Investing in Unlisted Shares can offer significant returns, but it also carries the risk of overpaying due to limited information and lack of market transparency. Unlike listed companies, unlisted companies do not have the luxury of publicly available share prices, which can make it challenging to assess their value accurately. However, with the right knowledge and strategies, you can avoid this pitfall and make informed investment decisions. Here’s a detailed guide on how to avoid overpaying for unlisted shares. 

1. Understand Key Valuation Methods 

Valuation is crucial when it comes to investing in unlisted shares. Without public market data, you need to rely on various financial ratios and models to estimate a company’s true value. Here are a few valuation techniques you should understand: 

• P/E Ratio (Price-to-Earnings): This ratio compares the company’s market value to its earnings. A high P/E ratio typically suggests that investors are willing to pay more for each dollar of earnings, potentially due to future growth expectations. However, a very high P/E can also mean the company’s stock is overpriced. On the other hand, a low P/E might indicate undervaluation or poor prospects. Therefore, always compare the P/E ratio with industry peers for a more accurate comparison. 

• EV/EBITDA (Enterprise Value to EBITDA): This ratio compares the company’s enterprise value (EV) to its earnings before interest, tax, depreciation, and amortization (EBITDA). It’s particularly useful when comparing companies within the same industry. A lower EV/EBITDA ratio may indicate undervaluation, whereas a higher ratio might suggest the stock is overpriced. However, this ratio does not account for the company’s debt, so it’s important to analyse debt levels separately. 

• Discounted Cash Flow (DCF): The DCF method calculates the present value of a company’s projected future cash flows. It’s an excellent way to assess a company’s intrinsic value, especially for growth-oriented companies. However, the DCF method requires precise future cash flow projections, and the results can vary depending on the assumptions made. If you’re new to this method, it’s recommended to seek expert advice or use professional valuation tools. 

2. Benchmark Against Comparable Public Companies 

While Unlisted Companies do not have a market price, you can still compare their financials and performance to similar publicly listed companies. This helps provide context and insight into whether the unlisted company is overpriced or underpriced. 

For example, if you’re evaluating an unlisted fintech startup, check how similar listed fintech companies are performing in terms of market capitalization, growth rates, and profitability. By benchmarking the unlisted company against public peers, you can identify if the asking price is reasonable or inflated. 

3. Adjust for Risk Factors 

Investing in unlisted shares inherently carries more risk compared to publicly listed companies due to factors like lower transparency, higher volatility, and limited historical data. Therefore, it’s essential to factor in these risks when assessing a company’s value. 

Early-stage companies or startups often present higher risk due to their unpredictable growth patterns and market competition. To adjust for this risk, increase the discount rate in the DCF model or use higher risk premiums when comparing the company’s valuation to industry peers. 

In addition to market risk, consider other risk factors like: 

• Regulatory risks: Is the company subject to regulatory changes or compliance issues? 

• Management and governance: Assess the experience and stability of the management team. 

• Market dynamics: Understand how the industry is evolving and whether the company is well-positioned for future growth. 

4. Examine Financial Health and Performance 

To avoid overpaying, it’s important to thoroughly analyse the financial health of the unlisted company. While you may not have access to the same level of data as a listed company, you should request the company’s latest financial statements or projections, including the balance sheet, income statement, and cash flow statement. Here’s what to focus on: 

• Revenue and Profitability: Look for consistent growth in revenue over the past few years. A sudden spike in revenue may seem enticing but could be an anomaly. Pay attention to profitability trends and whether the company is generating consistent earnings. 

• Debt Levels: High debt levels can signal financial instability. Compare the company’s debt-to-equity ratio to industry averages to ensure it isn’t overleveraged. 

• Cash Flow: Positive and growing cash flow is a key indicator of financial health. If a company is struggling to generate cash, it might be an early warning sign, particularly for startups in the pre-revenue stage. 

5. Consider Market Conditions and Timing 

Market sentiment plays a significant role in the valuation of unlisted shares. If the broader market is experiencing a boom, valuations of private companies may also be inflated due to high investor demand. On the other hand, during market downturns, valuations may be more conservative and offer opportunities for better deals. 

Timing is crucial when it comes to investing in unlisted shares. If you’re investing in a company that’s planning to go public in the near future, you need to assess whether the IPO environment will be favourable. If the market is in a bullish phase, the company may get a higher valuation, whereas during a market correction, valuations could be more attractive. 

6. Seek Professional Guidance 

Valuing unlisted shares can be complicated, especially if you don’t have access to all the information. It’s highly recommended to seek professional guidance from experts or financial advisors who specialize in private market investments. A professional can help you evaluate the financials, apply the right valuation techniques, and navigate through the complexities of investing in unlisted shares. 

Conclusion 

Investing in unlisted shares can be rewarding, but it requires due diligence and a clear understanding of how to value these companies properly. By using appropriate valuation techniques like P/E, EV/EBITDA, and DCF, benchmarking against industry peers, adjusting for risk, and carefully analysing the company’s financial health, you can avoid overpaying and make more informed investment decisions. 

At Rits Capital, we help investors navigate the complexities of unlisted share investments, ensuring they have the tools and insights needed to make smarter, more profitable decisions. If you’re considering unlisted shares as part of your investment strategy, always remember to research thoroughly and consult experts to avoid the costly mistake of overpaying.