[Guest post by Rishi A, a 5th year at Hidayatullah National Law University, Chhattisgarh]
The London Stock Exchange (LSE) has a program that it runs for small and medium scaled enterprises called the ELITE Programme. Providing services like professional advice from industry experts about value-creation and also assistance in issues relating to raising of funds, it requires the enterprises to (i) sign-up with the entire programme, (ii) be generating more than £5 million in revenue, and (iii) be able to demonstrate progress till date as well as future growth potential. Subsequently, LSE launched the ELITE Club Deal (ECD), which allows the registered companies to access an online platform for private placements of their securities. By providing connections with various investors groups like venture capitalists (VCs), private equity (PE) firms and also individual investors, this deal provides a huge advantage to these small-scale enterprises.
Since private placements are negotiated between the parties before the offer is actually made, the ECD resolves this issue by providing stream-lined processes for obtaining the investment options. Furthermore, the claim that since most of the private placement transactions occur online these days, including the negotiation of the deal, favours the need for, and use of, an online platform for such a purpose.
The actual question here is whether such a platform is possible in India. It is true that India already has SME Exchanges that allow large numbers of small- and medium-scaled companies to list and raise public funds. India also has the Institutional Trading Platforms (ITP) that allow companies, especially start-ups, a great opportunity to raise Indian public funds, instead of seeking foreign VCs. The regulations on ITPs prescribed by the Securities and Exchange Board of India (SEBI) are very flexible, as they require companies to have a working capital of not more than Rs. 25 crores and they must have a minimum investment of Rs. 50 lakhs by an alternative investment fund (AIF) or a VC or other institutional or angel investor.
India, which ranks third in the Global Start-up Ecosystem and has also emerged as the fastest growing base for start-ups worldwide, is very likely to have numerous companies that fail to qualify the criteria imposed by the SME Exchanges or the ITP, due to which they will face immense difficulty in reaching out to potential investors. An online platform could be a perfect solution for such purposes. Even SEBI considered such an approach when it came up with its Consultation Paper on Crowd-funding in 2014. An online platform for private placements would be similar to equity crowd-funding, but one that would be working within the regulations prescribed for private placements under the Companies Act, and would not fall within the purview of a general offering to the public.
A private company is mandated to impose a number of restrictions and limitations on the transfer of its shares under the Companies Act, 2013 and private placement is the only method it can deploy to issue shares. Under section 42 of the Companies Act, 2013, an offer or an invitation to offer of securities through private placement can be made to a number of persons not exceeding 50 at one time and to an aggregate of 200 persons in one year, as per Rule 14(2)(b) of the Companies (Prospectus and Allotment of Securities) Rules, 2014. It will also be important to note that the offer to the 49 persons must be targeted in nature, and made without advertising the offer to anyone else. In this post, I hope to provide a model that would potentially allow such a platform to be set-up in a manner that is consistent with existing regulations.
Assume an online platform is created, which allows a private or public unlisted company to choose between multiple investors who are also registered on the platform. For such a purpose, apart from making the registration of the companies and the investors compulsory, the platform would also have to take precautionary steps like imposing eligibility criteria on the investors, like net worth, experience in investing in the stock market, etc. and for obvious reasons only institutional investors, VCs, PE firms and high net worth individuals (HNI) must be allowed to register as investors on this platform.
Since the companies registered on the platform have done so for the purposes of obtaining funding, the same need not be advertised. The companies would instead be required to list their company details, official website and the sector in which it conducts its business. Thus, none of this would be considered as an advertisement or offer being made to any investor.
Following these procedural formalities, the first step would require a registered investor to show its interest to fund the company online by either clicking on it or by any other mechanism that can be devised. This interest would be shown on the basis of the public profile provided by the registered company on the platform. Following this, the company would be able to view the final list of all the investors who have shown interest in funding it. Now keeping in mind the fact that the company is allowed to make a private placement offer to the maximum permissible number of persons at once, while deciding on the list of the investors to make private placement offer to, as the second step the Company’s board of directors would then review the list of the interested investors and select the investors to whom it would send its private placement offer letter, or the invitation of such an offer.
Finally, once such an offer is made by the company, and an acceptance would be required to be communicated by the investors within a prescribed time limit, the shares could be deposited in their respective demat accounts. The payment for the shares could be made directly to the company’s account from the investors account. The platform could also provide for a payment gateway that would allow the investors to execute the payments on the platform itself. However, to provide the facility for such a payment gateway an AD-I Bank would have to be brought in as a partner and the bank would be required to report this transaction to the Reserve Bank of India.
Some might argue that, in accordance with the model suggested above, an investor showing interest in a company on the first instance may be considered as an offer made. Alternatively, it may be argued that the fact that a company is registered on the platform might itself be reflective of its intention to potentially offer securities. On the emergence of similar start-ups, questions relating to its legality have been raised. Even SEBI has cautioned investors against dealing with such electronic platforms. However, under the first step in the model proposed, an investor would be able to show interest in the registered company on the basis of its public profile only. No details of the funding will be disclosed to any prospective investor until after the second step in the model, i.e., the finalisation of the list of investors to whom the offer of securities is to be made. In such a manner, the platform would be able to function while respecting the securities regulations that apply to it.
As I had mentioned earlier in this post, logistics is also one of the major issues that arises in such a situation. However, by streamlining the process, the issues of logistics can be solved. Providing standardised contracts, allowing parties to communicate smoothly online and allowing easy modification of these standardised contracts based on their negotiations is quintessential for the success of such a platform, but providing such facilities should not be very difficult either with the introduction of numerous smart-contracting companies.
Finally, under the ITP Regulations, companies older than 10 years and making more than 100 crores in revenue have been restricted from accessing the ITPs. Providing a transparent electronic platform for private placement of securities may prove to be beneficial to older but smaller conventional businesses in India.
- Rishi A