What it means
When a company lists its shares on an exchange, anyone can buy and sell them at publicly quoted prices, and the company must meet disclosure and governance rules. An unlisted security has none of this infrastructure.
Trades are arranged privately between the parties, or through dealers who match buyers and sellers. The main drawback is liquidity, which is how quickly and cheaply something can be turned into cash.
If an investor holds unlisted shares in a family company, there may be no buyer when they want to sell, and the price may have to be negotiated. Because of this, investors usually expect a higher return to compensate, and valuers often apply a discount for lack of marketability.
Valuation is also harder. There is no daily market price, so the value must be estimated using methods such as discounted cash flow, comparable listed companies or recent transactions.
Different advisers can reach different numbers, which can create disputes between shareholders or with tax authorities. On the other hand, unlisted securities offer advantages.
Companies avoid the cost and public scrutiny of a listing, and investors may gain access to early-stage businesses with high growth potential. Private equity, venture capital and many employee share schemes involve unlisted securities.
Accounting and reporting rules require that unlisted investments be measured at fair value where possible, with judgements disclosed in the notes. Investors should take particular care with the legal terms, since transfer restrictions, pre-emption rights and shareholder agreements often decide whether and when a holding can be sold.
Due diligence is essential before investing. Regulators treat unlisted investments with extra caution because information can be limited.
Many jurisdictions restrict who may be offered private securities, often to professional or high-net-worth investors, who are assumed to understand the risks. Smaller investors who do take part should ask for audited accounts and for clear details of exit routes.
In practice
Real-world examples.
Example
An engineer receives shares in the private start-up where she works. The shares are unlisted, so she cannot sell them on an exchange and must wait for a sale of the company or a private deal.
Example
A pension fund buys privately placed corporate bonds that are not listed on any exchange. It accepts lower liquidity in return for a higher yield, and holds the bonds to maturity. The fund treats the lack of a daily price as a known cost of the higher yield.
Example
A family business owner wants to value the company for an inheritance plan. The adviser uses comparable listed companies and applies a discount because the shares are unlisted and hard to sell. The agreed figure is then used to decide how the family splits the shares between the children.
Formula
Calculation
Estimated value = value of comparable listed security x (1 - discount for lack of marketability)
Suppose a 10% stake in a private company would be worth $10,000,000 if the same stake were in a comparable listed company. A valuer applies a 25% discount because the shares cannot be sold quickly. Estimated value = 10,000,000 x (1 - 0.25) = 10,000,000 x 0.75 = $7,500,000. The discount of $2,500,000 reflects the difficulty of selling, and the percentage used is an assumption that varies case by case.Case study
Seen in the real world.
Oakfield Brewing is an illustrative, fictional private company with 200 shareholders, mostly local investors who bought unlisted shares years ago. When one investor needed cash for medical bills, she discovered no market for her holding.
The company's accountant suggested a valuation based on earnings of $1,500,000 a year and a multiple of 8, giving $12,000,000, then applied a 20% discount for lack of marketability to reach $9,600,000. The investor's 2% stake was therefore worth about $192,000.
The board arranged an internal share matching service twice a year so holders could trade with each other. The illustrative lesson is that unlisted securities can be valuable, but liquidity must be planned, because there is no ready buyer. It also began publishing audited accounts to all holders each year, which made valuations simpler and reduced disputes.
Watch out
Common mistakes.
- Assuming an unlisted security can be sold quickly at a fair price, when there may be no ready market.
- Ignoring transfer restrictions in the shareholder agreement, which may require approval before a sale.
- Using the price of a listed competitor without any adjustment for lack of marketability and size.
Questions
People also ask.
Is an unlisted security the same as a private company share?
Often yes, but unlisted securities also include bonds and other instruments that simply are not traded on an exchange.
How is an unlisted security valued?
Advisers use methods such as discounted cash flow, comparable companies and recent transactions, and then adjust for illiquidity.
Why would anyone invest in unlisted securities?
Investors may seek higher returns, early access to growth companies, or diversification away from public markets.
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