Corporate Restructuring and Entity Optimization

Preferential allotment of shares is primarily a method adopted by companies to raise capital efficiently. Under this method, the company issues additional equity shares or convertible securities to a select group of people, rather than to through a public offer or rights issue

Under the Indian Corporate law, preferential allotment is governed by Section 62(1)(c) of the Companies Act, 2013, read along with Rule 13 of the Companies (Share Capital and Debentures) Rules, 2014. Furthermore, if the company is listed on a recognized stock exchange, the preferential allotment is additionally governed by Chapter V of the Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2018 (hereinafter SEBI ICDR Regulations).

The primary regulations governing preferential allotment include:

• Section 62(1)(c) of the Companies Act, 2013.
• Rule 13 of the Companies (Share Capital and Debentures) Rules, 2014.
• Section 42 of the Companies Act, 2013 (Private Placement rules, which often run parallel to preferential allotments).
• SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 [ICDR] (Applicable strictly to listed companies).

The execution of a preferential allotment requires adherence to several key sequential steps to ensure complete regulatory compliance:

• The Board must first convene a board meeting to consider and approve the proposal for a preferential allotment, identify the proposed allottees, and approve the draft notice for calling a general meeting of the shareholders.
• The company is required to obtain a detailed valuation report from a registered valuer, which will determine the fair market value of the shares and establish the minimum issue price for the transaction.
• The company must issue a notice to all its shareholders to convene a general meeting, ensuring that the explanatory statement attached to the notice contains all mandatory disclosures such as the object of the issue, pricing details, and the names of the proposed allottees as required under Rule 13 of the Companies (Share Capital and Debentures) Rules, 2014.
• During the general meeting, the shareholders must pass a special resolution which requires at least a seventy-five (75) per cent majority vote from the shareholders, approving the preferential issue.
• Within thirty days of passing the special resolution, the company must file Form MGT-14 with the Registrar of Companies to formally register the resolution.
• Following the shareholder approval, the company must circulate a formal private placement offer letter to the identified persons. Upon the receipt of the subscription money from the proposed allottees, a subsequent board meeting is convened to formally allot the securities.
• Finally, the company must file the return of allotment in Form PAS-3 with the Registrar of Companies within thirty days from the date of the actual allotment of the shares.

The timeline for completing a preferential allotment generally ranges from thirty to forty-five days, depending on the operational efficiency of the company and the time required to obtain the valuation report from a registered valuer.

One of the most time-consuming statutory requirements is the issuance of a clear twenty-one days’ notice to shareholders for convening the general meeting. However, a private company or an unlisted public company may convene the meeting at shorter notice if the requisite consent of members is obtained in accordance with the provisions of the Companies Act, 2013.

Once the shareholders pass the special resolution, Rule 13 of the Companies (Share Capital and Debentures) Rules, 2014 requires that the allotment of securities be completed within a period of twelve months from the date of passing of the special resolution. If the company fails to complete the allotment within this period, the special resolution lapses, and a fresh special resolution must be passed before proceeding with a new allotment.

The main documents ordinarily prepared and filed are:

• Board resolution approving the issue and calling the general meeting.
• EGM/AGM notice with Section 102 explanatory statement.
• Special resolution approving the preferential allotment.
• Valuation report from a registered valuer, where applicable and especially for unlisted issues.
• PAS-4 offer letter to identified investors only.
• PAS-5 / records of offers and applications, as applicable.
• Bank proof of receipt of application money.
• Minutes of board meeting for allotment.
• MGT-14 to be filed for recording the special resolution.
• PAS-3 to be filed to report the allotment of securities to the ROC

The pricing mechanism for a preferential allotment depends significantly on whether the issuing company is an unlisted or a listed entity. For unlisted companies, the allotment price cannot be less than the fair market value determined by a registered valuer. The registered valuer typically employs internationally accepted valuation methodologies such as the Discounted Cash Flow (DCF) method, the Net Asset Value (NAV) method, or the Comparable Company Multiple (CCM) method to accurately arrive at the price.

In contrast, preferential allotments by listed companies are governed by the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 (“SEBI ICDR Regulations”). The issue price is determined in accordance with the pricing formula prescribed under the ICDR Regulations, which is primarily based on the historical market price of the equity shares traded on the recognised stock exchange(s) during the prescribed reference period. The regulations generally consider the volume weighted average price (VWAP) of the shares over specified look-back periods preceding the relevant date.

Where the company fails to allot the shares within 60 days of receiving the money, it must refund the application money to the subscribers within the next 15 days. Where the company fails to refund such application money within this period, the company will be liable to repay the money with an interest of 12% per annum from the expiry of the 60th day.

For unlisted companies, the Companies Act, 2013, does not prescribe a statutory lock-in period for equity shares issued on a preferential basis; however, the investors and the company will typically agree to specific transfer restrictions contractually through a shareholders' agreement.

For listed companies, the SEBI ICDR Regulations mandates a strict statutory lock-in periods to prevent the immediate offloading of shares and to protect retail investors in the market. According to the amendments made in Chapter V of the SEBI ICDR Regulations in the year 2022, specified securities allotted on a preferential basis to promoters or the promoter group, up to twenty per cent of the total capital of the company, are locked in for a period of eighteen (18) months from the date of trading approval.

Allotments exceeding this twenty per cent threshold to promoters, as well as any preferential allotments made to non-promoters, are subject to a strict lock-in period of six months from the date of trading approval.

Yes, the Companies Act 2013 and the Companies (Share Capital and Debentures) Rules, 2014 impose several strict conditions and restrictions to protect the interests of existing shareholders and to ensure fair pricing.

Firstly, the price of shares issued on a preferential basis must be justified through a valuation report issued by a registered valuer, particularly in the case of unlisted companies. The price of the shares issued on a preferential basis must never be less than the price determined by the registered valuer in the formal valuation report.

Secondly, the shares or other securities allotted on a preferential basis must be fully paid-up at the time of their actual allotment.

Thirdly, if the preferential allotment is being made for consideration other than cash, the valuation of such consideration must also be conducted by a registered valuer, and this fact must be explicitly disclosed in the explanatory statement attached to the general meeting notice.

Lastly, the company must ensure that all critical disclosures and any potential change in the control of the company, are transparently presented to the shareholders before they cast their vote on the special resolution.

Yes. Pursuant to Section 42 of the Companies Act, 2013 read with Rule 14 of the Companies (Prospectus and Allotment of Securities) Rules, 2014, a company may make a preferential allotment (private placement) of securities to a maximum of 200 persons in aggregate during a financial year, excluding qualified institutional buyers and employees offered securities under an employee stock option scheme.