In this blog post, Abhishek Kumar, a student of law at Delhi University, who is currently also pursuing a Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata, discusses he concept of private placement in public.

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The private placement is funding of securities which are sold not through a public offering, but rather through a private offering, mostly to a small number of chosen investors. It usually alludes to the non-public offering of shares in a public company. Private Investment in Public Equity deals is one type of private placement. Private placements may typically consist of offers of common stock or preferred stock or other forms of membership interests, warrants or promissory notes (convertible promissory notes included), bonds.

Types of Placements

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Private placements fall into either of two categories:

Traditional private placements as long-term loans from a separate or groups of investors.  Investors receive their investment money back, besides the agreed upon additional profit percentage, no sooner the company reaches the required profit margin and can pay them.

Structured private placements offer investors the opportunity to make additional income as the stock prices increase, all the while protecting them if the stock price falls. This protection, allows shareholders to gain additional stock up to the value of their original investment if the stock price falls.

Types of Private Placements

Stock option:

Pension funds and pension pools are often invited to participate in the non-public offering, making it possible for the issuing company to collect a great deal of money before any of the remaining shares of stock are offered to the public in some initial public offering. In this scenario, private investors can often secure a significant interest in options that are anticipated to provide steady returns over the long-term.

Bond:

As with the stocks, private investors have the opportunity to purchase the bond issues before they are offered to the general public. The bonds may be structured with a short-term maturity date (<3 years). It is also possible to obtain bonds that provide a steady amount of returns in the form of interest over a much longer period (as long as 20 years).

 Promissory notes:

The terms of the notes are structured to comply with governmental regulations in the country of origin, with most providing some guidelines for when the note can be called, and the buyer can redeem the note. This particular type of investment opportunity may come with an attractive rate of interest that is paid when the note is settled in full, or it may provide periodic payments according to a schedule agreed upon by the buyer and the seller. Private placement investments are traded by industrial investors that specialize in private investments, rather than being offered to investors who buy smaller lots in the marketplace.

Advantages Disadvantages
  • Staying private allows the company to choose its investors, unlike a public offering which is open to the general public.
  • The private placement, especially when structured, can have disadvantages in both the long and short term.
  • Because private investors often are more patient than public investors, with a private placement there is more time to arrive at the agreed upon return.
  • If only a few investors are interested, and they don’t want to invest a large amount of money it becomes difficult to raise the required amount of capital.
  • The options for type and amount of funding give more flexibility and get capital much faster than searching for venture capitalists, or waiting for shares to sell on the public market.

 

  • Sometimes, private investors only buy in when the shares cost substantially less than the projected cost of the company, requiring you to sell more shares for the same amount of income.
  • The reset feature of structured private placement allows private investors to gain additional shares, thereby reducing the number of shares one can sell to new investors, especially if you decide to go public in the future.

 

Background and recent developments

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The earlier version of the Companies Act, 1956 contained loopholes in the provisions relating to private placements. It can be very well illustrated in the case of Sahara Group (Sahara India Real Estate Corporation & Ors v. SEBI (2012) 10 SCC 603[1]).
SEBI found that under the garb of an OFCD, Sahara was running an extensive para-banking activity without conforming to regulatory disclosures and investor protection norms pertaining to public issues.
The court directed Sahara to furnish details of the OFCDs it had issued including subscriptions and refunds within a stipulated time and submit these to SEBI.

Companies took advantage of various such lacuna and overlapping powers of the Ministry of Corporate Affairs (MCA) and SEBI. The new provisions of the Companies Act, 2013 have now made the law more secure to prevent any malpractices.

Private Placement has been defined under Section 42 of the new Companies Act, 2013: “Private Placement means any offer of securities or invitation to subscribe securities to a select group of persons by a company (other than by way of a public offer) through the issue of a private placement public offer letter and which satisfies the conditions specified in this section.”This new Act of 2013 sets out the manner in which a company can raise capital in securities as follows[2]:

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Qualified Institutional Placement (QIP)

A capital-raising tool, primarily used in India, whereby a listed company can issue equity shares, fully and partly convertible debentures, or any securities other than warrants which are convertible to equity shares to a qualified institutional buyer.
Apart from the preferential allotment, this is the only other speedy method of private placement whereby a listed company can issue shares or convertible securities to a select group of persons.
QIP scores over other methods because the issuing firm does not have to undergo elaborate procedural requirements to raise this capital.

Regulations Governing a QIP

To be able to engage in a QIP, companies need to fulfill certain criteria.

  • The Company must be listed on an exchange which has trading terminals across the country and having the minimum public shareholding requirements which are specified in their listing agreement.
  • During the process of engaging in a QIP, the company needs to issue a minimum of 10% of the securities under the scheme to mutual funds.
  • It is mandatory for the company to ensure that there are at least two allottees if the size of the issue is up to Rs 250 crore and at least five allottees, if the company is issuing securities above Rs 250 crore.
  • No individual allottee is allowed to have more than 50% of the total amount issued. Also, no issue is allowed to a QIB who is related to the promoters of the company.

Who can participate in the issue?

  • The specified securities can be issued only to QIBs, who shall not be promoters or related to promoters of the issuer.
  • The issue is managed by an SEBI-registered merchant banker. There is no pre-issue filing of the placement document with SEBI.
  • The placement document is placed on the websites of the stock exchanges and the issuer, with an appropriate disclaimer to the effect that the placement is meant only QIBs on private placement basis and is not an offer to the public.

 

Qualified Institutional Buyers (QIBs)

‘Qualified Institutional Buyer’ shall mean:
a) Public financial institution as defined in section 4A of the Companies Act 1956
b) Scheduled commercial banks c) Mutual funds
d) Foreign institutional investor registered with SEBI
e) Multilateral and bilateral development financial institutions f) Venture capital funds registered with SEBI.
g) Foreign venture capital investors registered with SEBI.
h) State industrial development corporations.
i) Insurance companies registered with the Insurance Regulatory and Development Authority (IRDA).
j) Provident Funds and Pension Funds with minimum corpus of Rs.25 crores;

These are not required to be registered with SEBI as QIBs. Any entities falling under the categories specified above are considered as QIBs for the purpose of participating in primary issuance process.

Benefits of QIPs

Time saving: QIBs can be raised within a short span of time rather than in FPO, right Issue takes a long process.
Rules and regulations: There are fewer formalities with regard to rules and regulation, as compared to follow-on public issue (FPO) and rights Issue.
Cost-efficient: The cost differential in terms of legal fees, is huge.
 Lock-in: It provides an opportunity to buy non-locking shares and as such is an easy mechanism if corporate governance and other required parameters are in place.

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QIPs in India

  • The QIP Scheme is open to investments made by “Qualified Institutional Buyers” in any issue of equity shares/ fully convertible debentures/ partly convertible debentures or any securities other than warrants, which are convertible into or exchangeable for equity shares at a later date.
  • Under the QIP Scheme, the securities may be issued by the issuer at a price that shall be not lower than the higher of the average of the weekly high and low of the closing prices of the related shares quoted on the stock exchange during the preceding six months; or the preceding two weeks.

The issuing company may issue the securities only by a placement document, and a merchant banker needs to be appointed for such purpose.

Footnotes:

[1] http://www.business-standard.com/article/companies/sebi-vs-sahara-5-things-you-need-to-know-113100400713_1.html

[2] FAQs on issues http://www.sebi.gov.in/faq/pubissuefaq.pdf

 

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