Modes of Allotment of Shares other than Public Offers

What this chapter covers

Chapter 8 carries 2 marks out of 100 — 2% of the paper, the smallest chapter in the workbook.

Learning Objectives: After studying this chapter, you should know about private placement of shares: Private Placement of Shares · Qualified Institutions Placement (QIP) · Rights Issues · Employee Stock Options (ESOPs) · Conversion of Convertible Debentures/Bonds into shares

Why an alternative to a public offer exists

A public offer of shares involves regulatory compliances and process that have been laid down to ensure that public investors are protected. These requirements can be time-consuming, elaborate, and intended to protect the less informed investor.

A company may decide to make an offer to a selected group of investors, who may be better informed, and therefore not requiring elaborate protection mechanisms. The company can also save time, cost and effort in placing its shares to such a group. This is called a private placement of shares.

Better-informed investors need less protection — the same principle Chapter 7 stated when it said that raising capital from large institutions that have the capacity to evaluate the issue attracts simpler requirements.

Private placement and preferential allotment

A private placement of shares can be done by a company irrespective of whether it has made a public offer of shares or not. A private placement of shares made by a listed company is called a preferential allotment of shares.

The first sample question tests exactly that — a private placement by a listed company is a preferential allotment.

Since the company is listed and has public shareholders, it is required to meet the regulation in this regard of SEBI and the Companies Act.

Which answers the fifth sample question — it is false that a private placement is unregulated.

These regulations aim at ensuring that promoters and large investor groups do not take any action that may be detrimental to the interests of the public investors. The regulations require that a resolution is passed by the shareholders allowing such allotment of shares.

Shareholder approval is required, because the allotment dilutes them without giving them the chance to participate.

The lock-in

If the shares are allotted to promoter or promoter group, the said shares shall be locked-in for a period of 18 months from the date of trading approval. The shares that are allotted to other than promoter or promoter group, will be locked-in for a period of 6 months from the date of trading approval.

Eighteen months and six — and note that both run from the date of trading approval, not from allotment. The second sample question tests the six-month figure.

8.1 Private placement under section 42

Under section 42 of the Companies Act, 2013, a company may make allotment of share through private placement subject to certain conditions.

To whom: a company shall make private placement to select group of persons as identified by the company ("Identified Persons").

How many: number of allottees shall not exceed 50 or such higher number as may be prescribed, (excluding Qualified Institutional Buyers, and employees of the company) in a financial year.

Fifty in a financial year — and two categories fall outside the count: shares allotted to the qualified institutional buyers and employees of the company being offered securities under a scheme of employees' stock option shall not be considered in aforementioned number.

Process: company shall issue private placement offer and application in prescribed manner to identified persons. Company is required to record name and addresses of such identified persons.

Payment: every identified person who is willing to subscribe shall apply for allotment for shares along with subscription money either paid by cheque or Demand Draft or other banking channels but not by cash.

Never in cash — the money must move through a traceable banking channel.

Filing: the company has to file details about the allotment to Registrar of Companies (RoC).

One at a time: no fresh offer or invitation for private placement can be made till the time earlier issued offer or invitation (if any) is pending.

The sixty-day rule

The company shall make allotment of shares within 60 days of receipt of application money.

If the company fails to make allotment of shares within 60 days then the company will be liable to refund such money to the subscribers within 15 days from expiry of such 60 days.

Further, if the company fails to repay the money within the aforesaid period, it will be liable to repay that money along with interest at the rate of 12 percent per annum from the expiry of the 60th day.

Sixty days to allot, fifteen more to refund, then 12 per cent interest — running from the sixtieth day, not from the seventy-fifth.

The money is ring-fenced meanwhile: money received on application for private placement shall be kept in a separate bank account in a scheduled bank and shall not be utilised for any purpose other than: (a) for adjustment against allotment of securities; or (b) for repayment of monies where the company is unable to allot securities.

Two permitted uses only.

And no publicity: no company issuing securities under this section shall release any public advertisements or utilise any media to inform the public at large about such an issue.

That prohibition is what keeps a private placement private — advertise it and it becomes, in substance, a public offer.

8.2 Qualified Institutions Placement

Qualified institutions placement (QIP) is a private placement of eligible securities made by a listed company to certain identified categories of investors known as Qualified Institutional Buyers (QIBs) and includes offer for sale of specified securities by the promoter or promoter group.

**The third sample question asks whether a QIP can be made only to QIBs — it can, so the answer is true.

Eligible securities are defined to include equity shares, non-convertible debt instruments along with warrants and convertible securities other than warrants.

Eligibility: to be eligible to make such a placement, the shares of the company should have been listed on the stock exchange for a period of at least one year before the notice of such issue is given.

One year of listing.

Pricing

A qualified institutions placement will be made at a price not less than the average of the weekly high and low of the closing prices for the two weeks preceding the relevant date.

However, the issuer may offer a discount of not more than 5 percent on the price so calculated for the qualified institutions placement, subject to approval of shareholders.

Two weeks of closing prices, with a discount of up to 5 per cent — and only with shareholder approval.

Who is a QIB

Qualified institutional buyers (QIB) include financial institutions, mutual funds, alternative investment funds, venture capital funds, scheduled commercial banks, foreign portfolio investors (other than individuals, corporate bodies and family offices) and the like.

Note the exclusion within the FPI category — individuals, corporate bodies and family offices do not qualify.

Allottee limits

There must be a minimum of 2 allottees under QIP category, if the issue size is less than or equal to Rs. 250 crore; and minimum of 5 allotees, if the issue size is more than Rs. 250 crore.

However, no single allottee in a QIP shall be allotted more than 50 percent of the issue size.

And no one may take more than half — which prevents a QIP from becoming a transfer of control by another name.

Resale restriction: a sale of shares allotted under this category, within one year from the date of allotment, can be made by the QIB only on a recognised stock exchange.

Disclosure: a placement document giving all material information will be made available to select investors and on the websites of the company and the stock exchange.

8.3 Rights Issue

A rights issue is an issue of fresh capital made to the existing investors of a company. In a rights issue the company has to decide on the proportion of fresh shares to be issued to the investors.

For example, a company may decide to issue rights shares in the ratio 2:3. This means that existing investors of the company on a specified date called the record date will be entitled to 2 shares for every 3 shares held by them.

The first number is what you get; the second is what you hold. The fourth sample question tests a 3:4 issue — three shares for every four shares held.

When this results in a fractional entitlement, the decision is left to the discretion of the Board of Directors.

The protective effect: an investor's percentage holding in the company remains the same after the rights issue unless the shares are foregone by the investor.

Unless foregone — the protection depends on taking it up.

If specified in the letter of offer, promoters may subscribe to the unsubscribed portion of the rights issue over and above their entitlement.

Employee reservation: the issuer may make a reservation for employees along with the rights issue subject to the condition that the value of allotment to any employee does not exceed Rs. 2 lakh.

Regulation: the rights issue by a listed issuer is subject to the Companies Act as well as the SEBI (ICDR) Regulations. Most of the conditions applicable for public issue also apply to the rights issue.

Plus specific requirements: announcement of record date, restrictions on rights issue, letter of offer, abridged letter of offer, pre-issue advertisement for rights, reservation for employees along with rights issue and utilisation of funds raised in rights issue.

The modernisation of the rights issue process

Rights Issue process has undergone significant changes.

Payments of all applications in a rights issue have to be through Applications Supported by Blocked Amount (ASBA) facility only.

Validation of application bids received for subscribing to the shares in rights issue and finalization of basis of allotment shall also be carried out by the Stock Exchanges and Depositories along with the Registrar to the issue.

Note the R&T agent's place there — validation and basis of allotment are done by exchanges and depositories along with the Registrar to the issue.

Also, email delivery of entitlement form and offer document is permitted which makes it convenient for investors who have registered their email ID with Depository Participants (DP) or Registrar and Transfer Agents (RTA) to receive it electronically.

Introduction of a new concept of Rights Entitlement (REs) allows electronic trading of REs through stock exchanges which is more efficient.

Rights Entitlements can now be traded — so a shareholder who does not wish to subscribe can sell the right itself rather than simply let it lapse.

Discontinuing allotment in physical mode in favour of electronic credit ensures elimination of additional paper based holdings.

8.4 Employee Stock Options

ESOP is a scheme or plan or programme set up by a company for its employees. Employee Stock Options are options under which a company gives the right to its employees to purchase its shares at a discounted price. ESOP is a type of retirement and employee benefit plan which offers its employees, ownership interest in the shares of the company on fulfilment of certain conditions.

Who may receive them: Employees Stock Option means the options given to the directors, officers or employees of the company or of its holding company or subsidiary company or companies, if any, which gives such directors, officers or employees, the benefit or right to purchase, or to subscribe for, the shares of the company at a future date at a pre-determined price.

The group extends to the holding and subsidiary companies.

The vocabulary

Stock options: These are not shares, but the right to own shares at a future date by paying the price.

Vesting period: This is the period only after which the employees are allowed to exercise the options and convert them to shares. The minimum vesting period of 1 year is prescribed for the same. During this period, the employees who have been granted the options are required to stay in the company if they want to become the shareholders in the future.

A minimum vesting period of one year — the retention mechanism at the heart of an ESOP.

Exercise period: This is the period during which the employees can exercise their right to convert stock options to shares.

Exercise price/ Grant price/ Strike price: This is the price at which the employees are given shares of the company.

Three names for one price.

Expiration date: ESOP is valid only for a limited period, i.e., during the exercise period. After the expiry of this period, they cannot be converted into shares. The expiration date is the date by which the employees must exercise their options.

A tax concession: the Finance Act, 2020 has made amendments to the relevant provisions of the Income-tax Act to defer the collection of tax on perquisite value of ESOPs. The benefit is given to the eligible Start-ups only.

Deferred, not waived — and only for eligible start-ups.

8.5 Conversion of convertible debentures and bonds

Convertible debentures or bonds are long-term debt instruments issued by a company that can be converted into equity shares of the company on a future date. They can be fully, partially or optionally convertible.

Three varieties — fully, partially or optionally convertible.

They pay a lower coupon rate (interest) than pure debt instruments. A debenture holder is a creditor or lender of the company. Investors benefit from interest payment and have the option to convert the loan into equity to participate in the growth of the company.

Why the lower coupon is accepted — because the conversion prospect supplies the rest of the return.

A convertible debenture is a hybrid product which tries to strike a balance between equity and debt. An investor will be paid a fixed-rate and will also have an option to take part in a stock price increase.

And the downside protection: in case an issuer's stock price dips, an investor can hold the bond until maturity and receive interest income.

Upside through conversion, downside cushioned by the coupon.

For early-stage companies, a convertible debenture is a very useful financial instrument — which echoes Chapter 3's observation that convertible debt securities are more suitable for low credit rating companies and companies with high growth potentials.

The sample questions confirm that a private placement by a listed company is a preferential allotment; that privately placed shares issued to persons other than promoters are locked in for 6 months; that it is true that a QIP can be made only to QIBs; that a 3:4 rights issue gives three shares for every four shares held; and that it is false that a private placement is unregulated by SEBI or the Companies Act.