We often hear the terms 'private placement' and 'preferential allotment' used in the transactions space as methods of raising funds, but there seems to be confusion as to the exact difference between them owing to their overlapping nature. Thus, they are sometimes used interchangeably in loose terms. In this article, we provide insight into the nature of these two methods and the difference between the two corporate actions.
Understanding the Concept
Preferential Allotment – Section 62(1)(c) of the Companies Act, 2013 ("Act") provides for preferential allotment of shares by a company. Preferential allotment means issuance of 'shares or other securities' by a company to any select person or group of persons on a preferential basis but does not include shares offered through a public issue, employee stock option scheme, rights issue, bonus shares.
The definition of 'shares or other securities' has been provided under Rule 13 of the Companies (Share Capital and Debenture) Rules, 2014 ("Rules"). As per the Rules, the expression 'share or other securities' means equity shares, fully convertible debentures, partly convertible debentures or any other securities, which would be convertible into or exchanged with equity shares at a later date.
Interestingly, Rule 13 of the Rules also mandates that preferential issue of shares shall comply with the conditions and procedures which have been provided under section 42 of the Act, which also governs private placement under the Act.
Private Placement – As stated above, private placement has been provided under section 42 of the Act and Rule 14 of the Companies (Prospectus and Allotment of Securities) Rules, 2014 ("Allotment Rules"). Private placement means issuance of 'securities' to only a select group of persons who have been identified by the board of the, which shall not exceed 200 excluding qualified institutional buyers and shares issued under a scheme of employees stock option. In the event, a private placement is made to a number of persons exceeding 200, then such issuance is deemed to be a public issue.
The important thing is to note the definition of 'securities' here. Section 42 provides that 'securities' shall have the same meaning as ascribed to it under the Securities contracts (Regulation) Act, 1956 ("Securities Contract Act") and the Securities and Exchange Board of India Act, 1992. Section 2(h) of the Securities Contract Act defines 'securities' in an exhaustive manner which has been reproduced hereinbelow for reference:
"2. Definitions
...
(h) securities include--
(i) shares, scrips stocks, bonds, debentures, debenture stock or other marketable securities of a like nature in or of any incorporated company or or a pooled investment vehicle or other body corporate;
(ia) derivative;
(ib) units or any other instrument issued by any collective investment scheme to the investors in such schemes;
[(ic) security receipt as defined in clause (zg) of section 2 of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (54 of 2002);
[(id) units or any other such instrument issued to the investors under any mutual fund scheme;
(ida) units or any other instrument issued by any pooled investment vehicle;
Explanation.--For the removal of doubts, it is hereby declared that securities shall not include any unit linked insurance policy or scrips or any such instrument or unit, by whatever name called, which provides a combined benefit risk on the life of the persons and investment by such persons and issued by an insurer referred to in clause (9) of section 2 of the Insurance Act, 1938 (4 of 1938).
(ie) any certificate or instrument (by whatever name called), issued to an investor by any issuer being a special purpose distinct entity which possesses any debt or receivable, including mortgage debt, assigned to such entity, and acknowledging beneficial interest of such investor in such debt or receiveable including mortgage debt, as the case may be;
(ii) Government securities; and
(iii) rights or interests in securities;
..."
Point of Difference
Now, for the moment we have all been waiting for, the point of difference between private placement and preferential allotment. As indicated in the article, the underlying difference between the two corporate actions is kind of shares/securities that can be issued. In preferential allotment, as mentioned in the Rules, only equity shares or securities convertible into equity shares can be issued. Consequentially, preference shares or debentures not convertible into equity shares cannot be issued under preferential allotment as provided under section 62(1)(c) of the Act. However, the wide definition of 'securities' provided under Securities Contracts Act infers that all kinds of shares (equity or preference), debentures (convertible or non-convertible), derivatives, government securities, rights or interest in securities can be issued under private placement method. To reiterate, the preferential allotment of shares although have to be done by the following the conditions and procedures provided for private placement method.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
