For many companies, particularly closely held and unlisted companies, private placement is a practical way of raising funds without going through the extensive process involved in a public issue. It allows a company to approach a limited set of identified investors and raise capital on mutually agreed terms.

The principal provision governing private placement is Section 42 of the Companies Act, 2013, read with Rule 14 of the Companies (Prospectus and Allotment of Securities) Rules, 2014. Depending on the nature of the securities and the investors involved, provisions relating to preferential allotment, valuation, foreign investment and securities regulations may also apply.

What Does the Law Permit?

  • A private placement is essentially an offer or invitation by a company to a select group of identified people to subscribe to its securities. It is not an offer to the public and, therefore, the company cannot treat it as an open fundraising exercise.
  • A company cannot make a private placement to more than 200 persons in aggregate in a financial year for each kind of security, subject to the exclusions and conditions prescribed under the law, including those relating to Qualified Institutional Buyers and employees under an employee stock option scheme.
  • A private placement cannot be advertised or marketed to the general public. The company must approach identified investors in the manner prescribed under the Act.

Some of the key Compliances

  • Before proceeding with a private placement, the company should ensure that the proposal has the necessary Board and shareholders’ approvals, wherever applicable. The offer must be made to identified persons and the prescribed private placement offer letter, including Form PAS-4, must be used.
  • The subscription money also has to come through the permitted banking channels and cannot be received in cash. The money received is required to be kept in a separate bank account and cannot be freely utilized until the conditions prescribed under Section 42 are met.
  • There is also a clear timeline for completing the transaction. Securities are required to be allotted within 60 days from receipt of the application money. If the company fails to do so, the money has to be refunded within the prescribed period. Delay in refund can also result in interest being payable at 12% per annum. Once the allotment is made, the company has to complete the necessary statutory filings, including filing the return of allotment in Form PAS-3 within the prescribed period.

What Happens if the Company Gets it Wrong?

  • Under Section 42(10), where a company makes an offer or accepts monies in contravention of the private placement provisions, the company, its promoters and directors may be liable to a penalty of the amount involved in the offer or ₹2 crore, whichever is lower, subject to the statutory provisions. The company may also be required to refund the money received from the subscribers within the prescribed period.
  • There can also be consequences for delays in filing the return of allotment.
  • Further, if the requirements of Section 42 are not followed, an issue intended to be a private placement may, in appropriate circumstances, be treated as a public offer, bringing an entirely different set of regulatory requirements into play.
  • The financial penalty, therefore, is only one part of the risk. A defective fundraising process can also affect the company’s subsequent transactions, investor relations and corporate records.

What Should the Company and its Board Keep in Mind?

The company should first examine its Articles of Association, existing capital structure, shareholder arrangements and any restrictions applicable to the proposed issue. The identity and number of proposed investors should be checked carefully. The Board, for its part, should have sufficient information before approving the transaction. The proposed pricing, valuation, purpose of the fund raise, investor profile and dilution of existing shareholding should be properly considered and recorded. It is also important to maintain a proper trail of the transaction, starting from the initial proposal and approvals to the offer letter, receipt of funds, allotment and subsequent filings.

What Should Investors Look at?

An investor should not assume that compliance with Section 42 is solely the company’s responsibility. Before investing, it is sensible to verify the company’s constitutional documents, existing shareholding, previous allotments, valuation, outstanding shareholder rights, encumbrances and any material litigation or regulatory issues.

Where the investor is based outside India, the transaction should additionally be examined from the perspective of FEMA, RBI regulations, applicable pricing requirements and sectoral restrictions before the investment is made.

Existing Shareholders Should not Overlook Dilution

A new investment can change more than the company’s bank balance. Existing shareholders should look at the extent to which their shareholding and voting rights will be diluted. They should also consider whether the incoming investor is receiving special rights, whether the transaction changes the balance of control and whether the issue is consistent with existing shareholders’ agreements.

A Compliance Exercise, not Just a Funding Exercise

Private placement is often attractive because it can be faster and more targeted than a public issue. But the fact that the investors are privately identified does not mean that the regulatory requirements can be dealt with casually. A private placement should be viewed as a complete transaction—from structuring and approvals to valuation, documentation, receipt of funds, allotment and post-allotment filings. For companies, Boards and investors, taking legal and compliance advice at the beginning of the transaction is usually far easier than trying to correct a procedural defect after the money has already changed hands.

 

Author: Sarika Aggarwal (Head – Advisory & International Relations)