Preferential allotment deals with the allotment of shares or securities by a corporate to any person including individuals, venture capitalists, or others at a pre-determined price.
Rule 13(1) of the Companies (Share Capital and Debentures) Rules, 2014 defines preferential allotment as an issue of shares (or other securities) to a selected group of persons by a company on a preferential basis. The securities could be of any type be it equity shares, fully and partly convertible debentures, or other securities convertible into equity.
Such issue of shares is made to existing shareholders as well as to persons other than existing shareholders. Further, they can be issued either for cash or consideration other than cash.
This issue is one of the fastest ways for a corporate to raise capital. However, this issue does not include securities offered by way of a public issue, rights issue, sweat equity shares, ESOP, bonus issue, and depository receipts issued in a foreign country.
A corporation seeks cash from the general public to address a variety of financial needs. If it decides to issue shares to the public on a significant scale, the procedure will take a long time and be rather difficult. As a result, this technique of obtaining funds is the most convenient because it involves a very minimal amount of paperwork.
Why does a company go for a preferential allotment?
Generally, a company goes for preferential allotment to offer shares to persons who wish to acquire a strategic stake in the company. These could be promoters, financial institutions, angel investors, or venture capitalists who seek to increase their controlling stake in the company. As a result, a preferential issue enables a company to get equity participation from people whom it believes to be a valuable addition as shareholders.
When such an issue is made by a company whose shares are listed on a recognized stock exchange, then it must be made in accordance with the provisions of the Companies Act 2013 and regulations specified by SEBI. On the other hand, if a company’s shares are not listed, then the preferential offer has to be made in compliance with the provisions of the Companies Act 2013 and rules made thereunder.
The following is the list of provisions that get attracted:
Section 62(1)(c) of the Companies Act, 2013
Rule 13(1), (2) & (3) of the Companies (Share Capital and Debentures) Rules, 2014
Section 42 of the Companies Act, 2013
Rule 14 of the Companies (Prospectus and Allotment of Securities) Rules, 2014
Essential requirements for Preferential Allotment of shares
Given below are some essential requirements to be taken care of by a company that issues its shares on a preferential basis:
When a company goes for a preferential offer, the issue must be authorized by its Articles of Association (AOA).
Section 62(1)(c) of the Companies Act, 2013 prescribes that preferential allotment of shares must be made by a company only by passing a special resolution in a general meeting.
Another pre-requisite for preferential allotment of shares is that the price of such shares has to be properly determined through a valuation report of a registered valuer. In pursuance of Rule 13(3) of the Companies (Share Capital and Debentures) Rules, 2014, the price of securities to be issued on a preferential basis shall in no case be lower than the price determined by a registered valuer in his report for the said purpose. This valuation is necessary whether the shares are being issued for cash or consideration other than cash. The report given by a registered valuer will justify the price determined for such an offer.
However, in the case of publicly-traded listed companies, the price of shares to be issued on a preferential basis is not needed to be set by a valuation report prepared by a registered valuer. Hence, listed companies are not required to obtain a report from a registered valuer.
When a decision of preferential allotment is made, it is imperative that all the important information in that regard is provided to the members. Hence, the following disclosures must be made by a company in the explanatory statement to be annexed to the notice of general meeting:
- Objectives of preferential allotment
- Number of securities to be issued
- The price band at which such shares are being proposed to be issued
- The basis for determination of price along with the report of the registered valuer
- The relevant date with reference to which the price has been determined
- The selected group of persons to whom the allotment is proposed to be made
- The intention of directors, promoters, and KMP to subscribe to the issue
- The estimated timeline within which the allotment shall be completed
- The percentage of post preferential offer capital that will be held by the proposed allottees
- The change in ownership control of the company that may occur subsequent to preferential allotment of shares
- If any securities have already been allotted on a preferential basis during the year, then the details of such an offer
- If the preferential allotment is proposed to be made for consideration other than cash, then the justification for its valuation
- The shareholding pattern of the company, both pre-issue, and post-issue
Time for allotment:
Once a special resolution is passed at the company’s general meeting for the issue of shares on a preferential basis, the allotment has to be completed within 12 months from the date of passing of such resolution. In the case where the allotment could not be completed within the said period of 12 months, the company would thereafter need to pass another special resolution to give effect to such preferential allotment of shares.
Consideration other than cash:
When preferential allotment of shares is made for a consideration other than cash, then such non-cash consideration will either be recorded by the company in the form of a depreciable/ amortizable asset to be carried in its balance sheet or be expensed in accordance with Accounting Standards.
Procedure for Preferential Allotment of shares
The following steps must be followed by a company for the issue of shares on a preferential basis:
1. Check whether AOA authorizes the issue of shares on a preferential basis. If not, the company must make necessary arrangements to alter its AOA.
2. A board meeting must be convened to approve the notice of the general meeting which is proposed to be held to seek members’ consent on preferential allotment of shares. The approval of the board of directors must also be sought on the explanatory statement to be annexed to the notice of the general meeting. The explanatory statement should entail all the important information pertaining to such an issue.
3. To determine the price of securities to be issued on a preferential basis, the company must obtain a valuation report from a registered valuer.
4. Ensure that all the important disclosures in the explanatory statement are annexed to the notice of the general meeting as per Section 102 of the Companies Act.
5. A general meeting must be convened to pass the necessary special resolution.
6. File Form MGT-14 with ROC within 30 days of passing the special resolution. Additionally, dispatch offer-cum-application letter in Form PAS-4 to proposed allottees to subscribe to securities. It must be dispatched within a period of 30 days of recording their names in the company and can be dispatched either in writing or in electronic mode.
7. After the passing of the special resolution, the allotment of securities has to be completed within 12 months from the date of passing of such resolution. Hence, once a special resolution is passed in a general meeting, it shall be valid for one year.
8. Open a separate bank account in a scheduled bank.
9. Once the shares are allotted, file a return of allotment with ROC in Form PAS-3 within 15 days of allotment. The return contains the details of the securities allotted and the names of the allottees.
10. The company should deliver the share certificates of allotted shares within 2 months from the date of allotment.
11. The details of allotment must also be intimated to the Depository immediately on the allotment.
12. The company must maintain a complete record of the offer in Form PAS-5.
13. Where the preferential allotment of shares is made by a company to its existing members only, then, in that case, the requirement of PAS-4 and PAS-5 shall not be applicable.
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