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Understanding Preferential Allotment_ Concepts, Procedure and Regulations

Understanding Preferential Allotment: Concepts, Procedure and Regulations.

The Companies Act, 2013 allows companies to raise funds through various methods like preferential allotment, rights issues, Initial Public Offers (IPOs), Employee Stock Options (ESOPs), and sweat equity shares. Among these, preferential allotment stands out as an effective method for raising capital swiftly. This article delves into the key concepts, benefits, and regulations governing preferential allotment in India.

What is Preferential Allotment?

Preferential allotment involves issuing a bulk of fresh shares or convertible securities to a specific group of individuals, investors, or venture capitalists. Both listed and unlisted companies, whether private or public, can opt for this method. It is a favored approach due to its speed and efficiency in raising capital and increasing a company’s share base.

A person holding preferential shares has the right to be paid before common shareholders during the company’s winding up. These shares are issued at a predetermined price, often to investors and venture capitalists seeking a higher stake in the firm. This method can also offer an opportunity to shareholders who missed the IPO. Overall, it presents a win-win scenario: companies raise substantial capital, while investors secure a larger share in the company.

Governing Provisions for Preferential Allotment

Understanding the legal framework is crucial to ensure compliance and prevent misuse of preferential allotment.

Section 62 of the Companies Act, 2013

Section 62 deals with further issues of share capital. It specifies that companies must approach existing equity shareholders via notice, offering them new shares with a 30-day acceptance period. Shareholders have the right to renounce the shares. If they do not accept, the company can dispose of the shares. This section also allows companies to issue shares to employees under ESOPs or any group of persons authorized by a special resolution.

Applicable on Private Companies

In  Mrs. Proddaturi Malathi vs. SRP Logistice Pvt Ltd & Ors, the appellant challenged the allotment of shares by the respondent, claiming it violated Section 62. The Supreme Court held that Section 62 applies to private companies, ensuring allottees are given proper time to renounce shares.

Section 42 of the Companies Act, 2013

Section 42 prescribes the offer or invitation for subscription of securities on private placement. It limits offers to a maximum of fifty persons, excluding employees under ESOPs. Private placement involves offering securities to a select group through a private placement offer letter. Payments must be made through demand drafts or bank transfers, not cash, and allotment must occur within sixty days of receiving application money. In Sahara India Real Estate Co vs. SEBI It was held that private placements to friends, relatives, or close associates are valid under Section 42, provided the correct procedures are followed.

Rule 13 of the Companies (Share Capital and Debentures) Rules, 2014

Rule 13 outlines the procedures for issuing shares under Section 62, in conjunction with Section 42. The board must authorize share issues via special resolution in a board meeting, adhering to Section 42’s provisions. Preferential offers must be made to more than two members, and listed companies need not have prices set by a registered valuer. The rule defines preferential allotment as issuing shares or other securities to a select group on a preferential basis, excluding rights issues, public offers, and sweat equity shares. Authorization must be stated in the Articles of Association and passed by special resolution. Allotment must occur within twelve months of passing the resolution, with the price clearly stated.

Procedure for Preferential Allotment

The process for preferential allotment of shares and securities involves several key steps, each of which ensures compliance with legal and regulatory requirements:

A. Conducting a Board Meeting

  1. Approval of Allottees and Valuation Report:
    • The Board of Directors must meet to determine and approve the number of allottees.
    • Evaluate and approve the valuation report prepared by an independent valuer.
  2. Approval of Offer Letter and Application Forms:
    • Approve the offer letter in Form PAS-4.
    • Approve application forms, ensuring they are serially numbered.
  3. Approval of Form PAS-5:
    • Approve Form PAS-5 for recording the private placement offer.
  4. Setting Date and Time for Shareholders’ Meeting:
    • Decide the date and time for the Extraordinary General Meeting (EGM) or Annual General Meeting (AGM).

B. Issuing Notice of EGM/AGM

  1. Notice to Shareholders:
    • Send notice of the EGM/AGM to all shareholders.
    • Include an explanatory statement detailing the agenda and purpose of the meeting.

C. Holding of EGM or AGM

  1. Approval of Offer Letter:
    • During the EGM or AGM, present the offer letter for approval.
    • Pass a special resolution to approve the preferential issue.

D. Circulation of Offer Letter

  1. Distribution of Offer Letter and Application Form:
    • Circulate the offer letter within 30 days of the EGM or AGM.
    • Ensure the application form is serially numbered and specifically addressed to the intended allottees.

E. Filing of Form MGT-14

  1. Submission to Registrar of Companies:
    • File Form MGT-14 along with the explanatory statement as per Rule 13 (2)(d) of the Companies (Share Capital & Debentures) Rules, 2014.

F. Allotment and Issuance of Shares

  1. Board Meeting for Allotment:
    • Once the allotment monies are received, convene another board meeting to allot the shares.
    • Issue share certificates to the allottees.

G. Filing of Form PAS-3

  1. Return of Allotment:
    • File Form PAS-3 within 15 days of allotment, which should include:
      • List of allottees.
      • Valuation report.
      • Special resolution with explanatory statement.
      • Board resolution for allotment of shares.

H. Issuance of Share Certificates

  1. Timely Issuance and Compliance:
    • Issue share certificates within 2 months from the date of allotment.
    • Pay the requisite stamp duty as per the provisions of the relevant state laws.
    • Update the Register of Members following the issuance of share certificates to shareholders.

Advantages of Preferential Allotment

  1. No Charge on Assets: Shares issued do not create a charge on the company’s assets, unlike debentures.
  2. Benefits to Investors: Convertible securities can yield higher dividends and profits if share prices increase.
  3. No Dilution of Power: Investors do not receive voting rights, preserving the decision-making power of existing directors and shareholders.
  4. Improved Borrowing Capacity: Preferential allotment reduces the debt-to-equity ratio, enhancing borrowing capacity.

Disadvantages of Preferential Allotment

  1. Reputation Risk: Failure to pay consistent dividends can harm the company’s reputation, deterring future investors.
  2. Lack of Voting Rights: Investors in preferential allotment do not receive the same voting rights as common shareholders, potentially reducing their interest in investing.

Frequently Asked Questions

What is the difference between Preferential Allotment and Private Placement under the Companies Act, 2013?

Preferential Allotment: Issuing equity shares or convertible securities to a specific group of investors, typically to raise capital quickly at a price higher than the market rate.

Private Placement: Broader issuance of various types of securities, including both convertible and non-convertible instruments, to a select group of investors. This can include debt instruments, preference shares, and more.

What are the types of preferential issues?

Preference Shares:

  • Convertible: Can be converted into equity shares.
  • Non-Convertible: Cannot be converted into equity shares.
  • Participatory: Entitles the holder to additional profits.
  • Non-Participatory: Does not entitle the holder to additional profits.
  • Cumulative: Accumulates unpaid dividends.
  • Non-Cumulative: Does not accumulate unpaid dividends.

Equity Shares: Ordinary shares that must be issued by all companies. Preference shares are optional.

What are the different regulatory bodies or regulations in India?

  • SEBI: Regulates the securities market and protects investor interests.
  • RBI: Regulates the monetary and financial system.
  • MCA: Regulates corporate affairs through the Companies Act, 2013.
  • NCLT: Adjudicates disputes related to company law.
  • Income Tax Department: Administers tax laws and ensures compliance.

What is the difference between PIPE, QIP, and IPP?

PIPE: A publicly traded company raises capital by issuing shares or convertible securities directly to private investors, bypassing the lengthy public offering process.

QIP: Listed companies raise funds by issuing equity shares or convertible debentures to qualified institutional buyers, avoiding standard regulatory compliance of public offerings.

IPP: Companies issue shares to institutional investors to meet minimum public shareholding requirements, increasing their public float to ensure regulatory compliance.


The Companies Act, 2013, and associated rules provide a comprehensive framework for preferential allotment of shares and securities, making it a swift and efficient method for raising capital. While it offers numerous benefits, including no charge on assets and improved borrowing capacity, it also comes with potential downsides like reputation risk and lack of voting rights for investors. Understanding and adhering to the relevant provisions, such as Section 62 and Section 42, along with Rules 13 and 14, is essential for ensuring compliance and maximizing the advantages of preferential allotment. InstaFiling’s expertise in corporate compliance ensures that your company adheres to all relevant legal provisions, streamlining the process and minimizing risks. By leveraging our services, you can focus on your core business while we handle the intricate details of preferential allotment, ensuring a smooth and compliant capital-raising process.

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