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This article has been written by Bhabya Rani, pursuing the Diploma in General Corporate Practices from LawSikho. This article has been edited by Tanmaya Sharma (Associate, Lawsikho) and Ruchika Mohapatra (Associate, Lawsikho).

This article has been published by Shoronya Banerjee.

Introduction

As we all know, a “private placement” is an alternative to issuing, or selling, publicly offered security as a means for raising capital. In a private placement, both the offering and sale of debt or equity securities are made between a business or issuer, and a select number of investors. There may be as few as one investor for any issue. Companies, both public and private, issue in the private placement market for a variety of reasons, including a desire to access long-term, fixed-rate capital, diversify financing sources, additional financing beyond existing investors or, in the case of privately held businesses, to maintain confidentiality. 

In this article, the author seeks to discuss private placement as a tool of raising additional capital, as it is offered only to a limited pool of accredited investors; they are exempted from registering with the Securities and Exchange Commission. This helps companies in getting additional capital avoiding costs associated with a public offering as well as allowing for more flexibility regarding structure and terms. Businesses need various funds as they grow, so businesses choose a less complicated tool, that is, a private placement for raising it.

Private placement

The private placement is the sale of stock shares or bonds to investors and institutions privately rather than on the open market. It is an alternative to complicated tools like – Initial Public Offerings (“IPOs”) for raising capital. There are minimal regulatory requirements and standards for a private placement, private placements are sold using a Private Placement Memorandum (“PPM”) instead of prospectus and can’t be broadly marketed to the general public.  Explanation II (ii) of Section 42 of the Companies Act, 2013 (“Act”) defines private placement as an offer of securities or invitation to subscribe securities to a selected group of persons by a company through an issue of the private placement offer letter and which satisfies the conditions specified.

Many companies avoid many regulations and annual disclosure requirements that follow an IPO. The less complicated regulation of private placements allows the company to avoid the time and expense of registering as per SEBI Rules. A private placement allows the issuer to sell more complex security to accredited investors who are well versed with the potential risk and reward with the mandatory prior permission of shareholders. A private company may issue securities by way of rights issue or bonus issue as Section 23 (2) of the Act mentions. 

The most important features that would rather classify a securities issue as a private placement are:

1. No public offering

The securities are not publicly offered, which prevents the offeror from long processes of raising the capital and can always be opted if capital is needed urgently or additionally for a specific purpose.

2. No requirement of registration with SEBI

As we all know, shares require registration with SEBI for public offering. This is not the case in the private offering which gives freedom to the offeror for raising capital for the long term with help of a small number of investors.

3. A limited number of investors

Through private placement, the stocks are offered to a limited number of investors i.e. up to 200 investors, in other words, it is offered privately. Rather than, public offering where unlimited people are allowed to invest in the stocks or shares of the company. The private placement is generally used for fixed-rate capital, diversified financing sources, additional financing beyond existing investors, or, in the case of privately held businesses, to maintain confidentiality. 

Pros and cons of private placement for raising additional capital

Private placements have various pros and cons which mainly depend on the laws of the country where it is raised by the business. But, it has various advantages over an IPO to small and medium businesses or enterprises. It is less time-consuming and less expensive since it does not require the assistance of underwriters and brokers for complying with SEBI rules. It can be easily offered to investors after prior permission of shareholders. Raising additional capital from private placement helps in the expansion of business and fulfills the ever-increasing demand for capital. The private placement allows the companies to choose investors based on similar goals and interests of the company which is advantageous for its future. Also if the investors are entrepreneurs, they may help the company with their valuable skills and assistance to the company’s management. It helps in diversifying the company’s capital structure. Private placements provide flexibility in the amount raised and type of funding. It may allow investments to be done for a longer period. 

Cons of using private placement to raise business finances are a reduced market for the bonds or shares in your business, which may have a long term effect on the value of the business as a whole, a limited number of potential investors, who may not want to invest substantial amounts individually. The bonds or shares at a substantial discount to compensate investors for their greater risk and longer-term returns. Also, it isn’t a mandatory requirement, having a credit rating can be an advantage. However, this is time-consuming and will be an added cost to the process. 

Private placement market for raising additional capital

This method of privately raising capital is used by both private and public companies. The prolonged process of new issues market is a major reason for the popularity of private placement. The capital raised by private placement in India was at an all-time high of Rs. 7.77 lakh crore in 2020 as per reports of The Economic Times. This showcased a surge of 10% from the previous year. The largest mobilization through private placement of debt during the year was by HDFC at Rs. 57,813 crore, followed by REC (Rs. 53,946 crore), NHAI (Rs. 53,463 crore), PFC (Rs. 50, 9666 crore) and NABARD (Rs. 50,734 crore). So, the growing needs are being met with help of private placement and are preferred by both public and private companies. 

The private placement provides additional capital allowing various advantages over IPO to small and medium scale enterprises. It may be useful in business formats that are riskier and for which new investors are hard to find. Even for start-ups that don’t have the confidence of investor’s private placement is a useful mechanism to expand the business and fulfill the ever-increasing demand for capital. Private placements enable small and medium businesses to maintain their private status. It provides for flexibility in the amount raised and the type of funding. As private placement allows investment for a longer period and thereby creates more return on investment. It is a fast way to raise capital which helps in raising additional capital urgently. But, the procedure for a private placement of securities is very tedious and hard to follow about Section 42 of the Act. 

Procedure for private placement

A company intending to issue securities under private placement must follow these procedures-

  • Convene the meeting of the Board of Directors of the Company, for taking approval for issue of securities, a number of securities to be issued, the decision on the price of securities after checking valuation report, draft of offer letter in Form PAS 4.
  • File Form MGT 14 within 30 days of passing the Board Resolution for the issue of securities as per Section 117 & 179(3)(c). Private companies are not required to file MGT 14.
  • Approval of securities going to be issued through private placement and approval offer letter for identified persons, by the shareholders in extraordinary general meeting.
  • File form MGT 14 with ROC within 30 days of passing the special resolution approving the private placement.
  • Offer letters to identified persons must be sent within 30 days of recording the names of the identified persons.
  • Properly record the private placement offer in Form PAS-5
  • Calling Board Meeting after the closure of Offer Period for allotment of securities and issue securities certificate by passing the resolution.
  • File the return of allotment in Form PAS 3 within 15 days from the date of the allotment made.
  • Allotment of securities within 60 days of receipt of application money by the company.
  • Payment for stamp duty within 30 days of issue of securities certificates.
  • After the return of allotment in form PAS 3 filed with the registrar, companies will be allowed to utilize the money raised by private placement.

Comparative analysis with The United States

Private placement in the U.S means a securities offering exempt from registration with the Securities and Exchange Commission Rules, 1982 (“SEC”). A company can only issue or sell securities when it is either registered with SEC or an exemption from registration is available, and private placement is one such exemption. Section 4 (2) provides to raise capital through private placement for a company. This section has an exemption for the companies trying to raise $5 million in securities to a small number of accredited investors. 

Regulation D under the Securities Act provides a further exemption for private placement. It allows a company to offer and sell its securities without having to register these securities with the SEC. Companies that issue securities by using the mechanism mentioned in Regulation D have to file a ‘FORM D’ in electronic mode with the SEC after they first sell their securities. 

Rule 505 specifies the limit to issue securities up to $1 million in any 12 months. There is no limit as to how many people these securities can be sold and there is no requirement of any specific type of investors. 

Rule 506 an unlimited amount of securities can be issued by this rule. As per 506 (b), there is no limit on the issuance of securities to the accredited investor but not more than 35 non-accredited investors. This clearly specifies that there is no limit on the number of securities to be issued through private placement in the US.     

There are a lot of differences in law related to a private placement in India and the United States of America. In India, private placement is not taken as an exemption to raise capital by companies and is itself codified in the Companies Act. In India, private placement is another tool for raising the capital by the company and it is codified in the Companies Act. But, in the USA it is treated as an exemption to the general rule. The rules of the private placement are stricter in India than in the USA. In developing countries like- India, strong government intervention is required to safeguard the rights of poor people but in the USA, the securities market is governed by people’s ability and individual net worth. 

Conclusion

The private placement is a not expensive or cost-effective way of raising capital without going for public offering. As we know, a company needs funds for the purpose of setting up projects or new ventures of the existing business or for funding the working capital requirements. The company has various options to raise funds like debt funds such as a loan from banks/financial institutions/non-banking financial companies or by way of issue of debentures or bonds, or by issuing the share capital. The company will raise the additional capital or not depending on the current financial position of the company. Through private placement, companies generally seek to raise a small amount of capital from a limited number of investors. There is no need for financial reporting requirements if capital is raised through private placement. Marketing an issue may be more difficult for private placements, as these investments can be quite risky with lower liquidity than a public offering. But, companies still get liquidity maintaining privacy through private placement. An issuer can sell more complex security to accredited investors who understand the potential risk and rewards, which allows the firm to remain as a privately-owned company and avoid the need to file annual disclosures as per SEBI regulations.

References

  1. https://www.mca.gov.in 
  2. https://www.investopedia.com
  3. https://www.legalserviceindia.com
  4. https://taxguru.in
  5. https://www.lawrbit.com
  6. https://www.prudentialprivatecapital.com

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