Raising capital is essential for business growth and expansion. A public company in India raises funds through an IPO, FPOs, issuing rights, QIPs, debt financing, and private placements. Private Limited Companies are not allowed to raise funds from the general public like listed companies. However, they have multiple financing options like equity and debt financing. One of the important methods of raising funds in a private limited company is through the private placement of shares. Private Placements of shares allow a company to raise funds by offering its securities to a select group of investors instead of the general public. Private placement is regulated under Section 42 and Section 62(1)(c) of the Companies Act, 2013, along with the Companies (Prospectus and Allotment of Securities) Rules, 2014. The method is used by startups, growing enterprises, and established businesses looking to raise funds efficiently while maintaining control over their ownership and operations.
We will examine the idea of private placement in this blog, along with its legal framework, benefits, processes, and important factors, giving readers a comprehensive idea of how businesses might use this technique to raise money.
What is Private Placement?
Private placement refers to the sale of securities by a company to a pre-selected group of investors, which could include institutional investors, high-net-worth individuals (HNIs), or venture capitalists. Unlike public offerings in public companies, a private placement does not involve offering shares to the general public and is subject to stringent compliance regulations.
According to Section 42 of the Companies Act 2013, a private placement is an offer of securities to not more than 200 persons in a financial year (excluding qualified institutional buyers and employees under ESOPs). The process involves issuing a Private Placement Offer Letter (PAS-4) and adhering to specific regulatory requirements.
Legal Framework for Private Placement
The Companies Act, 2013 primarily governs private placement, and the Companies (Prospectus and Allotment of Securities) Rules, 2014 as:
- Section 42: It defines private placement and lays down procedural requirements.
- Section 62(1)(c): It governs preferential allotment and issuance of securities to investors.
- Rule 14 of the Companies (Prospectus and Allotment of Securities) Rules, 2014: It provides detailed guidelines on private placement offers, allotment, and compliance.
- SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018: Applicable to listed companies conducting private placements.
Types of Private Placement
Private placement can be classified into four main categories:
- Preferential Allotment: When a company issues shares to a specific group of investors, such as promoters, existing shareholders, or strategic investors. The company’s shares are not issued to the public in this case. This method helps businesses to raise capital quickly while ensuring that ownership remains within a trusted circle.
- Qualified Institutional Placement (QIP): Qualified Institutional Placement (QIP) is a way for companies to raise funds by issuing shares exclusively to Qualified Institutional Buyers (QIBs), such as mutual funds, insurance companies, pension funds, and banks. Listed companies primarily use this method to raise large amounts of capital quickly.
- Rights Issue to Select Investors: Â A rights issue occurs when a company offers additional shares to its existing shareholders. The company gives them the first opportunity to buy more shares before issuing the shares to outsiders. However, in some cases, the company may structure the rights issue so that only selected investors like stakeholders or strategic partners.
- Convertible Instruments: Convertible instruments refer to financial instruments, such as debentures or bonds, that start as debt but can be converted into equity shares at a later stage. Businesses that want to raise money while maintaining the option to pay back investors in cash or shares frequently employ these.
Advantages of Private Placement
- Faster Capital Raising: Private placement is a quicker process to raise capital than public issues, as it involves fewer regulatory approvals and procedural formalities.
- Cost-Effective: Companies can save costs in legal, marketing, and underwriting costs that are involved in public offerings.
- Preserves Privacy: Private placement, as opposed to public offerings, enables businesses to limit the amount of individuals who may access their financial and strategic data.
- Selective Investor Base: Businesses can lower the danger of hostile takeovers by selecting investors who share their long-term objectives.
Conditions for Private Placement
Certain conditions must be met before Private Placement in India, and these conditions are mentioned below:
1. Limited Number of Investors:
A company can offer shares to a maximum of 200 investors in a financial year. This limit does not include Qualified Institutional Buyers (QIBs) and employees receiving shares under ESOPs (Employee Stock Ownership Plans).
2. Private Placement Offer Letter is Mandatory:
The company must issue a Private Placement Offer Letter (PAS-4) to selected investors. This document contains details of the offer, including the price of shares, terms, and conditions.
3. Money Must Be Received Through Banking Channels:
Investors must pay for their shares using bank transfers, cheques, or demand drafts. Cash payments are not allowed. The money should come directly from the investor’s bank account.
4. No Public Advertisements or Marketing:
The company cannot promote or advertise its private placement offer through newspapers, social media, TV, or any other public platform. The offer must be made only to the selected investors privately.
5. Shares Must Be Issued Within 60 Days:
Once the company receives money from investors, it must allot the shares within 60 days. If this deadline is missed, the company must refund the money within 15 days. If the refund is delayed, the company is required to pay investors 12% interest per annum.
6. Filing with the Registrar of Companies (ROC):
Within 15 days of allotting shares, the company must file a Return of Allotment (PAS-3) with the Registrar of Companies (ROC), providing details of the investors and the shares issued.
7. Board and Shareholder Approval is Required:
- The company’s Board of Directors must approve the private placement offer in a board meeting.
- If the offer involves issuing new shares beyond existing shareholders, a special resolution must be passed in a general meeting, and the company must file Form MGT-14 with the ROC.
8. Price Must Be Fair and Justified:
The company cannot issue shares at an arbitrary price. The price must be based on a proper valuation report to ensure fairness for all investors. Listed companies must comply with SEBI pricing regulations.
9. No Transfer of Shares for a Certain Period:
Shares allotted through private placement cannot be freely transferred immediately. Restrictions based on company policies and regulatory guidelines may apply.
10. Funds Cannot Be Used Until ROC Filings Are Complete:
The company cannot use the funds received until it has properly filed the Return of Allotment (PAS-3) with the ROC.
11. Records Must Be Maintained:
For compliance purposes, the company must maintain a record of all investors and the private placement details in Form PAS-5.
Procedure for Private Placement
The Companies have to follow a structured process for private placement, which is as follows:
Step 1: Board Meeting
The Board of Directors must convene a board meeting to approve the private placement proposal and draft the Private Placement Offer Letter (PAS-4).
Step 2: Shareholders’ Approval (Special Resolution)
A special resolution must be passed in a general meeting to authorise the private placement offer. The company must then file MGT-14 with the ROC within 30 days of passing the resolution.
Step 3: Preparation of Offer Letter (PAS-4)
The company must prepare the Private Placement Offer Letter (PAS-4), specifying details of the securities being offered, the investors, and the terms of the offer.
Step 4: Subscription Money Collection
Investors will pay the application fee via banking channels in order to subscribe to the offer.
Step 5: Allotment of Securities
The company must allot securities within 60 days of receiving the subscription money. If the allotment is not completed within the stipulated time, the company must refund the amount within 15 days.
Step 6: Filing of Return of Allotment (PAS-3)
A return of allotment (PAS-3) providing details of the allotted securities must be filed with the ROC within 15 days of allotment.
Step 7: Issuance of Share Certificates
The company must issue share certificates to investors within two months from the date of allotment.
Challenges and Risks of Private Placement
- Limited Investor Pool: Since private placement restricts the number of investors, it may limit the potential capital raised.
- Stringent Compliance: Despite being less complex than public issues, private placements require strict compliance with ROC filings and legal documentation.
- Dilution of Control: Offering equity through private placement may lead to a dilution of promoter ownership and decision-making power.
Conclusion
For private limited companies in India, private placement is a an important fundraising tool that allows the company to effectively generate capital. However, companies must ensure strict compliance with regulatory requirements to avoid penalties. By following a structured approach, businesses can leverage private placement to fuel growth and expansion.
FAQs
1. What is the maximum number of investors allowed in a private placement?
A company can offer securities to a maximum of 200 persons in a financial year, excluding Qualified Institutional Buyers (QIBs) and ESOP allotments.
2. Can a company advertise its private placement offer?
No, the company cannot advertise the private placement offer publicly.
3. What happens if securities are not allotted within 60 days?
The company must refund the money within 15 days, failing which it is liable to pay interest at 12% per annum.
4. What is PAS-4?
PAS-4 is the Private Placement Offer Letter issued to investors.
5. Can private placement be made to existing shareholders?
Yes, but it must comply with the provisions of Section 42 and Section 62(1)(c) of the Companies Act 2013.
6. How is private placement different from a public issue?
Private placement is limited to select investors, whereas a public issue is open to the general public.
7. What is PAS-3?
PAS-3 is the Return of Allotment that must be filed with the ROC within 15 days of share allotment.
