Private Placement vs Preferential Allotment: How a Private Company Issues Shares

The term sheet is signed, the investor is ready to wire the money, and the founder asks me a simple question: “Can they just transfer it and we issue the shares next week?” The honest answer is no. An unlisted private company in India cannot take an investor’s money and hand over shares on a handshake. The Companies Act, 2013 lays down a fixed route, with forms, a separate bank account, a valuation report and filings at each step. Get the order wrong and the money you just raised can become money you have to give back, with interest.

This note covers the two provisions behind almost every equity round in a private company, Section 42 (private placement) and Section 62(1)(c) (preferential allotment), the sequence I follow, and the mistakes that make a clean round non-compliant. If you are still choosing an instrument, read my guide to startup fundraising in India first.

They are not two options. You usually need both.

The most common misunderstanding is that a company picks “private placement” or “preferential allotment” as if they were alternative routes. For a fresh issue of shares to a new investor for cash, they are two layers of the same transaction.

Section 62(1)(c) answers the question: who may receive new shares? By default, when a company increases its subscribed capital, Section 62(1)(a) says the new shares must first be offered to existing shareholders in proportion to their holding. That is a rights issue. Section 62(1)(c) is the exception that lets the company issue shares to any person, including an outside investor, if the members approve it by special resolution and the price is determined by the valuation report of a registered valuer. The detailed conditions sit in Rule 13 of the Companies (Share Capital and Debentures) Rules, 2014.

Section 42 answers the question: how may the offer be made? Any offer of securities to a select group of people, other than through a prospectus or a rights issue, is a private placement. Section 42 and Rule 14 of the Companies (Prospectus and Allotment of Securities) Rules, 2014 prescribe the offer letter, the bank account, the timelines and the return of allotment.

The link is written into the rules: Rule 13 says a preferential issue shall be made in accordance with Section 42. So when you issue equity or compulsorily convertible preference shares to an angel or a fund, Rule 13 governs approval and pricing, and Section 42 with Rule 14 governs the mechanics. Section 42 also stands alone for non-convertible debentures, where Section 62 has nothing to say.

How many people you can offer to

A private placement is, by definition, an offer to a select group, not to the public. Section 42(2) says the offer can be made only to persons identified by the Board, whose number shall not exceed 50 or such higher number as may be prescribed, in a financial year. Rule 14 prescribes that higher number: at the time of writing, an offer or invitation can be made to not more than 200 persons in aggregate in a financial year. Two groups are excluded from this count: qualified institutional buyers, and employees offered securities under an employee stock option scheme under Section 62(1)(b). The rule also says the limit is reckoned individually for each kind of security, so equity shares and debentures are counted separately.

Two points founders miss. The count is of persons offered, not persons who subscribe, so every name on a wide mailing list counts. And a private company has its own ceiling under Section 2(68): at most 200 members, with exclusions for current and former employees. A round with many small cheques can hit that first, which is one reason I push founders to plan the cap table before they plan the round.

Section 42 also bars public advertisement and the use of media, marketing or distribution channels or agents to inform the public. A pitch deck forwarded around a WhatsApp group with an “invest now” line should make you uneasy.

The sequence I follow on every issue

The order matters as much as the steps. Most non-compliant issues I clean up have every document in the file, produced in the wrong order or on the wrong dates.

Step 0: check the house before you invite guests. Confirm the articles permit the issue and whether the existing shareholders’ agreement gives anyone pre-emptive, consent or anti-dilution rights that must be honoured or waived. Check the authorised capital; if it is short, the members increase it under Section 61 and the company files Form SH-7 within 30 days. If yours is a private company other than a small company, check whether Rule 9B of the Share Capital and Debentures Rules requires the issue in dematerialised form and the promoters’ and directors’ holdings to be dematerialised first. Those dates have moved more than once, so confirm the current position.

Step 1: valuation. Section 62(1)(c) requires the price to be determined by the valuation report of a registered valuer, meaning a valuer registered under the Companies (Registered Valuers and Valuation) Rules, 2017. A chartered accountant who is not a registered valuer cannot sign this report for Companies Act purposes. If the investor is a non-resident, FEMA has its own pricing rule and a separate valuation may be needed; the two reports are prepared for different laws and should be reconciled before the price is fixed.

Step 2: Board meeting. Under Section 179(3)(c), the power to issue securities can be exercised only by the Board at a meeting, not by a circular resolution. At this meeting the Board approves the proposed issue, identifies the persons to whom the offer will be made and records their names, takes note of the valuation report, approves the draft offer letter, and calls a general meeting with a notice and explanatory statement.

Step 3: special resolution with a full explanatory statement. The members pass a special resolution, which needs at least three times as many votes in favour as against. Rule 13 and Rule 14 each list what the explanatory statement must disclose: among other things, the objects of the issue, the price and its basis, the valuer’s name and address, the relevant date for pricing, the proposed allottees and their post-issue holding, any change in control, and the time within which allotment will be completed. I draft one resolution and one explanatory statement that satisfy both rules. A general meeting normally needs 21 clear days’ notice under Section 101, with shorter notice possible on the members’ consent as the Act prescribes; check your own articles too.

Step 4: file MGT-14 before you send the offer. Every special resolution must be filed with the Registrar in Form MGT-14 within 30 days of being passed, under Section 117. For a private placement the timing is tighter than that in practice, because Rule 14 says the offer letter can be issued only after the relevant special resolution has been filed with the Registrar. Pass the resolution, file MGT-14, and only then move to the offer.

Step 5: the offer letter in Form PAS-4. The private placement offer cum application letter is in Form PAS-4. It must be serially numbered, addressed by name to the specific identified person, and it carries no right of renunciation, so the investor cannot pass the offer on to someone else. Alongside it, the company maintains a complete record of the private placement offers in Form PAS-5.

Step 6: money into a separate bank account. The investor applies using the application form and pays the subscription money by cheque, demand draft or another banking channel. Section 42 prohibits payment in cash. Rule 14 adds that the payment must come from the subscriber’s own bank account, and the company must keep a record of the account the money came from. Section 42(6) requires the money to be kept in a separate bank account with a scheduled bank. That account is not a general collection account. The money in it can be used only to adjust against allotment or to refund the investor if the company cannot allot.

Step 7: allot within 60 days. Section 42(6) requires the company to allot the securities within 60 days from the date it receives the application money. Allotment is done by a Board resolution. Separately, Rule 13 requires allotment under the special resolution to be completed within 12 months of the resolution; if that window lapses, a fresh special resolution is needed. The 60-day clock runs from the money, the 12-month clock runs from the resolution, and both must be respected.

Step 8: return of allotment in Form PAS-3 within 15 days. Section 42(8) requires the company to file a return of allotment with the Registrar within 15 days of the allotment, with a complete list of the allottees and their details. Note the contrast: the general rule for a return of allotment under Rule 12 of the Prospectus and Allotment Rules is 30 days, but an allotment made through a private placement has the shorter 15-day window.

Step 9: only now, use the money. Section 42(4) bars use of the money until the allotment is made and the return of allotment is filed. Then issue share certificates within two months of allotment as Section 56 requires, or credit the investor’s demat account, and update the register of members.

If the investor is a non-resident, there is a parallel FEMA reporting track after allotment. I cover that in detail in my guide to FC-GPR filing.

Common mistakes that make an issue non-compliant

Taking money before the paperwork. Money lands in the main current account weeks before the Board has identified anyone or the members have passed anything. There is no valid offer for it to answer, and if shares are not allotted and the money is not refunded within the time the Companies (Acceptance of Deposits) Rules, 2014 allow, it can be treated as a deposit. That is a far bigger problem than a late form.

Cash, or money from someone else’s account. Cash is barred outright. Money paid by the investor’s relative, a group company or a friend on the investor’s behalf breaks the rule that payment must come from the subscriber’s own account. Where shares are to be held jointly, the rule looks to the account of the first-named holder.

Spending before PAS-3 is filed. The mistake I see most in otherwise careful companies: allotment is done, salaries go out of the separate account, and the return of allotment is still pending. Both conditions must be met first.

Missing the 60-day allotment window. A tranche arrives late or a signatory is travelling, and the allotment meeting slips past day 60. The company must then refund, and the interest clock starts.

A stale or wrong valuation. The report predates the resolution by months, the relevant date does not match, the valuer is not registered, or the resolution price is not the one the report supports. Easy to spot in diligence, hard to fix later.

Offer letter before MGT-14. PAS-4 dated the same day as the general meeting, before the resolution has been filed with the Registrar, is a sequencing defect that shows up the moment someone lines up the dates.

Overlapping offers. Section 42 does not allow a fresh offer while allotments under an earlier offer are incomplete, unless that offer is withdrawn or abandoned. Close or withdraw the bridge before opening the main round.

Allotting to people who were never offered. The shares go to the investor’s fund vehicle or family trust rather than the person named in the resolution and PAS-4. The allottee has to be the identified person who received the offer. Settle the exact subscribing entity at the term sheet stage, not on the day of allotment.

What happens when it goes wrong

The consequences are set out in Section 42 itself, and they are not light.

Refund with interest. If the company cannot allot within 60 days, it must repay the application money within 15 days from the end of that 60-day period. If it fails to repay within that time, it is liable to repay with interest at 12% per annum from the expiry of the 60th day.

Penalty for late return of allotment. A default in filing PAS-3 within the prescribed time exposes the company, its promoters and its directors to a daily penalty under Section 42(9). At the time of writing, this is Rs 1,000 for each day the default continues, subject to a maximum of Rs 25 lakh. Late filing fees on the form are payable on top.

Penalty and refund for a contravening offer. If the company makes an offer or accepts money in contravention of Section 42, the company, its promoters and directors are liable to a penalty which, at the time of writing, may extend to the amount raised through the private placement or Rs 2 crore, whichever is lower. The company must also refund all the money, with interest, within 30 days of the order imposing the penalty.

Deemed public offer. A private placement that breaks the conditions on identified persons and the number of offerees is deemed to be a public offer, bringing in the prospectus regime and securities law, which a private company cannot satisfy.

The cost you pay later. Even a small defect follows the company. The next investor’s lawyers will trace every allotment since incorporation, and before a listing any irregular allotment has to be explained, compounded or regularised. I spend a meaningful part of every pre-IPO structuring exercise on exactly this clean-up.

Questions founders ask me

If an existing shareholder is putting in more money, is that still a preferential allotment? Yes, unless the new shares are offered to all existing shareholders in proportion to their holdings as a rights issue under Section 62(1)(a). An issue to one existing shareholder, or in a proportion different from current holdings, goes through Section 62(1)(c) and Section 42 like any outside investor.

Does the same process apply to CCPS and CCDs? Broadly, yes. Convertible instruments issued to identified investors follow the private placement route, and Rule 13 requires the conversion price of the resulting shares to be determined on the basis of a registered valuer’s report, either upfront when the instrument is offered or closer to the conversion date within the window the rule sets. The choice between instruments has commercial and tax consequences as well, which I compare in my note on SAFE vs CCD vs a priced round.

Can we collect money in tranches under one resolution? The special resolution can cover an allotment completed within its 12-month window, but each receipt of money starts its own 60-day allotment clock, and each allotment needs its own return of allotment within 15 days. Plan the Board meetings around the expected receipt dates.

Who signs off on all this? The Board and the members approve the issue, a registered valuer signs the valuation, and a director signs the forms filed with the Registrar, with professional certification where the form requires it. I advise and prepare the file; the signatures belong to the people the law names.

Bottom line

Section 62(1)(c) decides whether you may issue to a given investor and at what price; Section 42 decides how the offer is made and the money handled. Registered valuer, Board meeting, special resolution, MGT-14, named PAS-4, banking channels into a separate account, allotment within 60 days, PAS-3 within 15 days, and only then spend. The offeree limit, penalty amounts and dematerialisation dates are amended from time to time, so confirm the current position with your company secretary before you start. If you are working through a round right now, the first call is usually 45 minutes.