequently will have better price determination, while a lack of trading will create more valuation disparity and price determination will be more difficult.
What is the impact of fundraising activities on the valuation of unlisted shares?
Fundraising activities are usually a new opportunity to create a valuation ceiling as long as the institutional investors and strategic partners assess the target company and decide to trade. Generally, these become the go-to guides for price discussions in the unlisted market.
What is the impact of investor sentiment on unlisted share prices?
Investor sentiment can impact price discussions in a significant way, whether positive or negative. Generally, positive sentiment on a company’s growth and the direction of the industry and its prospects of listing on the stock exchange can increase demand and price expectations.
Why do sector trends matter for unlisted share valuation?
Changes in sector performance often affect the interest of the investing public. Different sectors like technology, fintech, clean energy, defense, and consumer goods may attract increasing interest in some cycles, and that may affect the valuation of companies in those sectors.
How do corporate announcements impact valuation?
Investors may pay attention to announcements, and this can shift perceptions of value as a result of partnerships, regulatory approvals, product launches, changes in management, or announcements representing a change in the scope of operations.
Why is the valuation of unlisted shares more difficult than that of listed shares?
Valuations of listed shares are simplified because of ongoing and readily accessible prices and transactions. Unlisted shares are more difficult to value because there are fewer transactions, more disclosures, and greater information asymmetry.
What do investors look at for unlisted share valuation?
To value unlisted shares, investors examine financial statements, annual reports, draft red herring prospectuses (DRHP), press releases about fundraising or investments, sector reports, and news about the business or industry, as well as financial reports regarding listed companies.
How are unlisted shares evaluated against listed firms?
To value an unlisted company, analysts evaluate companies working in the same sector and compare the same metrics, such as revenues and profitability, at market share or market capitalization.
Which is more important, company fundamentals or market activity?
Both matter. In the short run, the valuation may be affected by market activity, whereas the long-term value is generally affected by the fundamentals of the business (e.g., revenue and earnings growth), how well governance is upheld, and how scalable the business is.
What impact do growth narratives have on the valuation of unlisted shares?
Positive expectations for future growth often bring about higher valuations. Investors may perceive value based on product improvement and innovation, market growth, increased customers, and future business prospects.
Do unlisted shares require many transactions in order for the prices to change?
Yes. Unlisted shares typically have low trading volumes. Because of this, relatively few transactions may affect price references and valuation estimates, particularly in situations where there is little liquidity.
What do you think is more important besides market activity?
Besides market activity, investors may want to consider the financials, strength of the business model, quality of management, corporate governance, the industry and where it may be going, the potential for growth, the regulatory environment and how it may be changing when estimating the value.
Why is market activity important in unlisted shares?
Demand for unlisted shares can be gauged from market activity. Investors can also determine how active the market is and how investors are likely to behave. This plays a crucial role in determining unlisted share valuations.
What is the divergence between market price and intrinsic value of unlisted shares?
The price of unlisted shares reflects the most recent transaction. The intrinsic value of unlisted shares is much broader and is based on the evaluation of income, assets, growth, and future cash flows.
What is the most effective way to value unlisted shares?
When valuing unlisted shares, a combination of market activity, reliance on the most accurate information regarding the company, assessments of the company’s sector, and most importantly, adopting a long-term focus will be to the investor’s benefit.
Disclaimer
This article is for informational purposes only and should not be considered investment advice. Prices and data of unlisted shares are based on publicly available sources and may vary. Investors are advised to conduct independent research or consult financial professionals before making investment decisions.
