In this article, Rahul Kumar pursuing Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata discusses Legal framework regulating Equity Financing in India.
Equity financing is to raise capital by selling shares in the business. The definition of a common scenario is to raise funds for the company to meet liquidity needs of an organization by selling company’s stock in exchange for cash. In wider prospect, the company goes equity finance with an object, the motive to have diversification or expansion of the company.
- When a business owner uses equity financing, they are selling part of their ownership interest in the business firm. There are some significant factors or developments encouraging or inhibiting private equity transaction.
- Government from time to time also takes the responsibility for entrepreneurship and business management. On foreign investment, the government has also taken some crucial reforms in FDI policies.
- Equity financing is raised by an entrepreneur from:
- Family, and
- Initial Public Offering.
- Equity financing process is governed by:
- Local, and
- National securities.
- It is built with a sole motive to protect the investing public from unscrupulous operators who raise funds. Equity financing is totally different from debt financing, where funds are borrowed by the business to meet liquidity requirement.
- In a family-owned company, equity shareholding is generally with many family members. In such cases, the promoters of the group are lead members to exercise right on their behalf.
Different types of equity financing
Angel investors are the people who invest their personal wealth into specific business on an individual basis. They are generally former or current business leaders in the market. They also provide guidance and valuable advice to the company in taking crucial decisions.
Venture capitalists are individuals or firms who manage funds to invest in a new business. Venture capitalist firms focus on young and high growth companies. They invest in a high growth company and take active role and decision of the Company. A venture capital firm is an LLP and its main objective is raising money to invest in the private equity of the new company
Friends and family
They are the excellent sources of equity investments because they are persons whom you can trust and they the one who know your vision, desire and your potential. It generally sounds like an informal business relation build between both the parties.
Institutional investors include an insurance company, pension funds, mutual funds, these are the main investors in private sector and helpful in long-term financing.
In a corporate world, the much big company purchases the equity of younger or newly established company. The company who invest are known as strategic partners, such investors create a network of companies.
Types of equity finance
There are two types of equity finance:
- IPO (Initial Public Offer)
- Without IPO
It is governed by the SEBI regulation, Companies act, 1953, RBI guidelines
There is two main equity market exchange in India.
BSE (Bombay Security Exchange)
It is established in 1875, BSE is Asia’s oldest stock exchange and the first stock exchange recognized by the Government of India under securities contract regulation act.
NSE (National Security Exchange)
It is established in 1992 as India’s first screen-based electronic trading platform. The Nifty 50 index is the NSE’s benchmark stock market index for the Indian Equity market. NSE was instrumental in creating the national securities depository ltd, which allows investors to surely hold & transfer their shares and bonds electronically.
Small and medium-sized enterprise segment was introduced by the BSE and NSE on 12.03.2012 and 31.08.2012 respectfully to facilitate the listing and trading of shares of small and medium-sized enterprises.
It is subdivided into three parts
It is a dividend of subscription rights to buy additional securities in a company made to the company’s existing security holder. This done when the company plans to tap the market after their IPO’s. It is governed by the section 62 of the companies act, 2013.
Companies using private placements generally take a small amount of capital from a limited number of investors. A private placement is an offering of securities that are not registered with the securities and exchange commission. A private placement is governed by the section 42 of the companies act, 2013
The preferential allotment is a process by which allotment of shares is done on a preferential basis to select a group of the investor. Thus, a company plans to raise funds for its expansion and reduction of debt. In preferential allotment, a company raises its shares to a particular group or sector. The process is quite speedy to raise funds for the company. The process of preferential allotment is governed by section 62 of the companies act, 2013.
In order to avoid dilution of the stake of existing shareholders, company issues “rights” shares in proportion to their current holding. This is done when the company plans to tap the market after their IPO.
The main regulatory bodies are as under:
- Department of economic affairs.
- Ministry of corporate affairs.
- Policies and decisions of central government.
These regulators draft legislation and circulars, notifications and guidelines to regulate the securities market in India and have powers of oversight on the various market participant.
Stock exchange also frames their own rules, regulations, and bye-laws to regulate the market. The key statutes and regulations governing equity securities market in India are:- Companies act, 2013 rules, SEBI act, 1992, depositories act, 1996.
Laws which governs the equity finance in India
Foreign Investment Laws
When investment flows from one country located outside India for investment in some business activities and not merely for stock or trading. The amount is treated as FDI, every year the ministry of commerce and industry issues as an FDI policy. The concerned policy is reviewed and changed every year and change depending on the market scenario and policies implemented by the government.
FDI falls under two different routes such as:
- Automatic route
- Government route
The investors can directly invest in the target company without obtaining any prior approval from the government. The automatic route subject to the pricing, guidelines or the valuation norms are prescribed by the regulations under FEMA, 1999, for listing companies a valuation has to be made under SEBI for the issue of capital and disclosure requirement and regulations. FDI policy requires that any amount received by the target entity against capital should be reported to the RBI.
FDI policy restricts the level of investment in certain sectors such as:
- Defense sector
- Air transport etc.
Laws governing listed companies
Listing means an admission of securities to dealings on a recognized stock exchange. A company, desirous of listing its securities on the exchange shall be required to file an application in a prescribed form. The company is required to follow the guidelines, requirement, and criteria of Stock Exchange Board of India (SEBI) from time to time.
The main and sole object it is to protect:
- Liquidity of securities
- Protect the interest of the investors, and
- Mobilize their saving.
Insider trading regulations
An offense under SEBI (prohibition of insider trading), the main object is securities while in possession of unpublished price of sensitive information, thus if these things will be published will affect the price of the securities of the company. The companies act, 2013 has introduced the provision of insider trading, section 195 of the companies act, 2013 applies to unlisted companies and also lays down the punishment also.
Guidelines of SEBI for equity finance
- The object of SEBI is to stop fraudulent activities carried in the stock market, SEBI provides for the establishment of a board to protect the interest of investors in securities and promote overall development.
- Initially SEBI was a non-statutory body without any statutory power, however, in 1995 the SEBI was given additional statutory power by the government through some amendment. In the year 1998, SEBI made as an overall regulator of the capital market.
- All the mutual funds whether promoted by the public sector or private sector are governed by as per the guidelines of SEBI.
- SEBI also plays a very crucial role in IPO, the overall rules, regulations, and procedures relating to public issues are governed by independently by SEBI only. SEBI also regulates the business in stock exchanges and other securities market.
- SEBI governed the registration, regulation and the whole working of stock broker, sub-brokers, share transfers agents, merchant bankers, portfolio manager and investment advisers etc. SEBI perform three important functions such as- quasi-legislative, quasi-judicial, quasi-executive.
Equity finance is a long-term finance of the company, it is done in the form of shares and stocks. It gives the investors the ownership right to it. In equity finance investors bears the risk of investing in the company with a hope of getting a good return in future, for investing in the company, gets dividend or interest depending upon the ratio of shares. In a wider meaning equity finance is an assurance that the company can easily cover all lose of the company efficiently.