[The following post is contributed by Yashesh Ashar. Yashesh is a tax and regulatory consultant and the views expressed herein are personal]
The Companies Act, 2013 (‘New Cos Act’) which received the assent of the President on 30 August 2013 seeks to create a major overhaul in the functioning of the corporates in India. A major part of the New Cos Act is to be governed by the Rules proposed to be framed by the Central Government. The Draft Rules under the Companies Act, 2013 (‘Draft Rules’) have already been released by the Central Government for public comments.
The New Cos Act subjects private companies to a greater control and compliances and withdraws most of the exemptions available to private companies under the Companies Act, 1956 (‘Old Cos Act’). One of the aspects which is completely overhauled and widened under the New Cos Act is the conditions relating to issue or offer of securities by private companies. This post seeks to discuss various aspects of the new conditions relating to issue or offer of securities under the New Cos Act and Draft Rules and its impact on private companies.
The Old Cos Act did not refer to the expression ‘private placement’. Instead it provided in the negative that an offer or invitation shall not be treated as public offer, if shares or debentures are available for subscription or purchase only to those receiving offer or invitation and such offer and invitation is restricted to maximum of 49 persons. Further, the Unlisted Public Companies (Preferential Allotment) Rules, 2003 as amended by Unlisted Public Companies (Preferential Allotment) Rules, 2011 issued by the Ministry of Corporate Affairs (together referred to as ‘Preferential Allotment Rules’) prescribed conditions for preferential allotment by unlisted public companies. No such conditions were prescribed for private companies. Further, public companies whose shares are listed on the stock exchange required to comply with the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009 (‘ICDR Regulations’).
Thus, unlike the Old Cos Act, wherein the conditions relating to private placement were applicable only to public companies, the New Cos Act provides various conditions for private placement of shares and debentures which apply to both private companies and public companies. While some of the conditions in relation to private placements by companies appear as a direct fall-out of the recent cases and also in line with the latest amendments to Preferential Allotment Rules, only a few appear justified for private companies and others appear to have an unwarranted effect in curbing the flexibility available to companies in the fund raising exercise.
Under the New Cos Act, private placement has been defined to mean any offer of securities or invitation to subscribe to securities to a select group of persons by a company through issue of private placement offer letter. Non-compliance of the conditions require compliance with the requirement as regards public offer under the New Cos Act and ICDR Regulations.
Some of the key conditions and their effect are discussed hereunder:
(a) In order to qualify as a private placement, the New Cos Act states that offer of securities or invitation to subscribe to securities cannot be made to persons (excluding QIBs and employees subscribing to shares under an ESOP scheme) exceeding 50 or such higher number as may be prescribed in a financial year. Further, the Draft Rules provide that such offer or invitation shall be made to not more than 200 persons in aggregate in a financial year. On a harmonious reading of the provisions of the New Cos Act and the Draft Rules, it could reasonably be interpreted that though, during a financial year, an offer for private placement can be made to more than 50 but not exceeding 200 persons, aggregate of such offers of private placement during a financial year are to be restricted to 200 persons.
This may lead to availability of larger pool of capital for private companies and therefore, many of the unlisted public companies may consider becoming private. However, tax consequences post conversion of public company into private company may need to be considered on a case to case basis.
(b) A company making an offer or invitation through private placement is required to allot its securities within 60 days from the date of receipt of the application money. This could limit the timelines available to consummate transactions involving subscription of securities by non-residents. In such a case, escrow mechanism as provided for under the FDI Policy could be explored.
(c) The Draft Rules propose to restrict private placement to a maximum of 4 in a financial year with not more than one in a calendar quarter and a minimum gap of 60 days between any two private placement offers. This may create some inflexibility in structured transactions with investments in tranches as well as back to back investments by different investors in different instruments in a way not possible to treat them as single offer of private placement.
(d) The Draft Rules relating to issue of shares with differential voting rights provide for the following conditions:
- The shares with differential voting rights should not exceed 25% of the post issue paid-up capital of the company.
- The company (including private companies) is required to maintain a track record of 10% dividends for the preceding three financial years.
- The company shall not convert its existing equity share capital with voting rights into equity shares capital carrying differential voting rights.
These requirements could take away flexibility in organizing the capital as per the agreed commercials amongst the investors, especially, at project level investments which are proposed to be undertaken through newly set-up entities.
(e) The Draft Rules in relation to the issue of preferential issue of optionally convertible securities specify that the price of the resultant equity shares shall be determined beforehand on the basis of a valuation report of a registered valuer. In the Indian context, convertible instruments are widely used by private equity investors for the purpose of developing ratchets to preserve the value of their initial investments as well as participating in any potential upside in valuation after a predetermined period. It requires to be seen whether the conversion ‘price’ for the purpose could be formula based as in the case of FDI Policy.
While some conditions to regulate offer of securities by private companies are warranted considering some of the recent cases, the current set of regulations seem to be too far-fetched, cumbersome and restrictive for private companies.
With adequate regulatory oversight, investors should be provided with adequate flexibility to raise capital in a closely held private company wherein considerations relating to minority investor representation and / or protection are non-existent.