Unpacking the Pre-IPO Strategy - From Idea to Exit

In conversation with Rajender Saini, Chief Investment Officer (CIO) at NAIPL

Two weeks ago, we discussed India's succession gaps becoming structured opportunities. At Dealflow IQ, we aim to bring you not just insights not from the sidelines but from the players themselves. We followed up with an operator's take on deal dynamics and consolidation plays in this space. Today, we present an investor's view. Not all mid-market opportunities are private equity style buyouts; a subset of SMEs are leveraging increased formal financing to scale.

This article features Mr. Rajender Saini, the Chief Investment Officer (CIO) of Nakshatra Alternative Investments Private Limited (NAIPL). With 5+ years of experience at Nakshatra, he's led many investments in this segment. We asked him to share his view of this strategy and walk us through a deal, from idea to exit, from his experience.

Here’s him, unpacking the pre-IPO strategy:

Understanding the SME market in India

For years, the small and medium enterprises—our SMEs—were the quiet powerhouses of India's economy, often flying under the radar when it came to public markets. But that's really shifted, especially since dedicated SME exchanges like BSE SME and NSE Emerge kicked off in 2012. These platforms were a game-changer, giving ambitious SMEs a direct path to public capital, finally closing a big funding gap they used to face by offering relaxed listing requirements compared to the main board listings.

And what a change it's been! The Indian SME IPO market isn't just growing; it's thriving. Get this: in FY 2024-25 alone, 163 out of the 242 public issues were from SMEs that managed to raise over ₹7,111 crore (USD 855 million) on NSE Emerge. This isn't just a lucky streak. This boom is fueled by several factors, including India's strong economic growth, increasing formalisation of the SME sector, and a surge in retail investor participation. Everyone is keen on finding early-stage gems with huge potential. They're looking for that sweet spot of significant growth and portfolio diversification that SMEs can offer.

What is the Pre-IPO strategy?

Now, within this exciting environment, we've zeroed in on a strategy that's proving incredibly powerful: pre-IPO investments. Think of it as getting in on a promising company before it goes fully public. A pre-IPO strategy involves investing in the shares of a private company that is preparing for an Initial Public Offering (IPO) but has not yet listed on the stock exchange.

It's not quite private equity, nor is it a traditional IPO; it's a unique sweet spot. For business owners, it's brilliant. They can raise crucial funds and get strategic backing before facing the full public spotlight, which helps them fine-tune everything from governance to market readiness. Think of it as a test run for the IPO.

For us investors, the pre-IPO stage offers the opportunity to acquire equity at a discounted valuation compared to the expected IPO price, providing significant upside potential upon listing. This is because the valuation multiple for the same company is generally lower in the pre-IPO stage compared to its IPO valuation, reflecting the illiquidity and higher perceived risk of an unlisted company.

The Deal Flow of a Pre-IPO Strategy: A Look Behind the Curtain

So, you might be wondering, how do we spot a company for our pre-IPO strategy? It's a great question, because honestly, opportunities in this space don't just appear on a traditional research screen. This market is mostly relationship-driven.

Most of our deals come directly from the merchant bankers who specialise in this segment, and often, the invitations are exclusive. Building a robust pipeline here means constantly nurturing strong relationships with merchant bankers across the country. I think of them as our scouting agents, out there identifying the top players in the SME world that will fit our roster of investment portfolio. It’s not just about letting them know I'm interested; it's about communicating our investment parameters. That way, when a company fitting our criteria lands on their desk, we're one of the first calls they make. If you're not out there socialising and networking, your deal flow will simply run dry.

We regularly connect with these merchant bankers, travelling nationwide to meet them. When they have a potential company, they'll typically set up an investor-meet or a roadshow. I recall one such invite in June 2023 for a company manufacturing machinery for India's steel industry. Our first step, naturally, is to dive into a full analysis – understanding the company's profile, its sector, and its fundamentals. It's like doing your homework.

The investor-meet itself is fascinating. The merchant banker and the company founders present, and we, a room of 20-25 potential investors, get to grill them on their business, strategy, and everything in between. Since these are private companies, our initial homework is limited, so this direct face time is crucial for getting a true feel for the business. In India, it's common for SME businesses to be family-run, so you often have first or second-generation family members leading the presentations. It's vital to respect that cultural angle of family businesses here; as professional capital, we need to balance those scales.

If we genuinely like what we see after that initial meet, we take it to the next level. This is where our approach at Nakshatra might diverge from others. Our immediate next step? A site visit. My team or I will fly down to the company's main operations. We want to see the ins and outs for ourselves. This deep due diligence isn't just prudent; it's our fiduciary duty to our fund's Limited Partners. We often tell the merchant bankers, half-jokingly, that we want to "fly down and have dinner with the founder's family at their place." While not always literal, it circles back to that cultural aspect. Understanding the family dynamics, their values, and succession plans is incredibly important in these businesses. Their openness and receptiveness during this visit also give us a huge degree of confidence about the organisation's transparency, and help us spot any potential red flags. Spending a day or two on-site, truly engaging with the founders and their families, allows us to dig deep and clarify every query, giving us the full picture needed for a decision.

This intensive visit is followed by a comprehensive analysis, risk assessment, and portfolio suitability test by our team, before our investment committee makes the final call. In this particular example, yes, we did break bread with the founder's family! After all our due diligence, we invested in the round around August 2023.

And then comes the key ingredient: patience. Our pre-IPO strategy is predicated on an IPO exit. For this company, the merchant banker filed their Draft Red Herring Prospectus (DRHP) in June 2024. After the standard three-month approval process, the IPO was set. Crucially, the IPO valuation was significantly higher than our pre-IPO entry point. The company successfully listed around September 2024, debuting at an even higher premium.

One critical aspect to remember for pre-IPO investments is the lock-in period post-IPO. For us, it’s a 12-month lock-in from the listing date. This is crucial for managing both our liquidity and risk. But the waiting paid off handsomely. In this specific deal, we netted upwards of 36% (annualised) gains. Not a bad return for our strategy, if I do say so myself!

The Road Ahead

We at NAIPL have been piloting this pre-IPO strategy within our existing AIF Cat 2 fund since 2022. The results speak for themselves: this strategy has consistently yielded a 22-26% CAGR for our LPs, net of all fees. Building on this success, we're now in the process of raising a new fund of ₹750 crore (approximately USD 90.5 million). We expect 60% of this fund's strategy to be dedicated to pre-IPO investments. That’s how much potential we see in this market, and frankly, how much conviction we have in our ability and our networks to execute.

Disclaimer: For privacy reasons, the company name and the exact timelines of its IPO deal flow have been altered.