In this article, Kavita Karwa, pursuing Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata discusses whether a private company can issue securities or not

Introduction

A company means an association of people formed to achieve a common goal and it must be incorporated under the law. In India, companies are regulated by the Companies Act, 2013 which is an Act of the Parliament of India. Various types of companies with varying levels of liability for the shareholders and members can be incorporated under the Companies Act, 2013.

Types of Company

A company could largely be classified into the following:

• Private Limited Company;
• One Person Company;
• Limited Company;
• Section 8 Company.

What is a Private Company?

A private company is a company whose stock is not traded on public exchanges (example BSE Limited, National Stock Exchange of India Limited, etc.), unlike public companies. Rather, shares created by private companies are issued, offered, owned and traded privately amid interested investors.

A private limited company is incorporated with a minimum of two members and can have a maximum number of 200 members.

Securities under Companies Act, 2013

Section 2(81) of the Companies Act, 2013 defines Securities to mean Securities as defined in the Securities Contracts Regulation Act, 1956 under Section 2(h). As per the definition, Securities Include Shares, debentures, bonds, scrips, stocks, debenture stocks etc. in incorporated Company/ other body corporate, Derivatives, Units issued by Collective Investment Scheme, Units/instruments issued to the investors under any Mutual fund scheme, Government Securities, such other instruments/ rights/interest therein that may be declared by the Government to be securities.

In general, tradable financial instruments or the financial instruments that can be bought and sold are usually referred to as securities. Securities may mean entitlements/rights or can mean either an ownership position or debt position or both. The key characteristic of securities is that it must be transferable. For example, Fixed Deposit with banks being non-transferable instruments is not considered as a security. Exceptionally few instruments like mutual fund policies which though non-transferable are considered as securities, notwithstanding the fact that some of the mutual fund policies are tradable on the exchange platform. 

Securities can be issued either in the form of a “certificate” or in a “non-certificated,” which is in electronic or “book entry” form.

Can Private Company Issue Securities?

From the above, it’s clear that Private companies may issue securities and have members and shareholders, but their shares cannot be traded on public exchanges. Private company shares are not issued through an initial public offering (IPO). In general, the shares of private companies are less liquid since it is traded amongst few closely connected investors and public participation is not allowed. Also, it is not easy to determine the market value of shares of private companies.

Modes of Issue of Securities by Private Company

The Private Companies can issue securities through following modes provided under the Companies Act (the ‘Act’):

Private Placement [Section 42 of the Act]

A company may through private placement make any offer or invitation to subscribe securities to selective persons (other than by way of a public offer) by issuing private placement offer letter. The conditions specified in Section 42 of the Act must be satisfied for the issue of securities through Private Placement.

• Such offer or invitation to subscribe securities through Private Placement offer can be made to a maximum of two hundred persons in aggregate in a financial year (the limit of two hundred individuals excluded employees of the company who are offered securities under employees stock option scheme and qualified institutional buyers). The said ceiling of total number of individuals is calculated separately for various types of security i.e. equity share, preference share, debenture. [Rule 14(2)(b) of the Companies (Prospectus and Allotment of Securities) Rules, 2014]
• Each person should make a minimum Investment of Rs. 20,000 of the nominal value of the securities. [Rule 14(2)(c) of the Companies (Prospectus and Allotment of Securities) Rules, 2014]
• Provisions of Rule 14(2)(b) and (c) are not applicable to ‘non-banking financial companies’ and ‘housing finance companies’.
• The price of the securities issued through Private Placement mode is determined based on the valuation report of a registered valuer.
• The private placement offer letter must be accompanied with an application form which should be consecutively numbered, specifically addressed to the person to whom the offer is being given, and must be sent either electronically or in writing within thirty days from the date of recording the name of such person as per the Act.
• The Shareholders prior approval by way of a Special Resolution is required to be obtained for the proposed offer of securities or invitation to subscribe securities. However, prior approval of the Shareholders by way of Special Resolution can be obtained one time in a year for all the proposed offer or invitations to subscribe non-convertible debentures during the year. (Form MGT 14 has to be filed with Registrar of Companies for the Special Resolution)
• Fresh offer or invitation to subscribe to securities under private placement can be made only when allotment with respect to the earlier offer or invitation has finished/offer or invitation has been withdrawn by the company.
• The person to whom the offer is made should do the payment for securities directly from their bank account subscribing to such securities, complete records of which needs to maintain by the company.
• The Securities must be allocated within 60 days of receiving of the application money. If due to oversubscription of securities / insufficient subscription or whatever other reason, the company is not able to allocate the securities within the said timeline of sixty days, then the application money is required to be refunded within fifteen days to the applicant post the expiry of sixty days. In the event of failure on part of the company to refund the amount received from the applicant within said fifteen days, the company is liable to pay interest at the rate of twelve percent on the application amount.

The company is also required to file the following forms:

• PAS-3: the return of security allotment,
• PAS-4 : Private placement offer letter and
• PAS-5 : Complete record of private placement, with the Registrar of Companies:

Rights Issue [Section 62 of the Act]

Company with existing share capital can further increase its subscribed capital by issuing further shares –

(a) to its existing equity shareholders based on the Articles of Association of the Company

(b) to employees under an employees’ stock option scheme, subject to the passing of the special resolution.

(c) to any persons, irrespective of the persons mentioned in clause (a) and (b) above, for consideration in cash or other than cash, if it is authorised by a special resolution and the price of said shares has to be determined by means of the valuation report issued by a registered valuer.

Issue of Shares on Preferential Basis [Section 62(1)(c) of the Act]

A company may issue shares in any manner whatsoever including by mode of a preferential offer, to any persons whether or not those persons are referred to in Section 62(1)(a) & (b), if approval by way of a special resolution is given by the shareholders in a general meeting. The provisions provided under Section 42 of the Act on Private Placement will have to be complied with for sssue of shares on preferential basis. It is compulsory that that price of the shares is determined as per the valuation report of the registered valuer. The special resolution considered and passed by the shareholders for Preferential allotment is effective for a period of twelve months after expiry of which fresh resolution is required to be obtained.

Issue of Sweat Equity Shares [Section 54 of the Act]

A company by way of taking shareholders’ approval through a special resolution, issue sweat equity shares to its directors or employees similar to a class of shares already issued by the company. The special resolution passed by the shareholders for issue and allotment of sweat equity shares will be effective for a maximum period of twelve months from the date of passing after the expiry of which fresh approval will have to be taken from the shareholders.

Sweat equity shares can be issued by the company only after completion of a period of at least one year from the date of commencement of business of the company. In a year, such sweat equity shares cannot be issued for an aggregate value exceeding fifteen percent of the existing paid up equity share capital or shares of the issue value of rupees five crores, whichever is higher. Nevertheless, the percentage of sweat equity shares in the paid up equity capital of the company shall not exceed twenty five percent at any point of time.

Sweat equity shares are locked in / non-transferable for a period of at least three years from the date of allotment. Shares shall be valued at a price determined by the registered valuer as of the fair price.

Conversion of Loans or Debentures into Shares [Section 62(3) of the Act]

A private company subscribed capital shall increase on the exercise of the option to convert loans raised or debentures issued by the company into shares in the company. The option must form part of the terms attached to loan raised or debenture issued by the company and such term must be previously approved by passing of the special resolution by the shareholders.

Issuance of Bonus Shares [Section 63 of the Act]

The members of the company can be issued bonus shares to be fully paid-up, in any manner whatsoever, from company’s –

1. free reserves (reserves created by the revaluation of assets not to be considered);
2. the securities premium account; or
3. the capital redemption reserve account.

Once the decision of the Board of Directors recommending Bonus Issue is announced / made public, the decision cannot be subsequently withdraw by the Board. “Rule 14 of the Companies (Share Capital and Debenture) Rules, 2014”

Advantages of Issuing Shares

There are several additional benefits to the company on the issue of shares apart from the primary objective to raise capital like it attracts new investors, purchase/acquire other businesses, enhance company revenue, increase employee interest, less Debt & Debt reduction, enhance liquidity, credit ratings, etc.

Conclusion

To conclude, a private company is a company with private ownership. Private companies can issue securities and have members and shareholders, but then its shareholders are no able to trade their stocks in the open market. Private companies function similar as the public entities, however, ownership in the private company is limited to a relatively few closely related interested investors and they need not comply with the stringent regulatory requirements as applicable to public companies.  The high costs of undertaking an IPO, stringent regulatory requirements, intent to maintain private ownership etc., are some reasons why many smaller companies stay private. If a small private company wants to raise further capital to grow, the subsequent level of funding often flows from venture capital firms who specialize and focus in making capital investment for high-risk, high-reward opportunities. Further, some sizeable institutional investors also provide financing options to private companies generally through private placement route. If a private company is able to grow exponentially, it may ultimately opt to “go public” which means it issues securities through an IPO which are then traded freely on public stock exchanges.