In this article, Jitika, pursuing Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata discusses on whether a private company can make a public issue or resort to any activities related to the same.

Introduction

What is a private company?

A private company is a company whose shares cannot be traded publicly and which works under legal requirements less stringent than those for a public company. According to the Companies Act 2013, a private company works under the following provisions–

• The rights to transfer its shares is restricted
• Limitations on the number of its members to two hundred(except in One Person Company)

(If two or more people jointly hold a share, for the purpose of this clause, they will be considered as a single member)

• Any invitation is prohibited to the public to subscribe for any securities of the company

According to the Companies (Amendment) Act, 2017, the amendment done in the Section 366 sub-section (2) of Companies Act 2013, a company with less than seven members shall register as a private company.

(After the Companies (Amendment) Act, 2015, the requirement of minimum paid up share capital, which was 100,000 rupees, was omitted from the definition of ‘private company’ in sub clause iii of Section 2(68) of the Companies Act, 2013.)

Kinds of share capital

Share Capital is mainly all the funds a company raises in exchange for either preferred or the common shares of stock. Unlike the 1956 Act, where private companies were able to issue only equity shares with differential voting rights without having to conform to certain rules and restrictions that otherwise affected the public companies, in Section 43 of the 2013 Act a company can have only two kinds of share capital –

1. Equity shares (with or without differential rights to dividend, voting or otherwise)
2. Preference share capital.

The share capital is the money invested by the shareholders. It is basically a long-term source of finance for the company, In return of which, shareholders gain a share of the ownership of the company for their investment.

Restriction on inviting investments from public

As mentioned in the definition of Private Company in Companies Act 2013, Section 2[68] –

”(iii) prohibits any invitation to the public to subscribe for any securities of the company”

In term of this Section of the Act, the private company is prohibited to make any call to the public to subscribe for its securities. It also prohibits the company any invitation or acceptance of deposits from anyone other than its members, directors or their relatives.

Restriction On Transfer Of Shares under Companies Act, 2013

According to the provisions of the Companies Act 2013, a private company must restrict the transfer of its shares by its Articles of Association (‘AoA’). Therefore, any restriction on transfer of shares as agreed under the agreement of shareholders or consensual arrangement are duly included in its ‘AoA’ shall be valid and binding on the private company and shall be enforced against the shareholders of the private company.

However, if a private company does not register the transfer of the securities or interest of a member, whether in pursuance of any power of the company under its AoA or otherwise, it is required to intimate the transferor and transferee within the stipulated time period as mentioned in Section 58 of Companies Act 2013. Further as said by the Supreme Court had in the case V. B. Rangaraj vs. V.B. Gopalakrishnan and Ors, as reported in CDJ 1991 SC 464 that the only restrictions which were imposed under the Articles of Association against transfer of shares shall be enforced and any other which was not mentioned in the AoA cannot be imposed to prevent a valid buyer of shares from taking possession of the company securities.

Exceptions

(i) Not be valid in a case where a member is to transfer his/her shares to his/her representative(s).

(ii) As legal representatives may require the registration of share in the names of heirs(on whom the shares have been devolved) in the event of the death of a shareholder.

(Restriction cannot be in the form of ‘Prohibition’. It can only be imposed by the Articles of Association ‘AoA’).

So how can a Private Company raise finance?

There are several ways by which a private company can continue to have investments and issue its securities. The provisions laid down in the Companies Act provides the following ways of investment –

Rights Issue of Shares  

The fundamental idea of the rights issue is to raise additional capital. Rather than going to the public, the company gives specific the right to subscribe to freshly issued. Ideally, such an issue takes place when a company needs funds for a business expansion or a large takeover.

Rights Issue of shares is mentioned in Section 62 of the Companies Act 2013. Such shares could be offered –

• To existing members

It means to offer shares to present members in proportion to their existing shareholding. The aim is to ensure equitable allocation of Shares and the fraction of voting rights is not disturbed by the issue of Fresh shares.

• To employees

A company can issue shares to employees under a scheme of employees’ stock option, bound to a special resolution passed by the company.

• To any person

A company can issue shares to any persons, if authorized by a special resolution passed by the company, excluding the people referred to in clause (a) or clause (b), either for cash or for a consideration other than cash.

Conversion of loans and Debentures into Shares  

A company can issue debentures with an option to convert these debentures into shares, either wholly or partly at the time of maturity. A private company can convert loans raised or debentures issued by the company into shares by passing a special resolution if there is such condition attached to the debentures issued or loan raised so as to convert the said debentures or loans into equity shares in the company as given under Section 62(3).

Issue of Sweat Equity Shares  

Sweat equity shares are given to the deserving employees at zero cost by passing a special resolution. This means that the employee does not have to pay for the shares at all. The shares are simply allotted. This kind of shares cannot be allotted to the people who already have shares. According to the Section 54 of Companies Act 2013, an employee could be given these shares after ONE year of the incorporation of the business but Under The Companies (Amendment) Act, 2017 Sweat equity shares can be issued at any time after registration of the company without taking into consideration the termination of the time period of one year from the date of the commencement of business.

Bonus Issue

Bonus shares are added shares given to the existing shareholders without any additional cost, based upon the number of shares that a shareholder already has. These are company’s accumulated profit which is not given out in the form of dividends but are transformed into free shares. These are issued under following conditions –

1. Must be authorized by the articles
2. Must be authorized in general meeting on the recommendation of the board.
3. There is no default regarding the payment of interest or principal in fixed deposits or debt securities issued by it
4. Every share must be fully paid up before allotting the bonus issue
5. Bonus issue can be issued out of:       

• Free reserves
• Securities premium Account
• Capital Redemption Reserve

Note:

1. The bonus shares cannot be issued in place of a dividend.
2. A bonus issue cannot be withdrawn after its announcement.

Private Placement

A private placement can be made to a specific group of people who have been identified by the Board of the Company not exceeding fifty in number. It excludes the qualified institutional buyers and the employees of the company being offered securities under the scheme of employees’ stock option in terms of sub-section (1) of section 62 of the companies act 2013], in one financial year.

A private placement is an offer for the subscriptions to the securities of a company to a specific group of people (not exceeding 50 persons) in a financial year. A company issuing shares on private placement basis must comply with several requirements under the Companies Act, 2013

Issue of Shares on Preferential Basis – means an issue of the shares or other securities, by the company to any specific person or a select group of persons on a preferential basis and it does not include shares or other securities which are offered through a rights issue, public issue, employee stock option scheme, employee stock purchase scheme or the issue of sweat equity shares or bonus shares or depository receipts issued in a country outside India or the foreign securities.

Such issue on preferential basis is also required to comply with the term laid down in section 42 of the Companies Act, 2013 (private placement)

Contravention of Section 42 of the Act will result in a penalty which can extend upto the amount of the offer or invitation or twenty million rupees, whichever is the higher one, and the company will also refund all monies to subscribers within the period of 30 days from the order as mentioned in Section 42(10)

Conclusion

It is important for a private company to impose certain restrictions on the transferability of shares and the advertisement of the shares. A private limited company is distinct in that it has to restrict the transfer of shares in its Articles of Association. It is the fundamental idea behind the conception of private limited companies, which is generally started by families or friends or people who share common goals and ideas.

The restrictions that are placed on the sale or the transfer of shares or its advertisement can either be considered an advantage or disadvantage. It is an advantage to some shareholders as shareholders who want to sell shares cannot sell them to any outside buyers. Shareholders must agree to the sale or transfer of the shares; so, the risk of any hostile takeovers is relatively low. But on the other hand, it can also be a disadvantage because shareholders are left with limited options for liquidating their shares. In the end, it is one of the distinctive features of a private company.