Preferential issue

Sometimes a listed company does not want the market; it wants one particular investor — a strategic partner, a private equity fund, a promoter putting money back in. A preferential issue is how it sells shares to that named person without opening a book to everybody.

The definition is written as an exclusion list. It means an issue of specified securities by a listed issuer to any select person or group of persons on a private placement basis, and it does not include a public issue, a rights issue, a bonus issue, an employee stock option scheme, an employee stock purchase scheme, a qualified institutions placement, sweat equity shares, depository receipts issued outside India, or foreign securities.

Because the issuer is choosing the buyer and the price, almost every rule that follows exists to stop the price being chosen badly.

The gate. A listed issuer making a preferential issue must ensure that a special resolution has been passed by shareholders; that all equity shares allotted are fully paid up at the time of allotment; that the proposed allottees hold all their existing equity shares in dematerialised form before the in-principle application; that the issuer complies with the continuous listing conditions and LODR; that it has the PANs of the proposed allottees; and that the application for in-principle approval is made to the exchanges on the same day the general-meeting notice is sent.

Who is shut out. No preferential issue may be made where equity shares have been sold or transferred by any person including the promoter or promoter group within 90 trading days preceding the relevant date — subject to carve-outs for qualifying inter-se transfers and for transfers on invocation of a pledge by a scheduled commercial bank, public financial institution, systemically important NBFC, mutual fund or IRDAI-registered insurer. A promoter or promoter group member who subscribed to warrants and failed to exercise them is ineligible for one year from the expiry of the warrant tenure or the date of cancellation. An issuer is ineligible if any promoter or director is a fugitive economic offender, or if it has outstanding dues to SEBI, the exchanges or the depositories.

The price floor — frequently traded shares. Where the equity shares have been listed for 90 trading days or more as on the relevant date, the price shall be not less than the higher of:

• the 90 trading days volume weighted average price preceding the relevant date; or
• the 10 trading days volume weighted average price preceding the relevant date.

Where the shares have been listed for less than 90 trading days, the floor is the highest of the IPO price (or the value per share under the scheme by which it listed), the average VWAP over the period it has been listed, and the average of the 10 trading days' VWAP during the two weeks preceding the relevant date — and that price must be recomputed on completion of 90 trading days, with any excess payable by the allottees. A preferential issue to qualified institutional buyers not exceeding five in number is priced at not less than the 10 trading days VWAP.

The paperwork and the clock. A practising company secretary's certificate confirming the issue complies with the regulations must be placed before the general meeting, hosted on the website and linked in the notice. Allotment must be completed within 15 days of the special resolution — else a fresh special resolution is needed and the relevant date shifts to the later resolution. Allotment is in dematerialised form only.

Lock-in.

A listed speciality chemicals company with 12 crore shares outstanding wants to place 1.5 crore fresh shares with a strategic investor who is not a promoter. The relevant date is fixed by the special resolution.

Funds raised = 1.5 crore × Rs 344 = Rs 516 crore
Investor's stake = 1.5 ÷ (12 + 1.5) = 11.1% of the enlarged capital

The "higher of" rule is not a formality. Had the 10-day VWAP been Rs 305 instead — a share that has drifted down rather than run up — the floor would have been the 90-day figure of Rs 318, and the company would have raised 1.5 crore × Rs 318 = Rs 477 crore. The rule is worth Rs 39 crore to the existing shareholders in the first case, because it stops a short, cheap window being used to set the price.

The calendar.

Miss 19 May and the company must pass a fresh special resolution, and the relevant date — and therefore the whole VWAP computation — moves to the new one. In a rising market that is expensive.

And the lock-ins bite on both sides. The new 1.5 crore shares lock for 6 months from trading approval because the allottee is not a promoter. The 0.2 crore shares the investor already held lock from the relevant date until 90 trading days after trading approval — so the very act of subscribing freezes the stake it came in with.

Chapter 6 (Issue Management – General Obligations of Merchant Bankers and Due Diligence), section 6.2 (Preferential Issue) carries the whole framework, and Chapter 4 carries the definition. The lead manager is on the hook here: the regulation opens with "the lead manager shall ensure that listed issuer makes a preferential issue... only if the following conditions are met".

Expect a pricing computation — two VWAPs, asking for the floor — and expect the 15 day allotment window and the 18 month / 6 month lock-in pair as factual questions. The 90 trading days figure appears three separate times in this section (the sale bar, the frequently-traded test, the pre-preferential lock-in) and the examiner knows it.

• The floor is the higher of the 90-day and 10-day VWAP, not the lower and not the average. The rule is written to prevent cherry-picking a cheap window.
• A QIB-only preferential issue to not more than five QIBs is priced on the 10-day VWAP alone. Six QIBs, and the ordinary two-VWAP rule returns.
• 90 trading days, not calendar days — in all three places it appears.
• 15 days from the special resolution, and a miss is not a delay but a restart. A fresh special resolution moves the relevant date and re-prices the issue.
• Promoter lock-in is 18 months only up to 20% of total capital; anything above that locks for 6 months, not 18.
• The allottee's existing shareholding is locked in too — from the relevant date up to 90 trading days from trading approval. Candidates remember the new shares and forget the old ones.
• A preferential issue is not a QIP. A QIP is expressly excluded from the definition, is open only to QIBs, and runs on its own pricing rule — see Qualified Institutions Placement.
• Consideration other than cash is allowed only as a swap of shares, supported by a valuation report from an independent registered valuer that the exchange may second-guess.