How HNIs Can Leverage AIFs to Access IPO-Bound Companies

The Indian stock market has long been a preferred arena for high net-worth investors (HNIs). These investors engage in both direct and indirect investments through mutual funds and various other investment vehicles. HNIs currently hold an estimated 2% of the total direct equity in the stock market, underscoring their significant influence. The current bullish sentiment in the secondary market, where benchmark indices are hitting new all-time highs, has had a ripple effect on the primary market. This optimism has encouraged a wave of companies to go public, eager to capitalize on investor interest and the abundant liquidity in the system. As a result, almost all new IPOs offer upfront profits to those willing to invest.

However, the challenge for HNIs lies in securing a substantial allocation of shares in these initial public offerings (IPOs). High demand during a bull run typically results in IPOs being oversubscribed many times over, reducing the likelihood of obtaining a significant share allotment. Even though portions of IPOs are reserved for institutional investors, retail investors, and non-institutional investors—including corporates and HNIs—oversubscription often leads to HNIs receiving either a very small allotment or none at all.

HNIs do have access to mutual funds, which play a significant role as anchor investors ahead of IPO launches. By investing in mutual funds that participate as anchor investors, HNIs can indirectly gain exposure to IPOs. However, this method typically results in only a small portion of the desired allocation. Fortunately, there is an alternative approach that allows HNIs to more effectively tap into the IPO market: Alternative Investment Funds (AIFs).

Exploring Alternatives: AIFs as a Gateway to IPOs

The Securities and Exchange Board of India (SEBI) introduced a new asset class over a decade ago with the establishment of AIF regulations. Before these regulations, such funds were largely governed by foreign venture capital investment rules and were primarily funded by offshore investors. The introduction of AIF regulations enabled domestic investors, including HNIs, to participate in private markets through an organized and regulated channel.

AIFs have become an attractive avenue for HNIs to partake in the IPO boom through various types of funds. SEBI’s current AIF regulations classify these funds into three categories:

• Category I AIFs: These include funds that invest in startups, infrastructure, and stressed assets.
• Category II AIFs: These comprise private equity and private credit funds.
• Category III AIFs: These funds focus primarily on investments in public markets and often target IPO-bound companies.

While many AIFs invest in private markets, making them a potential route for backing companies likely to go public, Category III AIFs and some Category II funds specialize in targeting IPO-bound companies. These pre-IPO funds, registered as AIFs, focus on companies aiming to establish a valuation benchmark before going public. This can occur through deals made even before a company files its IPO documents with the stock market regulator.

The Role of Pre-IPO Funds

Pre-IPO funds provide HNIs with a unique opportunity to capitalize on the primary market's bullish trends. These funds typically invest in companies looking to create a valuation benchmark before their public offering. By doing so, these companies may strike deals even before filing their IPO documents, offering early investors an attractive entry point.

For companies, pre-IPO funds offer a way to clean up their cap tables by providing an exit, either partial or full, to some of their early investors ahead of the IPO. This process not only helps companies streamline their ownership structure but also sets the stage for a more successful public offering.

Pre-IPO funds offer HNIs a twofold advantage. Firstly, AIFs that act as anchor investors receive an assured portion of shares at the same price as in the IPO. Secondly, funds that invest before the public issue can benefit from immediate mark-to-market valuation gains, as IPOs are often priced at a premium to earlier deals. This allows HNIs to capture value both before and during the IPO process.

Benefits of Pre-IPO AIFs for HNIs

Pre-IPO funds, especially those under Category III, provide HNIs with an alternative that closely resembles direct IPO investments while also offering faster liquidity. Depending on the underlying portfolio, these funds can allow HNIs to harvest profits more quickly, making them an attractive option for those looking to capitalize on the IPO wave without committing to the longer lock-in periods often associated with direct investments.

This strategy also allows HNIs to diversify their exposure to IPO-bound companies. By allocating a portion of their investable corpus to direct IPO investments and another portion to pre-IPO AIFs, HNIs can effectively hedge their bets and increase their chances of participating in the success of companies set to go public.

Conclusion

For HNIs looking to maximize their exposure to IPO-bound companies, AIFs offer a compelling alternative to traditional investment routes. The structured and regulated nature of AIFs, coupled with their ability to invest in both private and public markets, makes them an ideal vehicle for HNIs seeking to capitalize on the ongoing IPO boom. Pre-IPO funds, in particular, provide a unique opportunity to gain early access to companies preparing to go public, offering potential valuation gains and faster liquidity. By employing a dual strategy of direct IPO investments and pre-IPO AIFs, HNIs can effectively navigate the competitive landscape of the primary market and secure a more significant share of the profits in the ongoing bull run.

AIFs are not just a gateway to IPOs; they are a strategic tool for HNIs to enhance their investment portfolios in the dynamic Indian market. As the market continues to evolve, the role of AIFs in providing access to high-growth opportunities will only become more significant, making them an essential consideration for any HNI looking to stay ahead of the curve.