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Preferential issues of capital

Preferential Issues of Capital

ICAI, Bangalore

CA. Pratap G. Subramanyam

B.Com., FCA, ACS


  • Preferential issues of capital classify as non-public offerings or issue of capital under the Companies Act. Such offerings are covered under the provisions of Section 67(3) read with first proviso which refers to ‘issues made to investors numbering less than 50’ .

  • All preferential issues of capital are executed through ‘preferential allotments’.

  • A preferential allotment is made pursuant to the provisions of Section 81(1A) under which members give up their pre-emptive right in public companies contained in Section 81(1). The act of allotting shares in a preferential issue is known as ‘Preferential Allotment’.

  • A preferential issue can also be made to outside investors with a fund raising objective in which case it is known as a ‘private placement’.

Uses advantages and pitfalls
Uses, Advantages and Pitfalls

  • Preferential Issues are primarily used for strategic purposes such as consolidation of promoters’ stakes, induction of strategic partners and issue of shares under ESOP / Sweat Equity plans. In such issues, the allottees are already identified prior to the transaction since they are mostly insiders or business partners.

  • Preferential Issues in the nature of Private Placements require a ‘placement’ process to be completed before the preferential allotment takes place, i.e. the identification and finalisation of terms with the potential investors.

  • Private Placements are time and cost-effective for the issuer. The placement requires less amount of paper work, approvals and clearances and can be placed with a closed community of investors.

  • As long as a company raises equity through preferential placements and postpones a public offering, there would be a significant growth prospect in its IPO pricing.

Uses advantages and pitfalls1
Uses, Advantages and Pitfalls

  • A listed company raising equity through preferential placement (PIPE) would mean equity expansion without corresponding increase in floating stock. This is beneficial from the point of view of prevention of stock volatality and threat of hostile takeover.

  • In listed companies, a preferential issue to promoter group may serve as a cost effective mechanism rather than alternative routes such as creeping acquisition. It also sends a positive signal to the market.

  • On the flip side, private placements are meant only for informed investors since the level of scrutiny and disclosures are not on par with public offers.

  • Private placements may not be based on issue related market factors but more on fundamentals and long term factors.

Regulatory framework
Regulatory Framework

  • Preferential Issues can be made both by unlisted and listed companies.

  • Preferential Issues by unlisted companies are governed by the provisions of the Companies Act read with the Unlisted Companies (Preferential Allotment) Rules 2003.

  • Preferential Issues by listed companies are governed by the Companies Act read with the relevant provisions of the ICDR Regulations issued by SEBI.

  • Preferential Issues to foreign investors are also governed by FEMA Regulations and extant FDI policy.

  • Preferential Issues by listed companies (known as PIPEs) are also governed by the SEBI Takeover Code 2011.

Pipe placements1
PIPE Placements

  • PIPE issues that do not classify as preferential issues –

    • All Public Offers (IPO and FPOs)offer of specified securities made through a public issue, rights issue,

    • Bonus Issue

    • ESOP or ESPS shares

    • Sweat Equity Shares

    • ADR / GDR issues

    • QIP / IPP which are regulated separately.

    • Schemes of arrangements under section 391-394

    • BIFR Schemes / Loan conversions by banks / DRT orders

  • All other PIPEs to any select person or group of persons on a private placement basis are classified as preferential issues. SEBI does not differentiate strategic preferential issues from private placements.

Pipe preferential issue
PIPE Preferential Issue

  • PIPE Preferential Issues require to be made within 15 days of the members’ resolution under section 81(1A), except for shares to be allotted under a CDR scheme.

  • No allotment to investors who have sold shares within the preceding 6 months.

  • Convertible instruments shall not have a currency of more than 18 months.

  • Full consideration shall be paid on allotment. In case of warrants, at least 25% to be paid. The balance shall be paid on allotment of shares. Warrant consideration is forfeited in case option is not exercised.

  • Shares allotted under this issue shall be locked in for 1 year including the holding period of the convertible. Shares held by allottees prior to the issue will be locked in for 6 months.

Pipe preferential issue1
PIPE Preferential Issue

  • Where warrants are issued on a preferential basis with an option to apply for and get the shares allotted, the issuing company shall determine before hand the price of the resultant shares.

  • The relevant date for determining the price at which the convertible would be converted into equity would be the date falling 30 days prior to the date of the shareholders’ meeting or 30 days prior to the date of conversion of the warrants, at the option of the issuer company.

  • It may be noted that the option is only with respect to that date. All other provisions apply mutatis mutandis straight equity allotments.


  • Qualified Institutional Placements are exclusively for institutional investors by listed companies. Promoters, non-institutional and retail investors cannot participate.

  • The company should have listing record for at least 1 year.

  • The issue should be only for pure equity or non-convertible debt with warrants and convertible instruments except warrants.

  • In a QIP of a non-convertible debt instrument along with warrants, an investor can subscribe to the combined offering of non- convertible debt instruments with warrants or to the individual securities at his option.

  • The minimum number of allottees for each QIP shall not be less than two for an issue size upto Rs. 250 crore and five for issues beyond that amount. No single allottee shall be allotted more than 50% of the issue size.

  • The total amount raised under the QIP shall not exceed five times the networth of the company prior to the placement.


  • The reference date for pricing of a convertible in a QIP shall be determined in the same way as in a PIPE preferential issue.

  • Convertible issued under QIP should have a maximum currency of 60 months from the date of allotment.

  • The currency of the special resolution passed under section 81(1A) shall be for a period of twelve months from the date of the EGM.

  • The shares allotted under QIP can be sold in the secondary market without any lock-in but not in off-market deals upto a period of one year.

  • Appointment of a merchant banker for the QIP is mandatory. The merchant banker shall conduct due diligence and issue necessary certificate to stock exchange on the compliance of the QIP guidelines and apply for listing of the QIP shares.

  • Mutual funds have a reservation of 10%. Unsubscribed amount can be added to other QIBs.

  • There should be a cooling off period of at least 6 months between two successive QIPs.


  • IPP is similar to QIP insofar as it concerns preferential allotment by the company.

  • However, the IPP issue will be reckoned as an issue under a prospectus under section 60 instead of a private placement. So the offer document should be registered with ROC.

  • The minimum number of allottees for an IPP shall not be less than ten. In addition, no single allottee shall be allotted more than 25% of the offer size.

  • An IPP shall not result in increase in public shareholding by more than 10% .

  • Minimum of 25% of eligible securities shall be allotted to mutual funds and insurance companies.

  • The issue shall be kept open for a minimum of 1 day and a maximum of 2 days. The bids made by the applicants shall not be revised downwards or withdrawn. The offer may be withdrawn by the issuer if it is not fully subscribed.

  • Lock-in applies as in a QIP.

Instruments used
Instruments used

  • In Preferential Issues to promoter group – Straight Equity, Warrants and DVRs.

  • In Preferential Issues to strategic investors – Straight Equity.

  • In JV companies – Straight Equity and Convertible Debt Structure.

  • In VC – Convertible Preference Shares (CCPS), Convertible Debt Structure.

  • In PE – Straight Equity, CCPS

  • In PIPE Placements – Straight Equity

  • In QIPs – Mostly Straight Equity

  • In IPPs – Straight Equity

Issue pricing
Issue Pricing

  • The pricing of shares for a private placement / preferential offer is governed by the provisions of the Companies Act, ICDR Regulations and FEMA Regulations insofar as it concerns non-resident investors.

  • The pricing cannot be less than the par value of the share (section 79 of the Companies Act).

  • ESOP shares and Sweat Equity can be priced freely by both unlisted and listed companies. ESOP shares should have a minimum consideration of the par value. Sweat equity is entirely in non-cash consideration.

  • Other preferential issues by unlisted companies have no price restrictions whatsoever, whether the company is public or private, except under the provisions of FEMA.

  • Under FEMA, fair market value for unlisted shares shall be as per the DCF method certified by a merchant banker or a CA. The issue pricing shall not be less than the FMV.

Issue pricing1
Issue Pricing

  • However, keeping in view regulatory procedures, it is essential to arrive at the fair value of the shares initially through an independent valuation. The ‘price’ at which the shares are being issued has to be justified in the context of the independent valuation.

  • In the case of issue of shares to non-residents, the price should not be less than the price arrived at under the independent valuation. RBI also does not prefer the pricing to be too high as compared to the independent valuation.

  • Unlisted companies should consider the provisions of Section 56(viib) of the IT Act which prescribe the BV method or the certified DCF value of a CA or a merchant banker as the fair market value at the option of the assessee.

  • The excess of the issue price over the FMV would become income from other sources for the issuer company.

Regulatory pricing pipes
Regulatory Pricing – PIPEs

  • Both strategic preferential issues and private placements have to conform to the same pricing formula in listed companies.

  • The pricing of the shares for a PIPE preferential issue by a listed company shall not be less than the higher of the following –

    • (a) the average of the weekly high and low of the closing prices of the share during the six months preceding the date which is thirty days prior to the date of the shareholders’ meeting or

    • (b) the average of the weekly high and low of the closing prices during the two weeks preceding the date of the shareholders’ meeting or

    • (c) the IPO price

  • FEMA pricing for PIPE preferential issues is identical to the SEBI pricing formula.

Regulatory pricing qip
Regulatory Pricing – QIP

  • The QIP shall be made at a price not less than the average of the weekly high and low of the closing prices of the equity shares of the same class quoted on the stock exchange during the two weeks preceding the relevant date.

  • The issuer may however offer a discount of not more than 5% on the price so calculated for the QIP, subject to approval of shareholders.

  • Where convertible instruments are issued, the issuer shall determine the price at which the conversion shall take place into equity shares by taking the relevant date as decided and disclosed by it while passing the special resolution.

  • The normal practice in QIP transactions is that a floor price is fixed by the book running issue manager based on the statutory minimum price and investors are asked to bid at their offer price.

Regulatory pricing ipp
Regulatory Pricing – IPP

  • There is no regulatory pricing for IPP as it is considered an issue under an offer document registered with the ROC.

  • The company can invite bids with a floor price and allot shares under any of the methods below –

    • The ‘proportionate basis method’ (Dutch Auction) whereby all successful allottees will be allotted shares at the same price discovered thorugh book building and the amount of shares allotted would be based on the bids received.

    • The ‘price priority method’ (French Auction) wherein the company allots shares to successful bidders based on the highest price offered.

    • The company may devise its own method of allotment and pricing which shall be disclosed in the offer document.

  • ONGC IPP – Floor Price Rs. 295, Ruling market price – Rs. 290.

Summary deal process for a preferential issue
Summary Deal Process for a Preferential Issue

  • No placement process is involved if it is a strategic transaction. Partner search may be involved.

  • Board meeting for passing requisite resolution for preferential allotment.

  • The first task is to prepare an Information Memorandum detailing the complete status of the company, financial history, business perspective, financial requirements and present investment proposal. The Infomemo is prepared on behalf of the issuer by an investment banker retained for this purpose.

  • Based on the type of private placement being contemplated, the investment banker begins the search. In case of strategic equity, a partner search is done. In the case of venture capital or private equity, the funds that are likely to be interested are short-listed and approached. In case of a QIP proposal, the investment banker may arrange a private investor meet for the issuer.

Summary deal process for a preferential issue1
Summary Deal Process for a Preferential Issue

  • The company makes necessary presentations, answers queries on the Infomemo and the interested investors engage in detailed dialogue on various aspects of the deal including the proposed deal structure.

  • The investors and the company agree on the valuation and the broad parameters of the deal. Financial investors issue term sheet.

  • The investors get into financial and legal due diligence. After completion thereof, issues arising from the due diligence are sorted out and the final terms are drawn up.

  • In the case of strategic equity or venture capital / private equity, the transaction documents are drafted and agreed upon in their final form. In case of other QIP investors, usually, a sanction letter is issued.

  • The company and if required, the investors as well, seek necessary under law for the proposed investment and allotment of shares. Necessary authorisations are also taken for execution of documents.

  • Execution of transaction documents takes place and the investors simultaneously make necessary applications, as may be required, for subscription to shares.

Summary deal process for a preferential issue2
Summary Deal Process for a Preferential Issue

  • The investors remit the funds on a set date (Closing Date) or as may be agreed upon by the parties. Funds coming from abroad are remitted through normal banking channels using swift codes.

  • In case funds are received through cheques or demand drafts, these are sent for clearing.

  • Simultaneously, in the case of a listed company, the company applies to the concerned stock exchange for the listing of the proposed shares.

  • After the funds are credited to the company’s bank account and on receipt of in-principle approval from the stock exchange, the company proceeds with the allotment of shares to the investors.

  • The listing process is completed after filing the details of allotments made and receipt of final listing approval from the stock exchange.

  • The shares become listed and the deal process is complete.

Issuer s perspective
Issuer’s Perspective

  • Private placements are inevitable if public offer markets are depressed or if the company is unlisted and too premature to go public.

  • Strategic equity has a wider business perspective than equity from financial investors. Financial investors are more focussed on financial performance and expected appreciation of their investment.

  • It is better to spread QIP between a group of investors rather than allowing concentration of shares.

  • Issuers (especially listed companies) should look for well-known institutional investors as that would reflect well on their market capitalisation.

  • Issuers should be well-prepared for due diligence and for subsequent increase in the levels of corporate governance.

  • Issuers should be prepared for more rigorous board meetings, shareholder meetings and disclosures since investor nominees and independent directors would be on the board.

Preferential issues by unlisted companies procedural requirements
Preferential Issues by Unlisted Companies – Procedural Requirements

  • Under the preferential allotment rules, the main requirements are –

    • The rules apply to all financial instruments, i.e. shares and convertibles.

    • The articles of association shall authorise a preferential allotment of shares.

    • The members shall pass a special resolution under section 81(1A) and the said resolution shall have a validity of 12 months from the date of the EGM to complete the allotment.

    • The warrants are issued on a preferential basis with an option to apply for and get the shares allotted, the issuing company shall determine before hand the price of the resultant shares.

    • In case of every issue of shares/ warrants/ fully convertible debentures/ partly convertible debentures or other financial instruments with conversion option, the statutory auditors of the issuing company / company secretary in practice shall certify that the issue of the said instruments is being made in accordance with these Rules. Such certificate shall be laid before the meeting of the shareholders convened to consider the proposed issue.

Preferential issues by unlisted companies procedural requirements1
Preferential Issues by Unlisted Companies – Procedural Requirements

  • The notice convening the general meeting of shareholders shall disclose the following -

    • The price or price band at which the allotment is proposed;

    • The relevant date on the basis of which price has been arrived at;

    • The object/s of the issue through preferential offer;

    • The class or classes of persons to whom the allotment is proposed to be made;

    • The intention of promoters/directors/key management persons to subscribe to the offer;

    • The shareholding pattern of promoters and others classes of shares before and after the offer;

    • The proposed time within which the allotment shall be completed;

    • Whether a change in control is intended or expected.

Preferential issues by listed companies main requirements
Preferential Requirements Issues by Listed Companies – Main Requirements

  • It should be ensured that the proposed preferential allotment does not violate the minimum non-promoter holdings required under the continuous listing requirements. This is going to be uniformly 25% for all companies from June 2013.

  • The requirements of board meeting and general meeting are identical since special resolution under Section 81(1A) has to be passed.

  • Notice to the concerned stock exchange before and after the Board Meeting should be given under the listing agreement. Other relevant provisions of listing agreement and Takeover Code to be kept in mind.

  • All existing shareholdings of the proposed allottees should be held in demat form. If not they should be dematted including promoter holdings.

Other procedural aspects for preferential issues
Other Procedural Requirements Aspects for Preferential Issues

  • Convene the Board Meeting to consider the final term sheet proposed by the investor after the negotiations and due diligence has been completed.

  • In cases where there is a subscription agreement, the Board meeting should be convened to approve the draft agreement(s) and authorise the signatories for execution of the agreements.

  • At the Board Meeting, the date for convening of the EGM for passing the necessary resolutions is considered and the Secretary / MD is authorised to convene the meeting.

  • Based on the proposed date of the shareholders’ meeting, the ‘Relevant Date’ for the pricing guideline of SEBI is ascertained and the issue price / conversion price is determined. In the case of convertibles, the relevant date can be fixed at 30 days prior to the date of conversion.

Other procedural aspects for preferential issues1
Other Procedural Aspects for Preferential Issues Requirements

  • For listed companies, the explanatory statement under section 173(2) for the proposed resolution authorising the preferential allotment shall specifically contain the following –

    • The objects of the preferential issue

    • Intention of the promoters / directors /key management personnel to subscribe to the offer.

    • Shareholding pattern before and after the offer.

    • Proposed time within which the allotment shall be completed.

    • The names of the proposed allottees and the percentage of their shareholding in the company on completion of the allotment.

Other procedural aspects for preferential issues2
Other Procedural Aspects for Preferential Issues Requirements

  • The statutory auditors of the company shall certify that the proposed allotment has met the provisions applicable to preferential allotments and such certificate should be laid before the EGM.

  • In case of shares being allotted for consideration other than cash, a separate valuation certificate will need to be obtained and it should also be submitted to the concerned stock exchange.

  • The EGM shall convene on the appointed date and pass a special resolution under section 81(1A) of the Companies Act authorising the company to allot shares on a preferential basis to the proposed investors. The resolution shall specifically state the relevant date being used for determining the allotment price / conversion price.

  • The EGM may also have to pass necessary resolution for increase in authorised capital of the company to accommodate the preferential allotment.

  • The EGM may also have to pass special resolution for amendment of the Articles of Association to the satisfaction of the proposed investors.

Other procedural aspects for preferential issues3
Other Procedural Aspects for Preferential Issues Requirements

  • ROC filings for special resolutions and increase in authorised capital where necessary.

  • The subscription list of the proposed allottees and amounts due on allotment has to be prepared based on the subscription agreement or the applications furnished by the investors. For this purpose, the company has to print limited amount of special application forms.

  • If non-resident investors are involved, it has to be examined whether the proposed investment falls within the sectoral FDI cap. If not, prior to the EGM passing the special resolution, the approval from FIPB should have been obtained.

  • Obtain the valuation certificate from the auditors / chartered accountant for the purpose of non-resident investors that the offer price is in conformity with RBI guidelines on pricing.

Other procedural aspects for preferential issues4
Other Procedural Aspects for Preferential Issues Requirements

  • Receipt of subscription amounts from the investors. From non-resident investors, the remittances have to come through normal banking channels. The company has to obtain the FICR from the authorised dealer for the remittance.

  • A second board meeting to be convened to approve the allotment of shares under the preferential issue. In the case of listed companies, the allotment has to be completed within 15 days from the date of the special resolution (EGM date). If FIPB approval is not received by such time, the 15 day period should be reckoned from the time of receipt of the approval.

  • If allotments are not completed within 15 days as stated above, the resolution shall lapse and fresh consent from shareholders would be required.

  • On completion of allotment, within 30 days, the return of allotment has to be filed and if there are non-resident allottees, form FC-GPR should also be filed with the RBI.

  • Listing formalities to be completed in compliance with the listing agreement.

Qip disclosures and placement document
QIP Disclosures and Placement Document Requirements

  • The QIP offer document should be prepared in accordance with the disclosure requirements and should contain inter alia, the following –

    • Summary of the Offering and Instrument

    • Risk Factors

    • Market Price Information and details of trading volumes as prescribed.

    • Use of proceeds

      • purpose of the issue;

      • break-up of the cost of project for which the money is raised through issue;

      • the means of financing such project; and

      • proposed deployment status of the proceeds at each stage of the project.

    • Industry Description

    • Business Description

    • Organizational Structure and Major Shareholders

    • Board of Directors and Senior Management

    • Taxation Aspects relating to the Instrument

    • Legal Proceedings

Qip disclosures and placement document1
QIP Disclosures and Placement Document Requirements

  • Capitalization Statement

  • The audited consolidated or unconsolidated financial statements prepared in accordance with Indian GAAP shall contain the following:

  • Report of Independent Auditors on the Financial Statements

    • Balance Sheets

    • Statements of Income

    • Schedules to Accounts

    • Statements of Changes in Stockholders’ Equity

    • Statements of Cash Flows

    • Statement of Accounting Policies

    • Notes to Financial Statements

    • Statement Relating to Subsidiary Companies (in case of unconsolidated financial statements)

  • Management’s Discussion and Analysis of Financial Condition and Results of Operations

  • Accountants

  • General Information

Qip disclosures and placement document2
QIP Disclosures and Placement Document Requirements

  • The QIP memorandum should be numbered and circulated privately and also placed on the website of the company and the stock exchange and also sent to SEBI within 30 days of allotment for record.

  • Appointment of a merchant banker for the QIP is mandatory.

  • The merchant banker shall conduct due diligence and issue necessary certificate to stock exchange on the compliance of the QIP guidelines and apply for listing of the QIP shares. A copy of the QIP memorandum should also be furnished. The listing application should also be accompanied by a certificate from the company that the issue has been made in accordance with the QIP guidelines and other necessary undertakings under the Listing Agreement.

Preferential issue vs qip an assessment
Preferential Issue vs QIP - An assessment Requirements

  • Currency of shareholders’ resolution – Preferential Issue has to completed in 15 days while QIP can be executed within 12 months. This provides greater flexibility for the company in negotiating the terms and finding appropriate investors.

  • The shares issued to investors under preferential issue are locked in for one year. There are also other lock-in restrictions. However, shares issued under QIP are free from lock-in for secondary market sales. This provides better flexibility for the investors and a premium to market price for the company.

  • Convertibles issued under QIP have a currency of 60 months vis-à-vis 18 months in a preferential issue. This provides a staggered dilution and better investor perception and market capitalisation.

  • There are however restrictive covenants on the number of investors and the maximum allotment per investor under QIP while no such restrictions exist under preferential issue.

  • The cost of a QIP would be higher since there is a requirement for appointment of a merchant banker and due diligence and preparation of QIP document.

  • The level of disclosures in QIP are higher than in a preferential issue.

Role of ca in preferential issues
Role of CA in Preferential Issues Requirements

  • As Practitioners –

    • Auditors’ certification for preferential issue of convertibles by unlisted companies.

    • Statutory audit or financial reporting to be included in Information Memorandum / Placement Document / IPP Offer Document

    • Tax benefits certificate for company

    • Tax benefit certificate for investor

    • Opinions as may be necessary in tax matters relating to company

    • As due diligence agencies to conduct Accounting and Financial DDR.

    • DCF Valuation Certificate under FEMA for unlisted companies.

    • Certification for the purposes of Section 56(viib) of the IT Act.

    • Independent Valuation Certificate / Fairness Opinion for pricing as per SEBI Regulations for furnishing under listing agreement / FEMA

Role of ca in preferential issues1
Role of CA in Preferential Issues Requirements

  • As Industry CAs working as merchant bankers, independent consultants and corporate advisors –

    • Mandatory merchant banking services for QIP and IPP offers . Role includes DDR, certifications, transaction advisory including pricing and deal compliance.

    • Mandatory certification for valuation under SEBI / FEMA

    • Independent certification / Fairness Opinion on Valuation.

    • Advisors and consultants are associated mainly to advise the company / promoters on transaction structure, term sheet conditions, commercial and tax/ legal aspects.

  • As CFOs / Finance Heads of Issuer Companies –

    • Back ending the transaction for preparation of offer literature, due diligence by external agencies.

    • Complementary role with Company Secretary in Board and AGM processes.

    • Certification from auditors / Merchant bankers

    • Statutory Compliance and deal close matters.

Thank you

THANK YOU Requirements

CA. Pratap Subramanyam


[email protected]