Investment and Securities Notes

This note covers all the topics of Module 1 & 2.

Table of Contents
MODULE 1: Preliminary ....................................................................................................2
Topic 1: Role and function of capital markets ............................................................................ 2
Topic 2 Types of capital ............................................................................................................ 5
Topic 3: Concept of securities & marketability of securities ....................................................... 7
Topic 4: Kinds of securities ....................................................................................................... 9
Topic 5: Depository receipt....................................................................................................... 9
MODULE 2: Capital Market & Issuance of Capital ............................................................13
Topic 1: Public offer ............................................................................................................... 13
Topic 2: Private placement ..................................................................................................... 16
Topic 3: Rights issue ............................................................................................................... 19
Topic 4: Preferential issue/allotment ...................................................................................... 23
Topic 5: Bonus issue ............................................................................................................... 26
Topic 6: Issue of sweat equity shares ...................................................................................... 28
Topic 7: Regulatory overview of capital markets ..................................................................... 30
Topic 8: Regulation of security dealings: laws and institutions ................................................. 30

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MODULE 1: Preliminary
Topic 1: Role and function of capital markets

What are Capital Markets?

Capital markets are venues where savings and investments are channeled between the suppliers
who have capital and those who are in need of capital. The entities that have capital include
retail and institutional investors while those who seek capital are businesses, governments, and
people. Capital markets seek to improve transactional efficiencies. These markets bring those
who hold capital and those seeking capital together and provide a place where entities can
exchange securities.

Capital Markets – Types

Primary Markets: The primary market is the part of the capital market that deals with
the issuance and sale of securities to investors directly by the issuer. An investor buys
securities that were never traded before. Primary markets create long term instruments
through which corporate entities raise funds from the capital market.

Secondary Markets: The secondary market, also called the aftermarket and follow on
public offering is the financial market in which previously issued financial instruments
such as stock and bonds are bought and sold

Capital Market – Examples

Stock Market: A stock market, equity market or share market is the aggregation of
buyers and sellers of stocks, which represent ownership claims on businesses

Bond Market: The bond market is a financial market where participants can issue new
debt, known as the primary market, or buy and sell debt securities

Currency and Foreign Exchange Markets: The foreign exchange market is a global
decentralized or over-the-counter market for the trading of currencies. This market
determines foreign exchange rates for every currency.

Why do we need the capital market?

Capital market is a cog in the wheel of the modern economy since capital markets move money
from the entities that have money to the entities that require money for productive use.

Capital Market – Features

In capital markets, there are 2 entities, one who supplies capital and the other entity is the one
who needs capital. Usually, entities with surplus capital in the capital markets are retail and
institutional investors. Entities seeking capital are people, governments and businesses.

Some common examples of suppliers of capital are

Pension funds: A pension fund, also known as a superannuation fund in some countries,
is any plan, fund, or scheme which provides retirement income

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 Life insurance companies: Life insurance companies offer contracts between an
insurance policyholder and an insurer or assurer, where the insurer promises to pay a
designated beneficiary a sum of money (the benefit) in exchange for a premium, upon
the death of an insured person (often the policyholder). The Insurance Development
and Regulatory Authority of India manage everything related to insurance in India.

Non-financial companies: Non-financial companies are those businesses which don’t

accept deposits or make loans. Examples of non-financial companies are Healthcare,
Technology, Industrial, sector related companies.

Charitable foundations: A charitable foundation is a category of a nonprofit

organization that will typically provide funding and support for other charitable
organizations through grants.

Some common examples of users of capital

1. People looking to purchase vehicles, homes

2. Governments
3. Non-financial companies.

Capital Market – Structure

Primary markets consist of companies that issue securities and investors who purchase
those securities directly from the issuing company. These securities are called Initial
Public Offerings (IPO). Whenever a company goes public it sells its stocks and bonds
to large scales institutional investors like hedge funds and mutual funds.

Secondary markets are places where the trade of already issued certificates between
investors are overseen by regulatory bodies. Issuing companies play no part in the
secondary market. Examples of secondary markets are New York Stock Exchange
(NYSE), London Stock Exchange (LSE), Bombay Stock Exchange (BSE).

Capital Markets – Functions

1. Capital markets bring together those requiring capital and those having excess
capital.
2. Capital markets aim to achieve better efficiency in transactions.
3. It helps in economic growth
4. It ensures there is the continuous availability of funds
5. By ensuring the movement and productive utilisation of capital, it helps in boosting
the national income.
6. Minimizes transaction costs and information costs.
7. Makes trading of securities easier for companies and investors.
8. It offers insurance against market risk.

Capital market – Advantages

1. Money moves between people who need capital and who have the capital.
2. There is more efficiency in the transactions.
3. Securities like shares help in earning dividend income.
4. With the passage of time, the growth in value of investments is high.

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 5. The interest rates provided by securities like Bonds are higher than interest rates
given by banks.
6. Can avail tax benefits by investing in stock markets.
7. Scope for a wide range of investments.
8. Securities of capital markets can be used as collateral for getting loans from banks.

Structure of Capital Market

The capital market in India consists of the following structure:

Difference between Capital Market and Money Market

Money Market Capital Market

Money Market provides short-term A capital market is a type of financial

borrowing and lending for providing short- market where long-term securities are
term liquidity to the Global Financial issued and traded
System

It deals with the borrowing and lending of Capital Market deals with the borrowing
short-term finance which is of one year or and lending of long- term finance (more
less than a year)

The institutions involved in Money Market Important Institutions of the Capital

are Commercial Banks Central Banks, Non- Markets are Stock Exchanges, Commercial
Banking Financial Institutions (NBCs) Banks NBCs like Insurance Companies etc

Credit Instruments used by Money Market The main instruments of Capital Markets
are Call Money, Collateral Loans, are Stocks, Shares, Debentures, Bonds, and
Acceptances, Bills of exchange Government Securities.

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 Since the duration of credit is much lesser in In the Capital Market, the risk is much
Money Markets, the degree of risk is greater in terms of degree and nature as it is
smaller. a long term investment.

The short-term credit requirements of the On the other hand, the Capital Market
companies like the working capital of the provides fixed capital to buy land and
industrialists are catered by the money machinery etc and caters the long-term
market. needs of the industrialists.

Role of SEBI in Capital Market

The Securities Exchange Board of India (SEBI) regulates the functions of the Securities Market
in India. It was set up in 1988 but didn’t have any legal status until May 1992, when it was
granted powers to legally enforce its control over the financial market intermediaries. With the
bloom of the scale of actions in the financial markets, there were a lot of malpractices taking
place. Practices like a false issue, delay in delivery, violation of rules and regulations of stock
exchanges are on a rise. In order to curb these malpractices, the Govt. of India decided to set
up a regulatory body known as the Securities Exchange Board of India (SEBI).

The roles and objectives of SEBI are elaborate and have been described as below:

Regulation of the activities of the stock market

Protecting the rights of investors

Ensuring the safety of the investments.

To prevent malpractices and fraudulent activities.

To develop a code of conduct for the intermediaries such as brokers, mutual fund sellers
etc.

Topic 2 Types of capital

What is capital?

Nic Barnhart of Pareto Labs defines capital as simply, “Money that is used to make more
money.” This definition can apply to individuals in the greater economy and to companies. In
the world of business, the term capital means anything a business owns that contributes to
building wealth.

Sources of capital include:

• Financial assets that can be liquidated like cash, cash equivalents, and marketable
securities.
• Tangible assets such as the machines and facilities used to make a product.
• Human capital; i.e. the people that work to produce goods and services.
• Brand capital; i.e. the perceived value of a brand recognition.

What is the difference between capital and money?

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The terms “capital” and “money” are certainly related, but they are not interchangeable. As a
business owner, it’s important to know the difference. Money is cash that you spend and capital
is cash (or other asset) that you put to work. The money in your wallet isn’t a form of capital
unless you put it to work earning you more money. People in finance often describe capital as
having “greater durability” than money because it can be continuously re-invested to earn more
value.

How is capital used?

Capital is absolutely essential to a company getting off the ground—it’s like the first fill on the
gas tank that will hopefully come to run a business that is profitable in the long term. Capital
can be infused into the business at any time, to refuel the tank if it gets low.

For a business, capital is made up of two sources:

• Liabilities: Money that a business owes and that has to be paid back.
• Shareholders’ equity: Money that investors put into the company in exchange for
ownership and that never has to be paid back.

Each company evaluates the right mix of liabilities and equity taking into account their risks,
cost of capital, tax opportunities, and their ability to raise capital. That ideal mix becomes the
business capital structure. Once a company finds the right debt-to-equity-ratio in their capital
structure, they can begin using financial capital to make investments in the resources and
securities that will build profitability.

On a balance sheet, capital and assets are equal. Capital is tied to the origin of the money where
it came from while assets indicate how the business is putting their capital to work.

Top 4 types of capital for business

There are four common ways that businesses gather capital, whether it is to fund the company
to launch or to help the company through a growth period. Working capital and debt and equity
capital are sources of capital for any business, but trading capital is only found in companies
in the financial space.

1. Working capital: The difference between a company’s assets and liabilities—measures a

company’s ability to produce cash to pay for its short term financial obligations, also known
as liquidity. Working capital = Current assets – Current liabilities. Positive working capital
means the value of a company’s current assets is more than its current liabilities Negative
working capital, on the other hand, means that current liabilities outweigh current assets. For
the company, this could lead to financial issues with creditors, growth, or production.

2. Debt capital: is acquired by borrowing from financial institutions, banks, friends and family,
credit cards, federal loan programs, and venture capital, or by issuing bonds. Just like an
individual needs established credit history to borrow, so do businesses. Debt capital has to be
paid off on a regular basis (with interest) but unlike an individual’s debt, it is seen as more of
an essential part of building a business instead of a financial burden.

3. Equity capital: is any capital raised through selling shares with a key difference being
whether those shares are sold privately or publicly:

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 • Private: Shares of stock in a company within a private group of investors.
• Public: Shares of stock in a company that are listed on the stock exchange (think: IPO).

The money an investor pays for shares of stock in a company becomes equity capital for the
business.

4. Trading capital: applies exclusively to the financial industry where brokerage companies
need enough capital to support their investment strategies. Trading capital supports the many
daily trades that brokerage companies need to make to generate a profit and the large-scale
trades made by the biggest brokerage firms. Sometimes it is granted to individual traders and
sometimes to the firm as a whole.

Capital gains and capital losses

Capital gains and losses tell you how your investments performed. Capital gains are exactly as
they sound—your invested capital gains value after an investment. Capital losses occur when
your capital loses value after an investment.

Example: Capital gain: Let’s say that your business is a craft brewery startup. It’s time to scale
up, and a brewery is selling a used brewery system that will triple your production. It needs
repair and requires the purchaser to arrange for transport. You invest $10,000 of your capital
in purchasing the system, $5,000 in transit, and $750 in labor for repairs. Within the next year,
you move your own production contract brewing and sell your brewing system for $25,000—
recorded as a capital gain because you sold the asset for more than the purchase price plus costs
for repair.

Example: Capital loss: Your craft brewery decides to open a taproom where you can sell your
beer directly to consumers. You raise private equity capital to purchase a property for $2.5m.
A year later, your P&L shows that while overall the company is profitable, the direct-to-
consumer sales is suffering a loss. You sell the property for $2.1M recorded as a capital loss
because you sold the asset for less than the purchase price.

Topic 3: Concept of securities & marketability of securities

Securities are financial instruments that represent ownership or debt in a company or

organization. They are bought and sold in financial markets, such as stock exchanges, and can
be used for investment or trading purposes.

Equity Securities: Equity securities represent ownership in a company and are also known as
stocks or shares. When you buy a share of a company, you become a part-owner of that
company. Equity securities represent a residual claim on the assets and earnings of the
company. This means that shareholders are entitled to a portion of the company's profits and
have the potential to earn capital gains as the value of the company's shares increase over time.
Equity securities are issued by both public and private companies. Public companies are those
that have issued shares of their stock to the general public and are listed on a stock exchange.
Private companies, on the other hand, are owned by a smaller group of investors and their
shares are not available for trading on a public exchange.

Debt Securities: Debt securities represent loans made to a company or organization and are
also known as bonds. When you buy a bond, you are effectively lending money to the issuer
of the bond. The issuer promises to pay interest on the loan and to repay the principal amount

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at a future date. The interest paid on bonds is typically fixed, and the maturity date is known in
advance. Bonds can be issued by governments, corporations, and other entities. Government
bonds, also known as sovereign bonds, are issued by national governments and are typically
considered to be the safest type of bond because they are backed by the full faith and credit of
the government. Corporate bonds are issued by companies and are considered to be riskier than
government bonds because the creditworthiness of the company issuing the bond can vary.

Derivatives: Derivatives are financial contracts that derive their value from an underlying asset.
The most common underlying assets are stocks, bonds, commodities, and currencies.
Derivatives are used for a variety of purposes, including hedging, speculation, and arbitrage.
Hedging involves using derivatives to offset potential losses in another investment. For
example, an investor who owns a portfolio of stocks might use futures contracts to hedge
against a potential market downturn. Speculation involves using derivatives to make bets on
the future direction of an underlying asset. For example, an investor might buy a call option on
a stock if they believe the stock will increase in value, or buy a put option if they believe the
stock will decrease in value. Arbitrage involves using derivatives to take advantage of pricing
discrepancies between different markets. For example, an investor might buy a stock index
futures contract if they believe the futures price is lower than the expected future value of the
underlying index.

Mutual Funds and ETFs: Mutual funds and ETFs are investment vehicles that allow investors
to invest in a diversified portfolio of securities. A mutual fund is a type of investment company
that pools money from multiple investors to purchase a portfolio of stocks, bonds, or other
securities. Each investor in the mutual fund owns a share of the portfolio in proportion to their
investment. An ETF is a type of investment fund that is traded on a stock exchange like a stock.
ETFs can invest in a variety of securities, including stocks, bonds, and commodities. ETFs are
typically designed to track the performance of a specific market index, such as the S&P 500,
and offer investors the ability to buy and sell shares throughout the trading day.

In summary, securities are financial instruments that represent ownership or debt in a company
or organization. They are used by companies to raise capital and by investors to allocate their
funds to different investment opportunities. Different types of securities carry different levels
of risk and return, and investors must carefully consider their investment objectives and risk
tolerance when selecting securities to invest in.

Marketability of securities

Refers to the ease with which a security can be bought or sold in the financial markets. It is an
important aspect of securities because it determines the liquidity of the security and the ease
with which investors can convert their investments into cash. The marketability of securities is
influenced by a number of factors, including:

1. Supply and Demand: The supply and demand of a security in the financial markets
play a critical role in its marketability. A security with a high demand and limited
supply will generally be more marketable than a security with low demand and
abundant supply.
2. Trading Volume: The trading volume of a security is a measure of how frequently
it is traded in the financial markets. A security with a high trading volume is
generally considered to be more marketable than one with low trading volume.
3. Liquidity: The liquidity of a security refers to the ease with which it can be bought
or sold without affecting its price. Highly liquid securities are generally considered

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 to be more marketable because investors can buy and sell them quickly and easily
without significant price movements.
4. Transparency: The transparency of a security refers to the amount of information
that is available to investors about the security and the issuer. Securities that are
more transparent are generally considered to be more marketable because investors
can make informed investment decisions based on available information.
5. Creditworthiness: The creditworthiness of the issuer of a security also plays a role
in its marketability. Securities issued by highly creditworthy issuers are generally
more marketable because investors are more confident that the issuer will be able
to fulfill its obligations.
6. Regulatory Environment: The regulatory environment in which a security is issued
and traded can also influence its marketability. Securities that are subject to less
stringent regulations may be more marketable because they are easier to issue and
trade.

In summary, marketability of securities is a critical aspect of securities because it determines

the ease with which investors can buy or sell them in the financial markets. Factors such as
supply and demand, trading volume, liquidity, transparency, creditworthiness, and regulatory
environment all play a role in determining the marketability of a security.

Topic 4: Kinds of securities

Dukki Page number 1.8-1.13

Topic 5: Depository receipt

Dukki page 4.1-4.14

What is Depository Receipt?

A depositary receipt (DR) is a negotiable certificate issued by a bank representing share in a

foreign company traded on a local stock exchange. The depositary receipt gives investors the
opportunity to hold shares in the equity of foreign countries and gives them an alternative to
trading on an international market. A depositary receipt, which was originally a physical
certificate, allows investors to hold shares in the equity of other countries.

A depositary receipt avoids the need to trade directly with the stock exchange in the foreign
market. Instead, investors transact with a major financial institution within their home country,
which typically reduces fees and is far more convenient than purchasing stocks directly in
foreign markets. When a foreign-listed company wants to create a depositary receipt abroad, it
typically hires a financial advisor to help it navigate regulations. The company also typically
uses a domestic bank to act as custodian and a broker in the target country to list shares of the
firm on an exchange, such as the New York stock Exchange in the country where the firm is
located.

Type of Depository Receipt

• American Depositary Receipt (ADR)

o An American Depositary Receipt (ADR) is a financial instrument that
represents a specific number of shares in a foreign company. ADRs are traded

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 on US stock exchanges and allow US investors to invest in foreign companies
without having to buy shares directly on a foreign stock exchange. When a
foreign company wants to issue ADRs, it will typically work with a depositary
bank, which will purchase shares in the company on the foreign stock exchange
and then issue ADRs based on those shares.
o The depositary bank will then hold the foreign shares on behalf of the ADR
holders and pay dividends in US dollars. There are two types of ADRs:
sponsored and unsponsored. A sponsored ADR is issued by a depositary bank
with the cooperation of the foreign company, while an unsponsored ADR is
issued without the cooperation of the foreign company. Sponsored ADRs
typically provide more information and support for investors, while
unsponsored ADRs may have less transparency and may be more difficult to
trade. Investors may choose to invest in ADRs for several reasons.
o For example, investing in ADRs can provide exposure to foreign markets and
companies, which can help diversify a portfolio. Additionally, investing in
ADRs can be more convenient than buying foreign shares directly, as it allows
investors to trade in US dollars and avoid currency exchange fees. However,
like any investment, ADRs come with risks, such as the potential for foreign
exchange rate fluctuations and political or economic instability in the foreign
country.
• European Depositary Receipt (EDR)
o There is no such financial instrument as a European Depository Receipt (EDR).
However, there is a similar financial instrument called European Depositary
Share (EDS), which is similar to an American Depositary Share (ADS).
o An EDS is a financial instrument that represents a specific number of shares in
a non-European company. Like an ADS, an EDS is traded on European stock
exchanges and allows European investors to invest in non-European companies
without having to buy shares directly on a non-European stock exchange.
o When a non-European company wants to issue EDS, it will typically work with
a depositary bank, which will purchase shares in the company on the non-
European stock exchange and then issue EDS based on those shares. The
depositary bank will then hold the non-European shares on behalf of the EDS
holders and pay dividends in euros or another European currency.
o EDS can provide European investors with exposure to non-European companies
and markets, which can help diversify a portfolio. Additionally, investing in
EDS can be more convenient than buying non-European shares directly, as it
allows investors to trade in a familiar currency and avoid currency exchange
fees.
o Like any investment, EDS comes with risks, such as the potential for foreign
exchange rate fluctuations and political or economic instability in the non-
European country. Additionally, EDS may have lower liquidity and be subject
to different regulations than domestic stocks. Therefore, it is important to
carefully research and evaluate potential investments before investing in EDS.
• Global Depositary Receipt (GDR)
o A Global Depository Receipt (GDR) is a financial instrument that represents a
specific number of shares in a foreign company, similar to an American
Depositary Receipt (ADR). However, unlike an ADR, a GDR is traded on an
international stock exchange outside of the company's home country.
o GDRs are typically issued by a depositary bank in a country other than the
company's home country. The depositary bank will purchase shares in the

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 foreign company on the home country's stock exchange and then issue GDRs
based on those shares. GDRs are then traded on an international stock exchange,
such as the London Stock Exchange or the Luxembourg Stock Exchange.
o Similar to ADRs, GDRs allow investors to invest in foreign companies without
having to buy shares directly on a foreign stock exchange. GDRs are often
denominated in US dollars or euros, which can make them more accessible to
investors outside of the company's home country.
o Investors may choose to invest in GDRs for several reasons. For example,
investing in GDRs can provide exposure to foreign markets and companies,
which can help diversify a portfolio. Additionally, investing in GDRs can be
more convenient than buying foreign shares directly, as it allows investors to
trade in a familiar currency and avoid currency exchange fees.
o Like any investment, GDRs come with risks, such as the potential for foreign
exchange rate fluctuations and political or economic instability in the foreign
country. Additionally, GDRs may have lower liquidity and be subject to
different regulations than domestic stocks. Therefore, it is important to carefully
research and evaluate potential investments before investing in GDRs.

There are several advantages of depositary receipts, such as American Depositary Receipts
(ADRs), Global Depositary Receipts (GDRs), and European Depositary Shares (EDS):

1. Access to foreign markets: Depositary receipts provide investors with the ability to
invest in foreign companies without having to purchase shares directly on a foreign
stock exchange. This can be particularly beneficial for investors who are interested
in gaining exposure to specific foreign markets or companies.
2. Liquidity: Depositary receipts are often listed on major stock exchanges, which can
provide investors with greater liquidity compared to purchasing shares directly on
a foreign stock exchange. This can make it easier for investors to buy and sell shares
and can help ensure that investors receive fair market prices for their investments.
3. Currency convenience: Depositary receipts are often denominated in a familiar
currency, such as US dollars or euros, which can make it easier for investors to
understand the value of their investments and avoid currency exchange fees.
4. Dividend payments: Depositary receipts may also provide investors with dividend
payments in the currency of the investor's choice, which can be particularly
beneficial for investors who are looking for regular income from their investments.
5. Information transparency: Depositary receipts typically require foreign companies
to provide information in English and adhere to US securities laws and accounting
standards, which can provide investors with greater transparency and regulatory
protections.

Overall, depositary receipts can be a useful tool for investors who are looking to diversify their
portfolios and gain exposure to foreign markets and companies. However, as with any
investment, it is important to carefully research and evaluate potential investments before
making a decision.

While there are several advantages to depositary receipts, such as American Depositary
Receipts (ADRs), Global Depositary Receipts (GDRs), and European Depositary Shares
(EDS), there are also some potential disadvantages to consider:

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 1. Costs: Depositary receipts can come with higher fees and expenses than investing
directly in foreign shares, such as depositary fees, custody fees, and other charges.
These fees can eat into investment returns over time.
2. Currency risk: While depositary receipts can offer the convenience of being
denominated in a familiar currency, such as US dollars or euros, they may still be
subject to foreign exchange rate fluctuations. This can create additional currency
risk for investors, which can impact investment returns.
3. Limited access: Not all foreign companies issue depositary receipts, which can limit
an investor's ability to access certain foreign markets or companies. Additionally,
depositary receipts may not be available in all countries or on all stock exchanges.
4. Liquidity risk: While depositary receipts are often listed on major stock exchanges,
they may still be subject to liquidity risk, particularly for smaller or less well-known
companies. This can impact an investor's ability to buy or sell shares at fair market
prices.
5. Regulatory differences: Depositary receipts may be subject to different regulatory
requirements and accounting standards than domestic shares, which can make it
more difficult for investors to fully understand the risks and potential rewards of
investing in foreign companies.

Overall, while depositary receipts can provide investors with a convenient way to access
foreign markets and companies, they also come with certain risks and potential disadvantages.
As with any investment, it is important to carefully consider these factors and conduct thorough
research before making any investment decisions.

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MODULE 2: Capital Market & Issuance of Capital
Topic 1: Public offer

What is public offer?

A public offer refers to the sale of securities, such as stocks, bonds, or mutual funds, to the
general public. A public offer can be made by companies, governments, or other organizations
that are looking to raise capital for their operations or projects.

A public offer is typically made through a prospectus, which is a legal document that provides
detailed information about the securities being offered for sale, including the terms and
conditions of the offer, the risks associated with the investment, and the financial information
of the issuer. The prospectus is required to be registered with the regulatory authorities, such
as the Securities and Exchange Board of India (SEBI) in India and made available to the public.

Investors who are interested in participating in a public offer can purchase the securities by
submitting an application form and making the required payment. The securities are then
allotted to the investors based on the terms of the offer.

A public offer can be made through various methods, such as an initial public offering (IPO),
a follow-on public offer (FPO), or a rights issue. An IPO is the first time a company offers its
shares to the public and raises capital from the market. An FPO is when an already listed
company offers additional shares to the public to raise more capital. A rights issue is when a
company offers its existing shareholders the right to purchase additional shares at a discounted
price.

Public offers are regulated by various securities laws and regulations, which aim to protect
investors from fraud, misrepresentation, and other unethical practices. The regulatory
authorities oversee the public offer process, review the prospectus, and monitor the activities
of the issuer to ensure compliance with the applicable laws and regulations.

In summary, a public offer in investment law refers to the sale of securities to the general
public. It is typically made through a prospectus and regulated by securities laws and
regulations to protect investors. Public offers can be made through various methods, such as
IPOs, FPOs, and rights issues.

Types of Public offer.

In investment law, there are various types of public offers that companies, governments, and
other organizations can make to raise capital from the market. Here are some of the most
common types of public offers:

1. Initial Public Offering (IPO): An IPO is the first time a company offers its shares to
the public and raises capital from the market. In an IPO, the company hires
investment banks to underwrite the issue and market the shares to the public. The
shares are priced based on various factors such as the company's financial
performance, industry outlook, and demand from investors.
2. Follow-on Public Offer (FPO): An FPO is when an already listed company offers
additional shares to the public to raise more capital. In an FPO, the company can
offer shares at a discount to the market price to attract investors.

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 3. Offer for Sale (OFS): An OFS is when the promoter or shareholder of a company
sells their shares to the public through a public offer. The company does not receive
any capital in an OFS, but the promoter or shareholder can monetize their
investment in the company.
4. Rights Issue: A rights issue is when a company offers its existing shareholders the
right to purchase additional shares at a discounted price. The shareholders can
exercise their rights or sell them in the market to other investors.
5. Preferential Allotment: A preferential allotment is when a company issues shares to
a specific group of investors, such as institutional investors or promoters, at a price
higher than the market price. This type of public offer is often used to raise capital
quickly without going through the lengthy process of an IPO or FPO.
6. Qualified Institutional Placement (QIP): A QIP is when a listed company issues
shares to qualified institutional buyers (QIBs) such as mutual funds, banks, and
insurance companies, without making a public offer. The QIP process is faster and
more cost-effective than an IPO or FPO.

In summary, there are various types of public offers in investment law, including IPOs, FPOs,
OFS, rights issues, preferential allotment, and QIPs. Each type of public offer has its own
advantages and disadvantages, and companies choose the appropriate type based on their
funding requirements, market conditions, and regulatory compliance.

Section 23 of Companies Act 2013.

Section 23 of the Companies Act, 2013 deals with the minimum subscription requirement for
companies issuing shares to the public. This section lays down the requirement for the
minimum amount of shares that must be subscribed to by the public before a company can
commence its business activities.

According to Section 23, a company issuing shares to the public must receive subscriptions for
at least 90% of the total value of the shares offered for subscription within a certain period of
time. This period is typically 60 days from the date of the prospectus or the opening of the
subscription list, whichever is later.

If the company is unable to receive subscriptions for at least 90% of the total value of the shares
offered for subscription within the prescribed period, then all money received from applicants
must be refunded within a period of 15 days from the expiry of the subscription period.

In addition, if the company fails to refund the money received within the prescribed period, it
will be liable to pay interest on the money at a rate of 12% per annum until the money is
refunded to the applicants.

The purpose of Section 23 is to ensure that companies issuing shares to the public have a
sufficient amount of public interest and support before commencing their business activities.
This requirement helps to protect investors from investing in companies that may not have
enough public support or interest to sustain their business operations.

It is important to note that the requirement for a minimum subscription does not apply to private
companies or to companies issuing shares to their existing shareholders or employees.

In summary, Section 23 of the Companies Act, 2013 lays down the minimum subscription
requirement for companies issuing shares to the public. The section aims to ensure that

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companies have sufficient public interest and support before commencing their business
activities, thereby protecting investors from investing in companies that may not have enough
public support to sustain their operations.

Conditions of Section 23

Section 23 of the Companies Act, 2013 lays down the conditions for the issue of shares by a
company. The section states that:

1. A company can issue shares only after it is registered and has a Certificate of
Incorporation.
2. Shares can be issued only for cash consideration, except in certain specified cases,
such as the issue of shares for consideration other than cash in the case of conversion
of loans or debentures into shares.
3. The consideration for the shares must be received by the company before the shares
are allotted.
4. The shares must be allotted within 60 days of the receipt of the consideration, or
else the company must refund the money to the subscribers.
5. The shares must be issued at a price that is not less than the face value of the shares,
except in certain specified cases, such as the issue of shares for consideration other
than cash.
6. The company must comply with the provisions of the Companies Act and the rules
and regulations made thereunder in relation to the issue of shares.
7. The company must comply with the provisions of the Securities and Exchange
Board of India (SEBI) in relation to the issue of shares, if the shares are to be listed
on a stock exchange.
8. The company must comply with any other conditions that may be prescribed by the
Central Government or the SEBI in relation to the issue of shares.

In summary, Section 23 of the Companies Act, 2013 lays down the conditions for the issue of
shares by a company, which include the requirement for registration and receipt of cash
consideration, the issuance of shares at a minimum price, compliance with relevant laws and
regulations, and the listing of shares on a stock exchange if applicable. The section also
provides for the refund of money in case of non-allotment of shares within the prescribed time
frame.

ICDR on Public offer.

ICDR stands for Issue of Capital and Disclosure Requirements, which are the guidelines issued
by the Securities and Exchange Board of India (SEBI) for companies making public offers of
securities. The ICDR guidelines are intended to ensure that investors have access to accurate
and relevant information about the securities being offered, and that companies comply with
transparency and disclosure requirements.

1. Disclosures: The ICDR guidelines require companies to provide detailed

disclosures about their financial performance, business operations, risks, and
uncertainties, among other factors. This is intended to ensure that investors have
access to accurate and relevant information that can help them make informed
investment decisions. The disclosure document, such as the prospectus or offer
document, must be filed with SEBI and made available to investors.

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 2. Pricing of securities: The ICDR guidelines require that the pricing of securities
being offered is done fairly and transparently. The company must determine the
price based on various factors such as financial performance, industry outlook,
demand from investors, and market conditions. The price must be disclosed in the
prospectus or offer document, and the company must not manipulate the price
through any unfair means.
3. Minimum public shareholding: The ICDR guidelines require that a company must
have a minimum public shareholding of 25% of its total share capital. This is
intended to promote liquidity and market depth for the company's shares, and to
prevent excessive concentration of shareholding in the hands of a few investors.
4. Use of proceeds: The ICDR guidelines require companies to disclose how they
intend to use the proceeds from the public offer, such as for capital expenditure,
debt repayment, or other purposes. This is intended to ensure that investors are
aware of the company's plans for utilizing the funds raised from the market.
5. Corporate governance: The ICDR guidelines require companies to comply with
various corporate governance norms, such as having a board of directors with
adequate representation from independent directors, and establishing audit
committees and other internal control mechanisms. This is intended to ensure that
the company is managed in a transparent and responsible manner, with adequate
checks and balances in place to prevent fraud or mismanagement.

In addition to the above, the ICDR guidelines also cover various other aspects such as
disclosures related to related party transactions, restrictions on insider trading, and
requirements for disclosure of material events or information. Companies must comply with
these guidelines to ensure that their public offerings are conducted in a fair and transparent
manner, and that investors are protected from any potential risks or uncertainties. SEBI
monitors compliance with these guidelines and takes action against companies that violate
them.

Topic 2: Private placement

Einführung

A private placement is an efficient and economic option for a company to raise capital without
going public. It implies a company making an offer of securities or inviting a specific group of
people to subscribe to securities by means of a private placement offer letter. It is mandatory
that the process is in accordance with Section 42 of the Companies Act, 2013. Securities such
as debentures, equity shares, and preference shares can be issued through private placement.

However, a company opting for it, cannot make an offer of its securities using public
advertisements or resort to other marketing methods such as using the media or taking the help
of agents or channels to enlighten the public about the respective offer. Once the offer is
advertised or marketed, it will not be considered a private placement and will be treated as a
public offer.

Private Placement – Section 42 of Companies Act 2013: Offer Letter in Private

Placement:

The private placement by companies is regulated by the Companies (Prospectus and Allotment
of Securities) Rules, 2014. It offer letter in Form PAS 4 is used by the company to invite to
subscribe to the securities allotted. A company can make the offer only to those persons whose

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names have been recorded already before making the invitation. The persons thus mentioned
will receive the offer and the company thereafter should retain the record of the offers made
through Form PAS 5.

While addressing a private placement offer letter to a respective person, the company should
send an application form with a serial number either in writing or in electronic mode. The letter
should be sent within 30 days of recording the person’s name. Thereupon, the person receiving
the placement offer letter should accept the offer. The details pertaining to the offer should be
submitted to the Registrar of Companies (ROC) within 30 days from the date of sending the
private placement offer letter.

Special Resolution to Be Passed: Placement of securities can be made by a company only

after the approval of its shareholders by passing a special resolution for the respective offer to
subscribe to securities.

Threshold of Private Placement: The number of select persons to whom the company can
offer a private placement should not be more than 50 or more than the number prescribed by
the rules in the respective financial year. However, this does not include qualified institutional
buyers and the company’s employees who are offered securities under the Employee Stock
Option Plan as per the Companies Act, 2013.

The threshold limits pertaining to the maximum number of persons to whom the private
placement offer can be made and the value of the same does not correspond to:

• Non-Banking Financial Institutions, incorporated under the Reserve Bank of India Act,
1934
• Housing Finance establishments registered with the National Housing Bank under
National Housing Bank Act, 1987.

Subscription of Private Placement – Section 42 of Companies Act 2013: The persons who
intend to subscribe to the private placement shall apply through the private placement
application along with the necessary amount of money through a demand draft or cheque or
any other authorised payment channel of an authorised bank. It may be pertinent to note that
the payment shall not be made through cash. The payment must be made through the
subscriber’s bank account, wherein the company must duly maintain a record of such payments
made by the subscribers.

Maintenance of Record: The company must take all due care to maintain the records of the
private placement offers made and those that were accepted subsequently. The copies of the
Forms PAS 4 and PAS 5 should be documented and filed with the ROC filing with the
designated fee as directed by the Companies (Registration Offices and Fees) Rules, 2014. The
filing must be done within a period of 30 days from the date on which the offer for private
placement was made to the subscribers.

Filing of Return of Allotment: The company must duly furnish the return of the allotment of
securities with the ROC, once the allotment of securities has been accomplished. The return of
allotment has to be registered within 15 days in Form PAS 3 with the required fee as directed
by the Companies (Registration Offices and Fees) Rules, 2014.

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The following particulars have to be presented:

• A list of all the security holders with their details like name, address, PAN (Permanent
Account Number), e-mail etc
• Details pertaining to the class of the security held
• Date on which the security is allotted
• Number of securities and amount paid with the nominal value
• If the securities were issued for consideration other than cash, the details of such
consideration.

The Form PAS 3 filed by the company should be notarised by a practicing Chartered
Accountant or a Company Secretary if the filing company is not a One Person Company (OPC)
or a small company.

Penalty in Case of Non-Compliance in Private Placement Procedure:

The Companies Act 2013 lays down specific rules and procedures that companies must follow
when making private placements of securities to select investors. Failure to comply with these
rules and procedures can result in penalties and legal consequences for the company and its
officers. Here are some of the penalties that can be imposed in case of non-compliance with
the private placement procedure under the Companies Act 2013:

1. Refund of money: If the company has received any amount from investors in
contravention of the private placement procedure, it must refund the entire amount
along with interest at the rate of 12% per annum within 30 days of the order passed
by the regulator.
2. Penalty on company: The company can be penalized with a fine of up to twice the
amount raised through the private placement or Rs. 2 crores, whichever is lower.
3. Penalty on officers: The officers of the company responsible for the non-compliance
can be penalized with imprisonment for up to 2 years and/or a fine of up to Rs. 25
lakhs.
4. Debarment from raising funds: In case of repeated non-compliance, the company
may be debarred from making any private placements for a period of up to 5 years.
5. Prosecution: The company and its officers can also face prosecution under the
provisions of the Companies Act 2013.

It is, therefore, important for companies to strictly comply with the private placement procedure
under the Companies Act 2013 to avoid any legal and financial consequences. Companies must
ensure that they follow the prescribed rules and procedures, make accurate disclosures, and
maintain proper documentation to demonstrate compliance. Companies can also seek legal
advice to ensure that they are fully compliant with the law.

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Topic 3: Rights issue

Given under section 62 of Companies Act 2013

Rights issue (Pre-emptive Rights) There expression ‘rights issue’ is used in many sections of
the Act but the same is not defined or explained at any part of Act. However sub-clause (zg) of
regulation 2(1) of SEBI (ICDR) Regulations, 2009, defines as follows: This definition is
applicable to listed companies. “rights issue” means an offer of specified securities by a listed
issuer to the shareholders of the issuer as on the record date fixed for the said purpose.

Meaning: In general, fresh shares offered to existing shareholders in proportion to their existing
holding in the share capital of the company are termed as “Rights shares” popularly known as
rights issue. In the rights issue the shareholders have a right to participate in the issue. It is pre-
emptive rights given by the status to existing shareholders. In this rights issue, the offer is
required to be made to the existing shareholders on pro-rata to their existing holdings. The
shareholders who are offered may or may not subscribe to the same. They may subscribe partly
or fully the offer. They have a power to renounce the shares offered to any other person who
need not be an existing shareholder of the company.

It is the power of the board of directors to decide the time, price, number of shares, pro-rata
and other terms and conditions of the issue. The rights issue is not necessarily made at the time
of requirement of the funds. It can be even made to create the desired number of shareholders
to enable the company to exercise its legal powers or to comply with legal requirement. [In Re.
Needle Industries (India) Ltd. V Needle Industries Newey (India) Holding Ltd (1981) 51Com
Cases 743 (at p 816):AIR 1981 SC 1298.]

Power of the Board

In what way, mode and manner the additional resources are to be raised, it is for the board to
decide. The minority shareholders can’t approach the court to stop the rights issue saying they
don’t wish to subscribe the same and it would lead to oppression. [In Re. Sri Hari Rao V Gopal
Automative Limited (1999) 96 Comp Cas 493 CLB]. Honourable Baboo Lall Jain, J. while
dismissing the case Milan Sen vs Guardian Plasticote Ltd. on 12 April, 1996: (1998 91 Comp
Cas 105 Cal) observed as follows:

The principle is that although primarily the power is given to enable capital to be raised as and
when required for the purposes of the company, there may be occasions when the directors
may fairly and properly issue shares for other reasons, so long as those reasons relate to a
purpose of benefiting the company as a whole, as distinguished from a purpose, for example,
of maintaining control of the company in the hands of the directors themselves or their friends.
An inquiry as to whether additional capital was presently required is often most relevant to the
ultimate question upon which the validity or invalidity of the issue depends; but that ultimate
question must always be whether in truth the issue was made honestly in the interests of the
company’.

Financial difficulty of the shareholder to subscribe the proposed rights issue does not need to
be considered while offer the rights issue made by the Company. (In Re. Freewheels (P) Ltd.,
New Delhi vs Veda Mittra And Anr. AIR 1969 Delhi 258, 1969 39 Comp Cas 1 Delhi, ILR
1969 Delhi].

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In this case the holding company held 52 per cent in the subsidiary. The subsidiary company
was admittedly a prosperous concern, and the holding company was the selling agent of the
product of the subsidiary company. This selling agency admittedly yielded good profits to the
holding company. On 22nd July, 1968, the subsidiary company by a resolution of the Board of
Directors, decided to issue a further capital, of Rs. 3,00,000.00- and to offer the same, in
accordance with section 81, to the holders of equity shares in the subsidiary company. If the
holding company were in a position to subscribe to the additional capital issued, they would
retain their majority of 52 per cent. as under section 81 the shares have to be offered to the
existing equity shareholders in proportion, as nearly as the circumstances admit, to the capital
paid up on their shares. A communication was accordingly addressed by a letter, dated
24/7/1968 by the subsidiary company to the holding company offering to the latter 1568 equity
shares out of the fresh issue. The holding company due to financial difficulties being unable to
subscribe went to court to stop the rights issue. The court declined the same.

Statutory right of shareholders

The right provided under the rights issue of shares is a statutory right to the shareholders to
subscribe new share in the company in proportion to their existing holding. However, unless
and until the board offers the rights issue, the pre- emptive right of the shareholder does not
exist.

Subscribed capital - share and other securities

Subscribed capital includes equity and preference share capital. Hence this section also applies
to issue of the preference shares. It does not apply to issue of nonconvertible debenture or non-
convertible bonds or non-convertible. Further the phrase “subscribed capital” does not include
the convertible debentures (whether fully or partly convertible optionally or compulsorily
convertible) other convertible securities. Though convertible securities are regarded as
potential equity, however by issuing these types of convertible securities the subscribed capital
of the company is not increased until the conversion takes place. It appears that these
convertible securities can’t be offered under the rights issue. However, these convertible
securities can be issued either under preferential offer under clause (c) of sub-section (1) of
section 61 of the Act or under private placement offer under section 42 of Act alone. At the
explanation provided under sub-rule (1) of Rule 13 of Companies (Share Capital and
Debentures) Rules 2014 the expression ‘Preferential Offer’ is defined as means as “issue of
shares or other securities”. Further expression “shares and other securities” is explained as it
means equity shares, fully convertible debentures, partly convertible debentures or any other
securities (convertible or exchanged at later date into equity).

The words used “For the purpose of this Rule” at the explanation are confined only to rules
made under clause (c) of sub-section (1) of section 62 of the Act and not for entire section. We
can’t borrow this extended definition of “shares and other securities” same for clause (a) or
clause (b) of sub-section (1) of section 62 of the Act.

As per clause 86 of Section 2 of the Act, “subscribed capital” means such part of the capital
which is for the time being subscribed by the members of a company. It is an exclusive
definition. It says such part of capital subscribed by the members of the company. The persons
who had subscribed to equity or preference shares can be called as members. However the
persons who had subscribed to convertible securities like convertible debentures can’t be called
as members of the company till such time of conversion.

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One can draw a conclusion for the purpose of clause (a) [Rights issue] or clause (b) [ESOPs]
of sub-section (1) of the Section the expression “shares” used in main part of sub-section(1) of
the Section means only the shares as defined in sub-clause (84) of section 2 of the Act. Whereas
purpose of clause (c) of the shares means “shares and other securities” accordingly extended
definition provided at rules should be taken into account while determining the scope of this
section.

It seems it must have been a draft error at exclusive definition of expression provided at rules.
It says “shares and other securities” means “equity shares, fully convertible debentures, partly
convertible debentures or any other securities..........” It does not include “preference shares”.
Even we can’t assume expression “other securities” may include ‘preference share. But
following qualifying sub- clause of convertibility must be a condition to consider other
securities as such. However definition of shares provided at section 2(84) needs to be taken for
the expression of ‘shares’ mentioned rules, as the rule can’t over ride the Act.

Holders of equity shares

As per this section only equity shareholders are entitled to pre-emptive rights not the preference
shareholders even if they hold convertible preference shares. In Re. Kedar Nath Agarwal V Jay
Engg. Works Ltd [1963] 33 Comp. Case 102(Cal), the Culcatta High Court held that a
‘member’ may be a holder of shares but a holder may not be a member. A person whose name
appears on the register of members may have sold his shares and from the moment his property
in the shares has passed to purchaser and he has ceased to be ‘holder’ of those shares. This case
was relevant under 81 of the Companies Act 1956. The same seems to be relevant to the present
section. The Supreme Court in Balkrishna Gupta v. Swadeshi Polytex Ltd. [1985] 58 Comp
Case 563 held that: “The privileges of a member can be exercised by only that person whose
name is entered in the register of members. A receiver whose name is not entered in the register
of members cannot exercise any of those rights unless in proceedings to which the company
concerned is a party and an order is made therein

In case of Howrah Trading Co. Ltd. v. CIT [1959] 29 Comp Case 282 the Supreme Court
observed that even where the holder of a share whose name is entered in the register of
members hands over his share with blank transfer forms duly signed, the transferee would not
be able to claim the rights of a member as against the company concerned until his name is
registered in the register of members. The Supreme Court further held: In some situations and
contingencies the ‘member’ may be a holder of shares but a holder may not be a ‘member.’
Pre-emptive rights provided under section are available only to the equity shareholders not to
the preference shareholders whether convertible or not.

In many sections throughout the Act terms ‘members’, ‘shareholders’, ‘equity shareholder’,
‘holder of equity shares’ are synonymously used as some places as substitutes. For the purpose
of this section the expression “holder of equity shares” means subject to provisions section 126
(keep in abeyance) of Act those persons whose names are appeared in the register of members
on a particular day (it may be book closure date or record date). The company needs to send
rights issue offer letters only to such persons. It is immaterial to the company whether the
particular member still holds the shares or not. The company does not need to recognize the
actual holder of equity shares as on particular date.

However the company should keep such shares in abeyance in case of those shares the company
has received duly executed transfer instruments along with required documents before the date
of such particular decided date and the company has not registered the same i.e. pending

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registration of share transfers. In other words, the rights issue offer letters are not required to
be sent to the registered member of such shares. Rights shares will be kept in abeyance till
share transfer is registered by the Company. Once the transfer of shares is effective in the
records of company, then the transferee would be entitled the rights issue offer to subscribe.

In case of disclosure of beneficial interest made under section 89 of the Act, though it is
constructive notice on the company, the company is required to offer the rights shares to
registered owner only. Disclosure of beneficial interest in the share does not take away the
rights and power of the company and shareholder as well. Disclosures made under section 89
are not directions to the company. This section is not guided by the section 89 of the Act. The
rights shares should be offered to the registered member alone. However, registered member
acting in accordance with the beneficial owner may renounce the same in favour of beneficial
owner. Further in case of death or insanity, pledge of shares and other legal constrains, the
company may need to keep in abeyance the rights issue on such shares based on facts available
with the company.

Offer to be made proportionately

In the rights issue, the shares should be proportionately offered to equity shareholders to their
existing shareholding. However the expression “as nearly as circumstances admit” used in the
sub-section (a) of sub-section (1) of this section gives a leeway to the board to decide such
nearest number of shares by avoiding the fractions.

Renunciation:

Under this section pre-emptive rights includes the right to renounce if it is not restricted by the
articles. Public and private companies both can have a suitable provisions at articles either to
restrict or prohibit the right to renounce the rights shares. If permitted, renunciation of issue
rights shares can be made fully or partly in favour of any person, who need not be an existing
shareholder of the Company.

Private Companies: The right to renunciation in favour of any other person is wholly
inconsistent with the structure of a private company having three characteristics contained at
section 2(68) of the Act. As this section is made applicable to all companies, in order to protect
its basic fabric of among the existing members, private companies may need to incorporate
suitable provisions at articles to restrict the right of renunciation similar to restrictions imposed
in case of a transfer of shares by existing member. Otherwise the existing shareholder having
received rights issue may renounce to any person and board of directors shall be bound to make
allotment to such persons. Their entry into the company as shareholders may not be
advantageous to company.

Listed Companies: In case of listed company, such restrictions or prohibitions imposed under
articles do not have any impact on rights shares to renounce unless those are approved by the
stock exchanges where the shares are listed. The clause 23(c) of listing agreement reads as the
company agrees to make such issues or offers in a form to be approved by the Exchange and
unless the Exchange otherwise agrees to grant in all cases the right of renunciation to the
shareholders and to forward a supply of the renunciation forms promptly to the Exchange.
Further Regulations 39 of Securities and Exchange Board of India (Listing Obligations And
Disclosure Requirements) Regulations, 2015 (Hereinafter called as Listing Regulations, 2015)
mandates the listed companies to comply with regulations 19 of the Securities Contract
(Regulation) Rules 1957.

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Topic 4: Preferential issue/allotment

Preferential allotment of shares is a procedure to allot a bulk of fresh shares to a specific group
of individuals, investors, or venture companies. It is an issue of shares or convertible securities
and can be by listed or unlisted companies. Any company, whether private, public, listed, or
unlisted, can go for the process of preferential allotment of securities. The companies choose
this method because it is one of the fastest ways to raise the capital and increase the shares of
the firm. A person holding preferential shares has the right to be paid before the common
shareholders at the time of winding up of the company. The issue is made at a pre-determined
price. A company issues such shares in favour of those investors and venture capitalists who
wish to gain a higher stake in the firm and can subsequently add value to the company. It can
also be a chance for those shareholders who were not able to purchase the shares at the time of
Initial Public Offer. It can prove to be a win-win situation for the company as well as
shareholders. It is because the company will be able to raise a large amount of capital and
increase the flow of money in the firm and the investors or the shareholders shall get a larger
share in the company. The provisions that govern the preferential allotment of shares must be
understood to prevent any misuse or abuse of the privilege.

Section 62 of the Companies Act, 2013 (Section 81 of Companies Act, 1956)

The provision deals with further issue of the share capital. The provision prescribe certain
categories of people that the companies must approach for the further raise of capital: persons,
who, at the date of offer, hold equity shares of the company by making an offer via notice
specifying the number of offered share, the time limit not exceeding thirty days, a right to
renounce the shares offered in favour of any person and if the person does not accept, then the
firm can dispose of the shares, to employees under Employees Stock Option or to any group of
persons authorised by a special resolution and are not included in the above mentioned
categories. The notice to such people must be sent by registered post or speed post or by any
electronic mode. The section does not extend to debentures or loans from any company or
government or financial institution.

In the case of Mrs Proddaturi Malathi vs Srp Logistice Pvt Ltd & Ors2, the appellant challenged
the allotment of shares by the respondent in violation of Section 62 of the Companies Act, 2013
as being prejudicial and discriminatory towards the appellant. The Supreme Court held that the
provision of Section 62 of the act is applicable to private companies also. The companies can
increase their capital by a further issue to existing shareholders. Thus, the allottees must get
proper time and chance to renounce the shares.

Section 42 of the Companies Act, 2013

The section prescribes the offer or invitation for subscription of securities on private placement.
It states that the offer shall be made to the number of persons not exceeding fifty, excluding
the provisions for employees under Employee Stock Option. For this section, private placement
means any offer of securities or such invitation to subscribe the securities to a select group of
persons by a company through the issue of private placement along with the satisfaction of the
provisions specified in the provided section. The money under such a rule should be paid
through demand draft or bank transfer and not by cash. Such an allotment must be done within
sixty days of the receipt of the application money.

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In the case of Sahara India Real estate Co vs Securities Exchange Board of India3, the Supreme
Court of India held that a private placement to friends, relatives or closed people is valid under
the provisions of Section 42, provided that the valid procedure is followed.

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

The rule prescribes the provisions and procedure for issue of shares under Section 62 of the
Companies Act, 2013 read with Section 42 of the act4. The shares must be issued after
authorization by the board by passing a special resolution in a board meeting. The offer or
allotment must be according to the provisions of Section 42. The preferential offer must be to
more than two members. The price for the issue on a preferential basis by a listed company
need not be done by a registered valuer. the rule also defines Preferential Allotment as an issue
of shares or other securities to a selected group of people on a preferential basis but does not
include rights issue, public offeror sweat equity shares. The same must be authorized by the
articles of association and passed by a special resolution in a board meeting. In addition to the
registration of forms, the directors must also attach an explanatory statement stating the
information about the issue. The preferential allotment must be made within twelve months of
passing the resolution. The price of shares must be mentioned and expressly stated in the offer
or application made to the allottees. The shares and securities also include convertible
instruments. The company's offer must also include a clause stating the price of such
conversion.

In the case of ABN Housing Private Limited v Unknown5, the Madras High Court held that
the directors of the company must issue convertible instruments in accordance with Rule 13 of
the companies (share capital and debentures) rules, 2014 and should be mutually agreed with
the transferors.

Advantages of Preferential Allotment

Preferential Allotment of shares is beneficial for the company in many ways. The following
are the advantages of Preferential Allotments:

The first advantage is that there shall be no charge on the assets. Under Preferential
allotment, shares and convertible securities are offered. The shares do not create a
charge on the assets unlike debentures. Moreover, it is not a requisite for preferential
allotment to keep the assets in risk. Thus, it is beneficial for both the companies and
existing shareholders.

The next advantage is an additional benefit to the investors and shareholders.

Preferential allotment is a way to deal in convertible securities. If the price of shares
increases, the investors and shareholders can convert their convertible securities into
shares and earn dividends and extra profits. The dividends and profits are more than the
predetermined and fixed interest on the securities or debentures. It is a great opportunity
for all the existing shareholders and investors.

The next advantage is that there need not be any dilution of power. Preferential
Allotment does not involve dilution of power as the shareholders do not receive voting
rights. The shareholders or investors are entitled to dividends and interest but do not
have voting rights or say in the board meetings. It is a benefit for the company and the
directors as they will not be required to dilute their powers and share with other
shareholders.

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 The last advantage is that preferential allotments improve the borrowing capacity of the
firm. It reduces the debt-to-equity ratio because it helps them to create a space for non-
convertible debentures and loans.

Disadvantages of Preferential Allotment

Every blessing is attached with a curse, likewise, there are both advantages and
disadvantages of the concept of preferential allotment. It is also essential to apprehend
and understand the limitations of the process:

Harm to the reputation of the firm: If a company does not pay a fixed amount of
dividend or dividend every year, this might not invite legal penalties, but this can harm
the reputation of a company. First things first, an investor will not invest in a firm or in
a security that will not yield any gain in future. For instance, Firm A earns profits and
pay dividends every year to its shareholders and Firm B does not give dividend every
year, then an investor will invest in Firm A to yield gains.

Moreover, it can also affect the reputation of the firm while borrowing the money. It is
because lenders will only provide funds if they are satisfied that the company shall pay
back the entire amount.

Lack of voting rights of the investors: An investor delving the funds under preferential
allotments shall not receive the same level of voting rights or ownership as a common
shareholder. It can also prevent them from investing their savings in such a scheme.
Thus, it can provide a benefit of raising a large amount of funds for the operations of
the company but may not provide simultaneous benefits to the shareholders.

Fazit

The Companies Act, 2013 and the rules provided govern the methods like preferential
allotment of shares and securities. The allotment of securities includes convertible securities
and shares also. It is one of the fastest ways to raise capital for the operations of the business.
A person holding preferential shares will be given more importance at the time of winding up
of the company. The issue is made at a predetermined price. There are certain provisions of the
Companies Act, 2013 and certain rules provided under Companies (Share Capital and
Debentures) Rules, 2014 and Companies (Prospectus and Allotment of Securities) Rules, 2014.
But it can also lead to power in only few hands because only some people shall buy the shares
and keep the decision-making power in the hands of the majority shareholders. There are
practical scenarios where the companies and the majority shareholders took the advantage of
the preferential allotment of shares. Thus, preferential allotment of shares is an efficient and
effective way so that the directors can raise money.

Difference Between Both

Right Issue Preferential Allotment

The right issue is governed through Section Preferential Allotment is governed through
62(1)(a) of Companies Act 2013 Section 62(1)(c) of Companies Act 2013

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 Through this offer, the company issue the Company issue the shares to both existing
shares to existing shareholders in proportion shareholders and even outsiders
of their holding

Only board approval through board meeting Both board resolution and special resolution
is required is needed to approve preferential allotment

Offer period remains open for the minimum No as such specific provision for offer
period 15 days and maximum 30 days period is specified

Company shall allot the shares within 60 The allotment shall be made of the earlier of
days of receipt of application money these two:

12 months of Special Resolution

60 days from receipt of application money

No need for a valuation report The valuation report is mandatory in case of

preferential allotment

Shareholders under this option have right to No such right is provided to shareholders
renounce, reject or approve the offer letter under this offer

Topic 5: Bonus issue

Bonus shares are an additional number of shares given by the company to its existing
shareholders as “BONUS” when they are not in the position to pay a dividend to its
shareholders despite earning decent profits for that quarter. Only a company has the right to
issue bonus shares to their shareholders, which has earned massive profit or large free reserves
that cannot be utilized for any particular purpose and can be distributed as dividends. However,
these bonus shares are given to the shareholders according to their existing stake in the
company.

For example: If a company declares one for two bonus shares, it would mean that an existing
shareholder would get two additional shares for one existing share. Suppose a shareholder
holds 2,000 shares of the company. When the company issues bonus shares, he will receive
1000 bonus shares, i.e. (2000 *1/2 = 1,000).

Who is Eligible for Bonus Shares?

Shareholders who own the company's shares before the ex-date and record date are eligible to
receive bonus shares from the company. In India, the T+2 rolling system is set for the delivery
of the shares, wherein the record date is two days behind the ex-date. Shareholders must
purchase shares before the ex-date because if they purchase on the ex-date, the company will
not give the ownership of shares, and therefore, they will not be eligible to receive bonus shares.
Once a new ISIN (International Securities Identification Number) is allotted for the bonus
shares. The bonus shares will be credited to the shareholder's account within 15 days of time.

Advantages and disadvantages of Bonus Shares

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Advantages From Investor's Point of View

1. Investors do not have to pay any tax while receiving bonus shares from the
company.
2. Bonus shares are considered beneficial for long-term shareholders of the company
looking to multiply their investment.
3. Bonus shares are free of cost to shareholders as they are issued by the company,
which increases the outstanding shares of an investor in the company and enhances
the liquidity of the stock.
4. Bonus shares help build the trust of an investor in the company's business and
operations because they have invested in the company and, in turn, gives capital to
the investor.

From Company's Point of View

1. The issue of bonus shares enhances the company's value and increases positions
and image in the market, gaining the trust of existing shareholders and attracting
several small investors to be a part of the stock market.
2. The companies have more free-floating shares with the issue of bonus shares in the
market.
3. Issue of Bonus shares benefits companies to get themselves out of the situation
where they are not able to or simply not prefer to pay cash dividends to their
shareholders.

Disadvantages of Bonus Shares: From Investor’s Point of View

1. There is no much of a disadvantage of owning the bonus shares from an investor’s

point of view. However, they should know about receiving bonus shares because
the profit will remain the same, but the number of shares will be increased as the
earning per share will fall.

From Company’s Point of View

1. The company do not receive any cash while issuing bonus shares. As a result, the
ability to raise money by following an offering is minimized.
2. When a company keep on issuing bonus shares instead of paying dividends, the cost
of the bonus issued keeps adding up over the years.

Types of Bonus Shares

Fully Paid Bonus Shares: Fully paid bonus shares are those shares that are distributed at no
extra cost in the proportion of the investors holding in the company. These types of bonus
shares can be issued from the following sources: 1) Profit and loss account 2) Capital reserves
3) Capital redemption reserves 4) Security premium account.

Partly Paid Up Bonus Shares

Before understanding party-paid up bonus shares, let’s understand what a partly-paid share is?
A partly paid share is a share in a company that is only partially paid compared to the full issue
price. It means that the investor can buy partly paid shares without paying the total issue price.

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However, the remaining amount for partly paid shares can be paid in instalments when the
company makes calls. So when the bonus is applied in the partly-paid shares and converted
into fully paid shares without calling out the uncalled amount through profit capitalization, it
is called partly-paid up bonus shares. However, unlike fully paid up bonus shares, partly paid-
up bonus shares cannot be issued through a capital redemption reserve account or security
account.

Topic 6: Issue of sweat equity shares

The definition provided in Section 2 (88) is as follows: ““sweat equity shares” means such
equity shares as are issued by a company to its directors or employees at a discount or for
consideration, other than cash, for providing their know-how or making available rights in the
nature of intellectual property rights or value additions, by whatever name called.” The
definition of “value addition” provided in the Rule 8(1) of the Companies (Share Capital and
Debentures) Rules, 2014 is as follows: “the expression ‘Value additions’ means actual or
anticipated economic benefits derived or to be derived by the company from an expert or a
professional for providing know-how or making available rights in the nature of intellectual
property rights, by such person to whom sweat equity is being issued for which the
consideration is not paid or included in the normal remuneration payable under the contract of
employment, in the case of an employee.” Sweat equity shares are issued by a company
normally to compensate the employees/ directors for contributing intangible asset in the form
of technical know-how, value addition, and intellectual property rights etc by which the
company arrives at some benefit.

Only type of share that can be issued at discount

Section 53 of the Act, prohibits issue of shares at discount, except as provided in section 54 it
appears that. For companies other than listed companies which are not required to comply with
SEBI regulations, sweat equity shares can be issued at discount, subject to compliance of
requirements as specified under section 54, read with Rule 8 of The Companies (Share Capital
and Debentures) Rules, 2014.

Applicability of SEBI Regulations

Where the equity shares of the company are listed on a recognized stock exchange, sweat equity
shares should be issued in accordance with regulations made by the Securities and Exchange
Board of India in this regard. Listed companies which are issuing sweat equity shares are
required to comply with SEBI (Issue of Sweat Equity) Regulations, 2002.

Issue of Sweat Equity Shares is not a ‘preferential issue’

As per regulation 2(1)(z) of SEBI (ICDR) Regulations, 2009 which gives the meaning of a
preferential issue excludes an issue of sweat equity shares there from, which means issue of
sweat equity shares is not a preferential issue within the meaning of preferential issue Further
Rule 8 (13) of The Companies (Share Capital and Debentures) Rules, 2014, clearly excludes
issue sweat equity shares from the definition of preferential offer.

Eligibility to receive sweat equity shares?

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As given in thedefinition of “sweat equity shares” provided under Section 2(88), such equity
can be issued either to directors or employees. The definition of “employee” is provided in the
Rule 8 (1) of the Companies (Share Capital and Debentures) Rules, 2014 as follows:

“(i) the expressions ‘‘Employee’’ means.

a) a permanent employee of the company who has been working in India or outside India,
for at least last one year; or
b) a director of the company, whether a whole-time director or not; or
c) an employee or a director as defined in sub-clauses (a) or (b) above of a subsidiary, in
India or outside India, or of a holding company of the company;”

Hence, a meaning wider than popular connotation is provided in the Rules.

Conditions for issue of sweat equity For issue of sweat equity shares, there are following
conditions which are to be fulfilled by the Company:

a. The issue of sweat equity shall be authorized by way of special resolution. The said
resolution shall specify the following details:

i. Number of shares
ii. Current market price
iii. Consideration, if any
iv. Class or classes of directors or employees to whom shares are to be issued.

b. On the date of issue, not less than 1 year has elapsed since the Company has commenced
business.

c. Compliance of either Rule 8 (which includes the conditions dealt with below) or SEBI
(Issue of Sweat Equity) Regulations, 2002.

Maximum cap on sweat equity

There are twin caps which are provided for issue of sweat equity. In one-year, maximum value
of sweat equity shares is 15% of the existing paid up equity share capital or shares of the issue
value of Rs. 5 crores, whichever is higher. The other limit is overall limit which provides that
total issue of sweat equity shares in the Company shall not exceed 25% of the paid-up equity
capital of the Company at any time.

Lock-in period

The sweat equity shares so issued shall be locked in for a period of 3 years from the date of
allotment. Further, it shall either be stamped in bold or mentioned in any other prominent
manner on the share certificate the fact that theshare certificates are under lock-in and the
period of expiry of lock in.

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Topic 7: Regulatory overview of capital markets

The next two topics are extremely vast and general which covers a lot of things, so I have
attached some links which gives the overall perspective of both the topics. These topics are
there to relate with the above module.

https://blog.ipleaders.in/overview-of-capital-market-and-its-regulation-in-india-a-critical-
analysis/

https://www.civilserviceindia.com/subject/Management/notes/regulation-of-capital-
market.html

Topic 8: Regulation of security dealings: laws and institutions

https://blog.ipleaders.in/laws-governing-the-stock-market-in-india/

https://corporatefinanceinstitute.com/resources/capital-markets/stock-market/

https://www.scconline.com/blog/post/2020/07/08/the-indian-stock-market-saga/

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