According to the Companies Amendment Act 2017, a Company can raise funds or Capital mainly in three ways: (1) Private Placement/ Preferential Allotment (2) Right Issue (3) Bonus Issue. According to the provision of Section-62 subsection (1) clause (a) at any time, a company having a share capital proposes can increase its subscribed capital by issue of shares. Such shares are offered to people who, at the time of the offering, are the holders of the equity shares of the company in any proportion. The preferential allotment of paid-up share capital is issued by sending the letter of offer for those shares before its issuance.

Concept of Preferential Allotment of Equity Shares

In India, if an existing company wants to expand its operation and affairs, it can raise funds in the manner as follows:

  • Issue of Right Shares to the Existing Shareholders;
  • Issue of Bonus Shares to the Existing Shareholders;
  • Initial Public Offer (IPO); and
  • Preferential Allotment;

Further, the term “Preferential Allotment” denotes the issuance of shares to a group of individuals at a pre-determined price. Further, this option allows the company to acquire Equity Participation from those whom it considers as being valuable as shareholders.

Companies Eligible for Preferential Allotment

The companies eligible for the Preferential Allotment of Equity Shares are as follows:

  • Private Limited Company;
  • Public Limited Company;
  • Listed Company;
  • Unlisted Company; and
  • Section 8 Company;

Reasons to Opt for Preferential Allotment of Shares

The reasons to opt for Preferential Allotment of Shares are as follows:

  1. To provide a route to the shareholders who were not able to purchase shares during IPO;
  2. To assist the company in obtaining Equity Participation;
  3. To assist in Raising Funds;
  4. To increase the Capital Flow in the economy;
  5. To increase the amount of Share Capital in a company;
  6. To offer an option of to the following for increasing stake in the company:
  7. Promoters;
  8. Venture Capitalists;
  9. Financial Institutions;
  10. Buyers;
  11. Suppliers;

Legal Provisions associated with the Issue of Shares on Preferential basis

The legal provisions associated with the Issue of Shares on Preferential Basis are as follows:

  • Section 62 (Allotment of Shares) of the Companies Act, 2013.
  • Section 42 (Allotment of Securities) of the Companies Act, 2013.
  • Rule 13 of Companies (Share Capital and Debentures) Rules, 2014.
  • Rule 14 of Companies (Share Capital and Debentures) Rules, 2014.
  • Specific Provisions of SEBI (ICDR) Regulations, 2018.

Benefits of the Preferential Allotment

The benefits of the Preferential Allotment of Equity Shares are as follows:

  • No Brokerage Cost Involved;
  • Preference Shareholder are given Preference over Shareholders at the time of Winding Up;
  • Preference Shareholders have a Right to Claim “Unpaid Dividend”;
  • Safer than Issuance of Equity Shares;
  • Preference Shareholders are paid first in the case of Bankruptcy and Insolvency;

Key considerations for Issue of Shares on Preferential Basis

The Company has to comply with the following conditions while making an Issue of Shares on Preferential Basis:

  • The Articles of Association (AoA) should authorize for the Issue of Shares on Preferential Basis through PAS. If the authorization is absent from the AoA, the amend the Articles of Association accordingly.
  • Letter of Offer should be sent to persons either in writing or in electronic Form.
  • The Company can come for the new offer of Issue of Preference Shares on once the earlier offer is completed as per Section 42 of the Companies Act. There is no requirement under the law regarding the minimum gap between the two offers.
  • No advertisement should be done in public at large for the offer made for the Issue of Preference Shares by the Company.
  • The issue of only fully paid-up securities and shares can be done
  • The approval of shareholders of the Company should be taken for the Issue of Shares on Preferential Basis.
  • Separate Bank Account should be opened for Issue of Preference Shares and Securities.
  • The price of the Shares and other Securities to be issued on preferential basis should be calculated as per the price determined in the valuation report of a registered valuer.
  • The offer shall be attached with the application form. The Form should be serially numbered and should be addressed to the person to whom the offer is made for the Issue of Preference Shares.
  • The PAN card of each Allottee should be there.

Procedure of Issue of Shares on Preferential Basis

The procedure followed for the Issue of Shares on Preferential Basis is as follows:

  • Call Board Meeting : The notice for the Board Meeting should be issued as per Section 173 of the Companies Act, 2013, to all the members 7 days before the Board Meeting. The notice of the Board Meeting should hold the agenda of the Board Meeting. The draft resolution of the Board Meeting should also be attached with the notice.
  • Hold Board Meeting: The Quorum of the meeting is first checked. In the Board Meeting, Resolution for the approval of Shares on Preferential Basis will be passed, and the following agendas will be discussed:
    1. The evaluation of the Valuation report
    2. The number of Allottees will be fixed.
    3. The time, date, place and day of the Extraordinary General Meeting (EGM) will be fixed.
    4. The draft of the Offer Letter will be prepared.
    5. The notice of EGM, along with the Explanatory Statement, will be finalized.
    6. The Resolution for the approval of the Offer Letter will be passed.
    7. To authorize any Director to issue the notice for EGM.
  • Call for Extra Ordinary General Meeting: The notice for EGM will be sent to all members, Directors and Auditors of Company along with agenda of the EGM. The notice should be sent at least 21 days before the date of the EGM.
  • Hold Extraordinary General Meeting: Firstly, the Quorum of the Meeting is checked. The EGM will be held for the following purpose:
    1. To present the Letter of Offer in PAS-4 Form to all the members of the Company
    2. To pass a Special Resolution for the Shares Issue on Preferential Basis.
  • Circulation of Letter of Offer: After the passing of the Special Resolution by the members in the EGM the approved Letter of Offer will be circulated. The Letter of Offer accompanied with an application form serially numbered and specifically addressed to the person to whom the offer of Shares Issue on Preferential Basis is made. The Letter of Offer should be sent in writing or electronic Form. The Letter of Offer should be issued within 30 days of the EGM.
  • File Form MGT-14: Form MGT-14 should be filed with the Registrar of Companies (RoC). The Form MGT-14 should be filed within 30 days from the date of passing of the Special Resolution in EGM by the Company. The following attachments should be made with the MGT-14 Form:
    1. The notice of EGM with the explanatory statement.
    2. The minutes of the EGM.
    3. The true certified copy of the Special Resolution passed in the EGM by the Company.
  • Open Separate Bank Account : A Separate Bank Account should be opened for the following purposes:
    1. The payment for the subscription for securities should be made from the bank account of the person subscribing for the securities.
    2. The Company should maintain the bank account from where the payment for the subscription for securities is received.
  • File Form to RoC: After the circulation of Letter of Offer, the Form GNL-2 will be filed with the Registrar of Companies. The GNL-2 should be filed within 30 days of the circulation of the Letter of Offer. The GNL-2 Form should be attached to the following:
    1. Letter of Offer in PAS-4 Form.
    2. A Complete record of Private Placement in PAS-5 Form.
  • Call for Second Board Meeting: The notice for the second Board Meeting will be issued at least 7 days before the date of the Board Meeting. The agenda of the Board Meeting should be attached with the notice pf the second Board Meeting. The second Board Meeting should be held within 60 days of the receipt of the Allotment money.
  • Hold Second Board Meeting: The Second Board Meeting will be held for the following purpose:
    1. To present the list of all the Allottees
    2. To pass Resolution for the Allotment of Shares.
    3. To pass Resolution for the Issue of Share Certificate to all the shareholders,
    4. To authorize any two Directors and an authorized person to sign on the Share Certificates to be issued to the Shareholders.
  • File Form PAS-3: After the second Board Meeting, Form PAS-3 will be filed to the Registrar of Companies (RoC). The Form PAS-3 should be passed within 15 days of the date of second Board Meeting. The Form PAS-3 should be attached with the following attachments:
    1. The list of all the Allottees
    2. The copy of the contract
    3. The true certified copy of the Special Resolution passed along with the explanatory statement.
    4. A true certified copy of the Board Resolution for the Allotment of Shares.
  • Issue Share Certificate: The Share Certificates will be issued to the shareholders within 2 months from the date of Allotment of Shares. The Stamp duty should be paid as per the provisions of the State. The Register of the Members should be updated after the Issue of Share Certificate to the shareholders.

Conclusion

The term “Preferential Allotment of Equity Shares” denotes a process in which a company allots shares to the individuals, companies, and venture capitalists at a pre-determined price. Further, these shares are mainly made to the individuals who want to acquire a majority or strategic stake in the company.

Moreover, this option allows the company to acquire Equity Participation from those whom it considers as being valuable as shareholders.

However, it shall be noteworthy to note that the process of preferential allotment is an intricate and lengthy process, and includes a lot of documentation and approvals.

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