A Study on Preferential Allotment in Indian Context

 | June 02,2010 03:37 pm IST

Every firm needs capital for investment. They need capital to meet expenditure like expansion, diversification, modernization, M&A, etc.

, from time to time.

 

When a listed company doesn't want to go for further public issue and the objective is to
raise huge capital by issuing bulk of shares to selected group of people, preferential allotment is a good option.

A private placement is an issue of shares or of convertible securities by a company to a select group of persons under Section 81 of the Companies Act, 1956, which is neither a rights issue nor a public issue. This is a faster way for a company to raise equity capital.

 

A private placement of shares or of convertible securities by a listed company is generally known by name of preferential allotment. A listed company going for preferential allotment has to comply with the requirements contained in Chapter XIII of SEBI (DIP) Guidelines, in addition to the requirements specified in the Companies Act. In short, preferential issue means allotment of equity to some selected people by a company which has its share already listed.

 

Example

On April 20 this year, ACC has entered into a Share Subscription Agreement with Shiva Cement Limited (SCL), Rourkela, Orissa, by which ACC would be inducted as a shareholder of this company.

 

According to this Agreement, ACC will subscribe Preferential Allotment of 1,45,00,000 Equity Shares of Shiva Cement Limited with a face value of Rs. 2/- and a premium of Rs. 9/- per Equity Share in all, aggregating to Rs. 15.95 crore and further Subscribing to Preferential Allotment of 2,27,00,000 warrants of Shiva Cement Limited, which has an option to convert into corresponding number of Equity Shares at a face value of Rs. 2/- and a premium of Rs. 9/- per Equity Share within 18 months from the date of allotment.

 

This is a strategic move by ACC as they have supply agreement with SCL which operates a mini cement plant with a clinkering capacity. It has the scope of being expanded further. ACC is hopeful that after this they can increase their production capacity in Orissa.

 

Advantages

One advantage of raising money via a preferential issue is that it helps save costs and time involved in a public issue. More important, if the concerned company is not doing too well at that point in time but requires capital, then retail investors may not want to participate in an issue.

 

At the same time, there could be some institutions which view the company's troubles as being temporary and feel that some injection of capital could help it out of the trough.

 

In fact, promoters need such investors in times when the market sentiment is weak and a public issue could fail. Moreover, if promoter is being allotted preferential issue and they acquire more shares in the company, it is a good sign because it shows that the corporate ship is not sinking and they have abiding interest in the company.

There is no requirement of filing any offer document / notice to SEBI in case of the preferential allotment and even no eligibility norm for the company for the preferential allotment.

 

Apart from this, in the preferential allotment, the shares are issued in bulk and, hence, when huge fund requirement is there without incurring much cost and without investing much time.

 

In current scenario, where there is lots of takeover in preferential issues, the shares are issued to friendly investors like promoters to ward-off the risk of take over. If shares are issued to public, there is a chance that later they can sell it to a firm which has an intension of take over.

 

Pitfalls

The preferential allotment is often misused by the promoters as they could secure it because of majority holding by them and they consolidate their hold on the company without paying a fair price for it. As per Section 81 (1A) of the Companies Act, it is merely a formality though special resolution need to be passed but only members present in person and through proxy are counted.

 

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