James R. Balmforth: Is Section 42 Applicable To Private Companies?

A private placement is a sale of stock shares or bonds to pre-selected investors and institutions rather than on the open market. It is an alternative to an initial public offering (IPO) for a company seeking to raise capital for expansion. Investors invited to participate in private placement programs include wealthy individual investors, banks and other financial institutions, mutual funds, insurance companies, and pension funds. Private placement is a cost effective way of raising capital without going public. A private placement is a method for both public and private companies to raise capital through the private sale of corporate debt or equity securities, to a limited number of qualified investors (aka lenders); it is an alternative to traditional capital sources, such as bank debt, or issuing securities on the public bond market.

Who can issue private placement?

A public company or private company can issue shares on private placement basis.

Maximum number of person to whom private placement can be made
Private placement can be made to maximum 50 persons or higher number prescribed in a financial year, excluding (a) Qualified Institutional Buyer (QIB)(b) employees under stock option scheme under section 62(1)(b) of Companies Act, 2013.

Maximum limit for making offer for Private placement

Offer or invitation can be made to not more than two hundred persons in the aggregate in a financial year, excluding offer to QIB and Employees stock option. This restriction would be reckoned individually for each kind of security that is equity share, preference share or debenture [i.e. 200 for equity shares, 200 for preference shares and 200 for debentures]. However, unless allotment with respect to one kind of security is completed, another kind of security shall not be issued. For example, if equity shares are issued first, preference shares or debentures cannot be issued unless allotment of equity shares is completed. This restriction does not apply to issues by NBFC registered with RBI and housing finance companies registered with NHB (National Housing Bank). If RBI or NHB has not specified similar regulation, the provision of Companies Act shall apply.

What is the time limit for making allotment?

Allotment must be made within 60 days. If not made within 60 days, amount should be refunded within 15 days. Otherwise, interest @ 12% will be payable. The money shall be kept in a separate bank account, either for allotment or for repayment. The offer shall be made to specific persons by name and complete information and record of such offer shall be filed with ROC within 30 days of circulation of private placement offer. No advertisement through media, marketing or distribution channels or agents shall be made of such offer. Return of allotment with complete details of security holders shall be filed with Registrar.

Payment only from bank account of person making application

The payment for subscription to securities shall be made from the bank account of the person subscribing to such securities only. The company shall keep the record of the Bank account from where such payments for subscriptions have been received. Monies payable on subscription to securities to be held by joint holders shall be paid from the bank account of the person whose name appears first in the application – Rule 14(2)(d) of Companies (Prospectus and Allotment of Securities) Rules, 2014.

Record of private placement

The company shall maintain a complete record of private placement offers in Form PAS.5. A copy of such record along with the private placement offer letter in Form PAS.4 shall be filed with the Registrar with prescribed fees, within 30 days from date of the private placement offer letter. If the company is listed, copy of such record shall also be submitted to SEBI, within 30 days from date of the private placement offer letter – Rule 14(3) of Companies (Prospectus and Allotment of Securities) Rules, 2014.

Return of allotment

A return of allotment of securities under section 42 (private placement) shall be filed with the Registrar within 30 of allotment in Form PAS.3 with fee. The return should be filed along with a complete list of all security holders containing –

• the full name, address, Permanent Account Number and E-mail ID of such security holder
• the class of security held
• the date of allotment of security
• the number of securities held, nominal value and amount paid on such securities; and particulars of consideration received if the securities were issued for consideration other than cash.

Pre-certification of form

The PAS.3 form filed by company (other than OPC and small company) shall be pre-certified by practicing CA, CMA or CS. (form filed by OPC or small company is not required to be certified by practicing CA, CMA or CS).

Requirements for Private Company for Private Placement In Utah

As per Section 23 of the Companies Act, 2013 a private company may issue shares by:
• An offer of private placement can be made to a maximum of 200 individuals in a single financial year.
• A private placement letter is sent to applicants (coded with serial numbers) electronically or in writing.
• In the case of issue of shares, a special resolution needs to be passed by the existing shareholders. (Form MGT 14)
• The value of the shares should be certified by a Chartered Accountant (CA) with at least 10 years of experience.
• The payment for securities should be made directly from the bank account for the individual subscribing.
• Securities should be allocated within 60 days of receipt of the application money. If securities are not allocated (because of oversubscription or inability to raise enough capital), then the application money should be refunded within 15 days post the expiry of 60 days. If a company still fails to do so, then the company is liable to pay a 12% interest on the application amount.
The company must file the following with the Registrar of Companies:
• PAS-3 (The return of security allotment within 30 days of allotment)
• PAS-4 (Private placement offer letter)
• PAS-5 (Complete record of private placement)

Ways Private Companies can Raise Capital

Running a business requires a great deal of capital. Capital can take different forms, from human and labour capital to economic capital. But when most of us hear the term financial capital, the first thing that comes to mind is usually money. While it can mean different things, it isn’t necessarily untrue. Financial capital is represented by assets, securities, and yes, cash. Having access to cash can mean the difference between companies expanding or staying behind and being left in the lurch. There are two types of capital that a company can use to fund operations: Debt and equity. Prudent corporate finance practice involves determining the mix of debt and equity that is most cost-effective.

Debt Capital

Debt capital is also referred to as debt financing. Funding by means of debt capital happens when a company borrows money and agrees to pay it back to the lender at a later date. The most common types of debt capital company use are loans and bonds—the two most common ways larger companies use to fuel their expansion plans or to fund new projects. Smaller businesses may even use credit cards to raise their own capital. A company looking to raise capital through debt may need to approach a bank for a loan, where the bank becomes the lender and the company becomes the debtor. In exchange for the loan, the bank charges interest, which the company will note, along with the loan, on its balance sheet. The other option is to issue corporate bonds. These bonds are sold to investors—also known as bondholders or lenders—and mature after a certain date.

Before reaching maturity, the company is responsible for issuing interest payments on the bond to investors. Because they generally come with a high amount of risk—the chances of default are higher than bonds issued by the government—they pay a much higher yield. The money raised from bond issuance can be used by the company for its expansion plans. While this is a great way to raise much-needed money, debt capital does come with a downside. This expense, incurred just for the privilege of accessing funds, is referred to as the cost of debt capital. Interest payments must be made to lenders regardless of business performance. In a low season or bad economy, a highly-leveraged company may have debt payments that exceed its revenue.

Debt Capital Scenarios

Let’s look at the loan scenario as an example. Assume a company takes out a $100,000 business loan from a bank that carries a 6% annual interest rate. If the loan is repaid one year later, the total amount repaid is $100,000 x 1.06, or $106,000. Of course, most loans are not repaid so quickly, so the actual amount of compounded interest on such a large loan can add up quickly. Now let’s take a look at an example of bonds as debt capital. Company A is an airline company that wants to finance a series of purchases for some new aircraft. Instead of going to the banks for a loan, the company may decide to issue debt in the form of bonds that mature within ten years. Investors can purchase these bonds in exchange for interest payments. Lenders are guaranteed payment on outstanding debts even in the absence of adequate revenue.

Equity Capital

Equity capital, on the other hand, is generated not by borrowing, but by selling shares of company stock. If taking on more debt is not financially viable, a company can raise capital by selling additional shares. These can be either common shares or preferred shares. Common stock gives shareholders voting rights, but doesn’t really give them much else in terms of importance. They are at the bottom of the ladder, meaning their ownership isn’t prioritized as other shareholders are. If the company goes under or liquidates, other creditors and shareholders are paid first. Preferred shares are unique in that payment of a specified dividend is guaranteed before any such payments are made on common shares. In exchange, preferred shareholders have limited ownership rights and have no voting rights.

The primary benefit of raising equity capital is that, unlike debt capital, the company is not required to repay shareholder investment. Instead, the cost of equity capital refers to the amount of return on investment shareholders expect based on the performance of the larger market. These returns come from the payment of dividends and stock valuation. The disadvantage to equity capital is that each shareholder owns a small piece of the company, so ownership becomes diluted. Business owners are also beholden to their shareholders and must ensure the company remains profitable to maintain an elevated stock valuation while continuing to pay any expected dividends. Debt-holders are generally known as lenders, while equity holders are known as investors. Because preferred shareholders have a higher claim on company assets, the risk to preferred shareholders is lower than to common shareholders, who occupy the bottom of the payment food chain. Therefore, the cost of capital for the sale of preferred shares is lower than for the sale of common shares. In comparison, both types of equity capital are typically more costly than debt capital, since lenders are always guaranteed payment by law.

Equity Capital Scenario

As mentioned above, some companies choose not to borrow more money to raise their capital. Perhaps they’re already leveraged and just can’t take on any more debt. They may turn to the market to raise some cash. A start-up company may raise capital through angel investors and venture capitalists. Private companies, on the other hand, may decide to go public by issuing an initial public offering (IPO). This is done by issuing stock on the primary market—usually to institutional investors—after which shares are traded on the secondary market by investors.

Private placements can be done by either private companies wishing to acquire a few select investors or by publicly traded companies as a secondary stock offering.

When a publicly-traded company issues a private placement, existing shareholders often sustain at least a short-term loss from the resulting dilution of their shares. However, stockholders may see long-term gains if the company can effectively invest the extra capital obtained and ultimately increase its revenues and profitability.