Investors today are exploring investment opportunities beyond mutual funds. And for Mutual Fund Distributors (MFDs), unlisted shares can be another way to expand investment discussions and cater to investors looking for different opportunities.
Since unlisted shares are not listed and are not traded in a recognised stock exchange, the way of assessing valuation, liquidity, information availability, and exit route is different from listed securities. It is necessary that before discussion of such assets by the MFDs with their clients, they must have proper understanding of this segment.
What are Unlisted Shares and Why Should MFDs Consider them?
Unlisted shares refer to shares that are not traded on any recognised stock exchanges. They may allow investors to have exposure to private firms, which may eventually seek to list themselves publicly in the future, but an IPO must never be seen as an assurance of an exit. In terms of the MFDs, having knowledge of this investment category will allow for broader discussion with clients without viewing it as a replacement for the mutual funds.
While private market investments provide investors with exposure to investment, they require a much more comprehensive analysis of the company’s finances, valuations, ownership, restrictions, and liquidity. MFDs should also consider what position they will play in such investments and make sure they understand the regulatory requirements.
How to Buy Unlisted Shares in India: Step-by-Step Process
Buying unlisted shares involves much more than choosing a company and making a payment. The investors need to confirm the identity of the company, go through the process of KYC, conduct due diligence, execute the transaction through appropriate channels, and understand how the securities will be held and transferred and most importantly understanding of investor need, suitability and expectations.
1. Identify the Company and Investment Opportunity
Before deciding to buy unlisted shares, investors need to ensure that they understand the business, nature of the security, the seller, and how the transaction will be structured. Information relating to the business, financial statements, shareholding details, and relevant statutory filings can help provide background on the issuer.
MCA records can be used for checking corporate information and filings, while company data can provide more information on the transaction. Investors need to be aware of their rights as securities holders and if there are any transfer restrictions.
2. Complete KYC and Investor Documentation
KYC verification becomes an important necessity before buying unlisted shares for the purpose of supporting compliant processing of the transaction. In certain transactions, the documents to be submitted include the PAN number and the Client Master List (CML), which comes from the demat account. This is to confirm the demat account information to make sure that the shares can be credited to the right account.
It is important for the investors to comply with the documentation needs as per the intermediary instead of having a common list for all transactions.
3. Conduct Due Diligence Before Purchase
Due diligence becomes very important before the commitment of capital to the unlisted shares, particularly considering that there is no continuously quoted exchange price. One should analyse the firm's financial statements, its income and profitability trends, its liabilities and capital structure, the information about ownership, and recent events of the corporation.
One needs to know how the valuation of the shares was done and whether there are any provisions of the shareholders’ agreement or other documents of the company concerning restrictions on transfer or approval of transfer.
4. Execute the Transaction
Upon completion of all necessary verifications, the transaction shall be conducted as per the prescribed documentation and transfer process. The transfer of funds should be done through proper banking channels to enable tracking and reconciliation with transactional data. In case of securities in physical form, MCA recommends the use of Form SH-4 as per the prescribed regulations.
Also, in case of dematerialised securities, the depository and intermediary processes should be followed accordingly. After completion of the transaction, the investor needs to ensure that the securities have been credited into the right demat account, wherever required.
How MFDs Can Expand Their Investment Offering
With respect to MFDs, moving into private market opportunities would require a clear distinction between the distribution of mutual funds and anything to do with other securities. The goal in this case would be to familiarise oneself with the regulatory framework before venturing into anything new.
1. Complementing, Not Replacing, Mutual Funds
Unlisted shares investment must be seen as a different investment class instead of a replacement for mutual funds. Mutual funds provide professional management and set structures, whereas private-company securities might have their own distinct qualities of liquidity, valuation, and information.
Mutual Fund Distributors (MFDs) must make sure that they distinguish the difference to the investors and do not treat an unlisted offering as just another type of mutual fund investment. The discussion must always focus on what is relevant for the particular investor.
2. Assess the Regulatory Framework First
The ARN of an MFD, which stands for AMFI Registration Number, has relevance to the distribution of mutual funds only and must not be considered a license to undertake all kinds of activities in relation to other types of securities.
The relevant regulations are dependent on the kind of activity involved, whether it is distribution, referral, execution or investment advisory. SEBI’s Investment Advisors Regulations pertain to those activities which qualify as investment advisory in relation to securities. Hence, MFDs need to consider the current regulatory environment and obtain proper compliance or legal advice before launching any new offering.
3. Build a Due-Diligence Framework
If MFDs are evaluating private market opportunities, it is important for the MFDs to have a standardised process with respect to their reviews of the issuer, transaction structure, and documents. The process needs to focus on company history, financial data, valuation, ownership, transferability, and exit options.
This is not about eliminating risk in the investment; rather, this is about having all pertinent data considered before presenting the investment opportunity to the client. Maintaining documentation of the review process can also support consistent investor communication.
4. Use the Right Product Structure
Before proposing an investment in an unlisted security, the MFD needs to be clear about the structure of the investment and its own specific involvement in the transaction. It needs to determine the ownership of the securities, how the transaction is to take place, the documents that will be issued, and how the investors can eventually liquidate their position.
The intermediary also needs to determine the nature of the fee arrangement and any issues arising from that arrangement that may require special treatment under the rules. A clearly defined structure can help reduce operational and compliance uncertainty.
Benefits of Adding Unlisted Shares to an MFD's Product Offering
Adding unlisted shares can help MFDs broaden their investment offering and engage clients in opportunities beyond traditional mutual funds.
1. Scale Your MFD Business
Unlisted shares allow MFDs to discuss private-market opportunities alongside mutual funds and scale MFD Buisness, subject to suitability and regulations.
2. Access to Private Companies
Investors can gain exposure to companies that are not currently listed on stock exchanges, although future listing should never be considered a guaranteed exit.
3. Meet Evolving Investor Needs
As investors explore alternative investment opportunities, understanding unlisted shares can help MFDs address client queries and have more informed investment discussions.
4. Strengthen Client Relationships
Discussing different investment categories can help MFDs provide a more comprehensive investment approach and build deeper client engagement.
5. Diversify the Product Offering
Unlisted shares can add another investment category to an MFD's product offering, while remaining distinct from and complementary to mutual funds.
Note: MFDs should assess applicable regulations, suitability, valuation, liquidity, transfer restrictions, and their permitted role before offering or discussing unlisted shares with clients.
Key Takeaways
Unlisted shares provide investors an opportunity to invest in private companies, but the entire process of investment requires extra caution on verification, documentation, valuation, liquidity, and exit. Investors should conduct the necessary due diligence, complete all required KYC processes, and record transactions accurately.
MFDs need to take into account the relevant regulatory structure as well as the position that MFDs assume when going beyond traditional mutual fund offerings. Communication with the investors is equally important, particularly with regard to future uncertainty such as IPOs and exit strategies. A structured approach can help MFDs evaluate whether a particular opportunity fits within their intended offering and compliance framework.
