Funding is most crucial resource for an organization to thrive and grow. With the advent of Companies Act 2013 effective 1st April 2014, new concept of raising capital came into play- rights issue vs private placement. In simple terms Rights issue is when share capital is raised from the existing shareholders in proportion to their current shareholding while private placement as the name suggests is when offer to subscribe the shares of the company is made to new Investors without any public advertisement or marketing or media usage.

Section 42- Private placement section of the companies Act is applicable to all companies and its covers various types of instruments unlike rights issue. “Subscription of securities” is mentioned in the Section, therefore, convertible or non-convertible debentures and shares, warrants are covered under this section. Private placement provision is the most debatable provision of the Act and there have been multiple amendments to the provisions since its effectiveness to meet the industry demands and plug the gaps.

Companies have to be extremely cautious of compliance of these provisions as the penalty is very high and any offer made without complying with these provisions would deemed to be public offer and provisions of SEBI will be triggered even though the company may be private limited or unlisted irrespective of whether the money is received or not. Higher penalty is prescribed for delay in filing return of allotment in PAS 3 within the time frame than delay in PAS 3 filing for capital raised through rights issue.

Penalty provisions as under:

(9) If a company defaults in filing the return of allotment within the period prescribed under sub-section (8), the company, its promoters and Directors shall be liable to a penalty for each default of one thousand rupees for each day during which such default continues but not exceeding twenty-five lakh rupees.

“(10) Subject to sub-section (11), if a company makes an offer or accepts monies in contravention of this section, the company, its promoters and Directors shall be liable for a penalty which may extend to the amount raised through the private placement or two crore rupees, whichever is lower, and the company shall also refund all monies with interest as specified in sub-section (6) to subscribers within a period of thirty days of the order imposing the penalty.

(11) Notwithstanding anything contained in sub-section (9) and sub-section (10), any private placement issue not made in compliance of the provisions of sub-section (2) shall be deemed to be a public offer and all the provisions of this Act and the Securities Contracts (Regulation) Act, 1956 and the Securities and Exchange Board of India Act, 1992 shall be applicable].”

Checklist of the provisions are summed up below:

  1. Offer can be made to maximum 200 investors in a financial year excluding offer to employees under ESOP Scheme and qualified institutional buyers. Also, this limit is for each class of security separately.
  2. No fresh offer can be made unless allotment with respect to any previous offer is completed or withdrawn by the company. In case a different class of securities is being offered, this restriction will not be applicable provided the maximum limit of 200 people to whom the offer is made is complied.
  3. Share application money is to be received in a separate bank account and money cannot be utilized till the return of allotment is filed with MCA. Our takeaway in this clause would be that companies are not required to open new bank accounts for each private placement. Separate bank account which is not used for day today operations and payments, can be used. Entries in such account should be only receipt of share application money and transfer of that amount to regular bank account after filing of PAS 3 is completed. The same account can be used for subsequent private placements once previous round is completed.
  4. Timeline to file the PAS 3 in private placement is 15 days from date of allotment unlike other allotments where timeline is 30 days.
  5. Shareholders special resolution is to be passed explanatory statement of which should mention mandatory disclosure. The requirement of passing special resolution is not applicable in case non-convertible debentures are being issued within the limit already approved under Section 180. In case of offer to qualified institutional buyers, only one resolution passed previously shall hold good for all allotments to such buyer in a year.
  6. Within 30 days of passing the Board and shareholders resolution offer and filing of MGT 14 with MCA for the Board or shareholders resolution, PAS 4 should be issued to the Investor whose name is recorded in the Board & shareholders resolution. Therefore, you cannot issue PAS 4 to another new Investor for whom the Board and shareholders resolution is not passed and in case 30 days have elapsed from passing of resolution, fresh resolution needs to be passed prior to issuance of PAS 4.
  7. List of allotees attached to the PAS 3 for private placement should contain additional information such as PAN Number, email address.
  8. Private limited companies also have to file 2 MGT 14s with MCA – one for special resolution of shareholders and one for resolution under Section 179(3) (c) although Section 179 filing is exempt for private companies.
  9. Valuation report is required prior to passing the Board and shareholders resolution from a Registered Valuer. In case allotment of shares are attracting FEMA compliance, the valuation report should not be more than 90 days old from the date of allotment and issue price for allotment of shares to foreign investor should not be less than the value derived by the Valuer. Further as per FEMA guidelines Valuation report should be obtained from Registered valuer who is a Chartered accountant or cost accountant or SEBI registered merchant banker only.
  10. Complete record of private placement is to be maintained in PAS 5

In recent times due to surge in funding to Startups and valuation gimmicks, there is a belief that almost every startup should raise funding to become success story. However, without thorough compliance and checks in place, funding should not be raised. If you are looking for seasoned advisors for seamless compliance on funding contact us.

Akansha Rathi and Associates (ARACS), Company Secretary Firm in Navi Mumbai is engaged into compliance related services. We have a team of experts who not only possess required skills and experience but also have worked in complex business environment and were engaged in providing complex solutions in terms of providing related Compliance services to our clients.

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