In late October 2025, SEBI issued a circular prohibiting mutual funds from investing in unlisted pre-IPO shares, citing concerns about illiquidity, subjective valuation practices, and misalignment with retail investors’ risk expectations. Until this directive, some hybrid and thematic schemes had been purchasing shares of companies expected to list soon, aiming to benefit from potential gains upon listing.
SEBI observed that valuing such unlisted holdings often depended on company-provided assumptions rather than transparent market-based pricing. These exposures also came with lock-in requirements, tying investors’ money to assets that could not be traded freely. This reduced clarity around the daily NAV blurred the intended risk profile of mutual fund schemes, which are meant to invest primarily in liquid, market-traded securities.
What is pre-IPO placement?
A pre-initial public offering (pre-IPO) placement is a fundraising method used before a company formally begins the IPO process. It involves the private sale of substantial blocks of unlisted shares. This allows existing shareholders to reduce the uncertainty and performance risk associated with how the stock will behave once it lists, a factor that largely depends on prevailing market sentiment.
Investors who join pre-IPO rounds usually get shares at a lower price than what the company expects to charge during the IPO. This lower price rewards them for taking on more risk, since they invest without a prospectus and with no certainty that the company will actually list. These deals are mainly offered to private equity firms and wealthy individuals and often include lock-up periods of six months or more. The lock-up helps stabilize the stock after listing by preventing early investors from selling large amounts of shares immediately.
Once the lock-up period expires, these investors may decide to hold or sell their shares. Because the shares are priced below the eventual IPO valuation — a practice not permitted in anchor allocations — pre-IPO investments can offer attractive return opportunities. At the same time, they carry notable liquidity risks, as the investors cannot exit their positions until the company is publicly traded.
A Regulatory Ambiguity
At present, Alternative Investment Funds (AIFs), family offices, and foreign investors are permitted to participate in pre-IPO rounds. For mutual funds (MFs), however, there is regulatory ambiguity. Clause 11 of Sebi’s Mutual Funds Regulations, 1996, allows MF schemes to invest only in listed or “to-be-listed” securities, but the term “to-be-listed” is not clearly defined. This gap has enabled MFs to enter such deals and benefit from preferential pricing, enabling their schemes to hold unlisted shares until the IPO.
During this interim phase, both liquidity and valuation risks arise for the mutual fund and its investors.
In the US, mutual funds primarily invest in liquid, easily traded securities such as listed stocks, bonds, and money market instruments. These investments must comply with strict rules on diversification, liquidity, and the policies outlined in the fund’s official documents—policies that cannot be changed without investor consent.
Mutual funds can invest in pre-IPO shares, but only within the limits of their regulatory framework. Regular open-ended mutual funds, which offer daily redemptions, usually avoid pre-IPO investments because these shares are difficult to value and hard to sell quickly. However, some funds may gain exposure indirectly through special structures such as interval funds or business development companies, which are permitted to invest in illiquid private companies, including pre-IPO deals.
SEBI’s Line in the Sand
Between 2020 and 2021, a surge in start-ups and tech IPOs prompted mutual funds to begin allocating to pre-IPO companies to capture early-stage gains. By 2022, SEBI had started flagging concerns over valuation irregularities in the unlisted holdings of certain hybrid funds. As unlisted exposures continued to grow, discussions around illiquidity risks intensified through 2024. This culminated in October 2025, when SEBI formally prohibited mutual funds from participating in pre-IPO placements and limited them strictly to anchor or public issues—marking a clear shift from an initial “observe and guide” approach to a more decisive “restrict and regulate” stance.
Although SEBI did not provide an exact figure, industry estimates suggest that ₹3,000–₹4,000 crore of mutual fund assets were invested in unlisted pre-IPO holdings across hybrid and opportunity funds between FY23 and FY25. The regulator appears to have viewed this as mission drift, with mutual funds venturing into AIF-like territory without the corresponding disclosure standards or risk safeguards.
Under the new rule, mutual funds are allowed to invest only as anchor investors or through public IPOs. They are no longer permitted to buy shares in pre-IPO placements or any unlisted funding rounds.
Existing pre-IPO investments must now be valued more conservatively and exited in accordance with the company’s listing schedule or liquidation timeline. In short, mutual funds can no longer use investor money for grey-market or pre-listing bets. Pre-IPO shares lack transparent market-driven prices, and fund houses were valuing them using internal models, which risked distorting NAVs.
Since daily-redemption mutual funds should not hold illiquid assets that may take months to exit, such investments created a mismatch. There was also the possibility that fund managers, PE firms, or investment bankers with overlapping interests could influence valuations or deal allocations. Moreover, many retail investors were unaware that their money was being deployed in pre-listing bets. This approach diverges from the typically low-risk profile of most open-ended funds.
Well-timed Move
SEBI’s intervention to decisively halt the unhealthy practice is both timely and imperative, especially considering the fiduciary duty that mutual funds owe to their investors. Over the last five years, India’s private markets have matured significantly, with numerous venture capital–backed companies scaling rapidly. This has created a large pipeline of firms preparing to go public and, in turn, has fuelled a booming — yet entirely unregulated — market for trading shares of private companies.
In this opaque ecosystem, employees, angel investors, and venture capital funds routinely offload their stakes to high-net-worth individuals and family offices eager to accumulate shares before an IPO. While investing in unlisted companies is inherently risky for these players, the danger is even greater when mutual funds enter this arena.
First, transactions in unlisted shares occur outside regulated exchanges, meaning there is no transparent order book, no reliable price discovery mechanism, and no verifiable valuation. Scarcity often drives irrational pricing, with buyers paying exorbitant commissions and accepting inflated quotes determined by intermediaries rather than market fundamentals. In stark contrast to listed securities, buying into private firms is akin to navigating blindfolded, with only sporadic, once-a-year filings with the Ministry of Corporate Affairs offering minimal insight into their financial health.
Second, valuations of unlisted shares are notoriously volatile. They can swing sharply depending on business performance, investor sentiment, or the pricing of subsequent funding rounds. Such unpredictability exposes mutual fund schemes to the risk of substantial losses. Moreover, IPO timelines frequently shift or get postponed indefinitely, leaving pre-IPO investors stranded without a clear exit route. For mutual funds — which must provide investors with the flexibility of anytime redemption — holding such illiquid and uncertain instruments is simply untenable.
There is also no assurance that the eventual IPO price will exceed private-market valuations. In fact, recent cases such as HDB Financial and NSDL have shown the opposite: IPO prices had to be set at discounts of 15–40%, resulting in significant value erosion. Such episodes can lead to steep write-downs for mutual funds, directly harming their unit holders.
Given these risks, mutual funds must adhere to their core mandate and confine themselves to listed, liquid, and transparently valued instruments. They already enjoy access to preferential IPO allocations in their role as anchor investors. This privilege offers them ample opportunity without exposing them to the dangers of unregulated private markets. Remaining within these boundaries is not just prudent; it is essential to protect investor interests and uphold market integrity.
SEBI’s ban on pre-IPO investments by mutual funds marks a decisive pivot toward uncompromising, investor-centric regulation. By sharply separating public-market obligations from private-market forays, the regulator is reinforcing what mutual funds are meant to deliver: full transparency, assured liquidity, and an equitable playing field for every participant — whether a powerful institution or a humble SIP investor.
