In this blog post, Meghana Balan, a Bangalore-based Lawyer with an Independent Practice and a student pursuing a Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata, discusses the rules and regulations that are prescribed for raising capital.
Introduction
Capital as referred to here generally means the cash received by the company, usually from investors and in return for the company’s shares. Capital is utilized for different purposes at different stages in a company. At inception, a company requires a start-up capital to set up the business, acquire office space, licenses, permits, employ the required staff and for marketing expenses. Throughout the lifespan of the company, companies require a certain amount of capital as working capital for the day to day running of the business; this is usually generated by the business itself. Companies that are looking to expand or improve operations also require Capital, a growth capital. In India, as in the case of most other countries, the inflow of capital to a company is regulated by the law, rules and regulations that are enforced by the government agencies.
What Are The Rules & Regulations Prescribed For Raising Capital?
Governing Laws
- Companies Act, 2013
- Companies (Share Capital and Debentures) Rules, 2014
- Companies (Prospectus and Allotment of Securities) Rules, 2014
- SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009
- Securities and Exchange Board of India Act, 1992
- Securities and Exchange Board of India (Merchant Bankers) Regulations, 1992
- SEBI (Issuance of Observations on Draft Offer Documents Pending Regulatory Actions) Order, 2006
Discussion
A company can raise cash mainly in two ways:
- Using a debt, like a loan from a bank or other financial institution, the issuance of debentures, bonds or other debt securities under the Companies Act, 2013 or;
- Through the issuance of shares, either equity or preference.
For the purpose of this article, we will consider the latter, as capital in common parlance means funds raised through the issuance of shares of the company. A company can raise capital currently by four means, namely: Private Placement & Preferential Allotment, Rights Issue, Public Offer and through the Alternative capital raising platform.
Private Placement and Preferential Allotment of Shares: A company can issue shares through a private placement of shares under Section 42 of the Companies Act, 2013 and Rule 14 of the Companies (Prospectus and Allotment of Securities) Rules, 2014 by issuing a private placement offer letter to not more than fifty persons per offer and not more than two hundred persons in the aggregate in a financial year. This excludes the offer to QIBs[1] And ESOPs as per the provisions of Sec 62(1)(c) and Sec 62(1)(b) respectively.
The private placement is a means of offering securities to a select group of persons to subscribe for the securities of the company other than by way of a public offer. SEBI would play no role in private placement if it offered by a private unlisted company.
When a company, private or public allots shares under Section 62 of the Companies Act, 2013 and Rule 13 of Companies (Issue of Share Capital and Debentures) Rules, 2014 this would be considered Preferential allotment of shares. It is one of the common methods of raising capital because of the flexibility it allows regarding bringing in new investors without going to the public at large. Preferential allotment of shares by a private company and an unlisted public company will have to comply with the provisions of Companies Act, 2013 and Rules[2] Whereas a public listed company will have to additionally comply with Securities the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009[3], the ICDR Regulations.
Rights Issue: Rights Issue is the means of increasing the company’s subscribed capital by issue of further shares to persons who on the date of offer are holders of equity shares in proportion, as nearly as circumstances admit, to the paid-up share capital of those shares by sending a letter of offer subject to the conditions prescribed in Section 62(1)(a).
This is a means of raising capital from within the company’s existing shareholders. Like in the case of preferential allotment, the rights issue by private and unlisted public companies is governed by the Companies Act, 2013 whereas a public listed company will have to additionally comply with Securities the ICDR Regulations[4].
Public Offer: Chapter III Part I[5] And the ICDR Regulations deal with Public Offer, which is a means of raising capital, reserved only for a public company. The first time a company offers shares to the general public, it is known as an Initial Public Offer (IPO), the procedure and pre-requisite conditions for undertaking an IPO are under the ICDR Regulations. Subject to the ICDR Regulations an IPO can either be a fresh issue or an offer for sale where the existing shareholders including the promoters may participate.
A company intending to raise fund through public offer must fulfill certain prerequisites set out in the ICDR Regulations[6], file a draft prospectus based on the ICDR Regulations[7] with SEBI through a merchant banker, filed a red herring prospectus with the ROC based on the observations made by SEBI. The sale price of the equity shares is determined by a book-building process that is run by the merchant banker and after that finalized by the Company.
When a company makes a further issuance of shares through a public offer post the IPO, it is known as Further Public Offer (FPO), the Companies Act 2013 and the ICDR Regulations too regulate this.
Institutional Trading Platform: The Institutional Trading platform (ITP) is a new initiative to encourage early stage ventures to raise capital, the ITP provides for easier exit options for informed investors like angel investors and venture capital funds, SEBI Board has approved a proposal to permit listing of SMEs in Institutional Trading platform (ITP) without having to make an IPO, however, companies are not permitted to raise equity capital through public issues though they can continue to make private placements.
Accordingly, SEBI has made the provision in ICDR Regulations by introducing Chapter XC, whereby, listing on the ITP is made possible without bringing an IPO. SEBI has also relaxed the regulations for listing on the ITP for instance, the lock-in period for the promoter’s capital is six months as opposed to three years for the normal IPO and the disclosure requirements are less stringent.
What Role Does SEBI Play In Raising Capital?
From the discussion above it is amply clear SEBI plays a very significant role in raising capital when it comes to public offer. Section 24 of the Companies Act, 2013, except as provided in the Act, grants SEBI the power to regulate the issue and transfer of securities in so far as they apply to listed companies or those companies that intend to get their securities listed on any recognized stock exchange in India.
According to Section 11of the Securities and Exchange Board of India Act, 1992,[8], it is the Board’s duty to protect the interests of investors in securities and to promote the development of, and to regulate the securities market.
Therefore, it is clear that SEBI was set up to protect the interests of the general public (investors in securities) while providing a fair marketplace for companies, its functions can be broadly categorized into developmental and regulatory.
Developmental
- promoting investors’ education and training of intermediaries of the securities market;[9]
- conducting research and furnishing information useful to all participants[10].
Regulatory
- regulating the business in stock exchanges and other securities markets;[11]
- registering and regulating the working of stock brokers, merchant bankers, etc.;[12]
- prohibiting fraudulent and unfair trade practices relating to the securities markets;[13]
- prohibiting insider trading in securities;[14]
- regulating the substantial acquisition of shares and take-over of companies;[15]
- inspection, investigation, and audits of the intermediaries, corporations and others associated with the securities market;
- To regulate or prohibit the issue of the prospectus, offer document or advertisement soliciting money for an issue of securities.[16]
In addition to the above mentioned SEBI issues various regulations, guidelines, circulars and informal guidelines in an execution of its powers and duties. Below is a brief look at the role SEBI plays in a raising capital through a public offer:
- Provides for the eligibility criteria for making a public offer under the ICDR Regulations 26.
- Deals with pricing and price brand under ICDR Regulations 30 and 31, minimum promoter’s contribution lock-in[17].
- Appointment of a merchant banker is a must for a company looking to make a public offer, the only merchant banker with a valid SEBI registration can be eligible for appointment. SEBI has listed the requirement and procedure for
appointment of merchant bankers under Securities and Exchange Board of India (Merchant Bankers) Regulations, 1992. - The draft prospectus is filed with SEBI for its approval; SEBI may issue observations, seek clarifications from the merchant banker or relevant regulatory authority. SEBI is obligated to keep issuance of observations in abeyance for 45 days or 90 days, as the case may be. Anytime is taken by entities/notice(s), being the issuer/its promoter(s)/director(s)/group companies against whom show cause notice has been issued by SEBI, shall be excluded while computing the period of 90 days.[18]
Conclusion
Raising Capital is serious business, companies that wish to market their shares are required to follow the rules and regulations primarily under the Companies Act, 2013 and the ICDR Regulations along with the list of other rules and regulations mentioned in this article.
SEBI plays a pivotal role in maintaining the balance between protecting the interests of investors as well as promoting business and providing a fair platform for raising capital.
References:
[1] Qualified institutional buyer as defined by the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009 as amended from time to time.
[2] Rule 13 of Companies (Issue of Share Capital and Debentures) Rules, 2014.
[3] Chapter VII, Regulation 70 to 79.
[4] Chapter II and Chapter IV, Regulation 52 to 56.
[5] Companies Act, 2013.
[6] Regulation 4 to 8 and Regulation 26
[7] Regulation 6, Schedule IV and Schedule V
[8] Under Chapter IV, Powers and Functions of the Board,
[9] Sec. 11(2)(f)
[10] Sec. 11(2)(l)
[11] Sec. 11(2)(a)
[12] Sec. 11(2)(b)
[13] Sec. 11(2)(e)
[14] Sec. 11(2)(g)
[15] Sec. 11(2)(h)
[16] Section 11A
[17] ICDR Regulations 32 to 40
[18] SEBI (Issuance of Observations on Draft Offer Documents Pending Regulatory Actions) Order, 2006 read with General Order Number 1 of 2008 dated March 31, 2008.
