The Potential for an Online Private Placement Platform in India

[Guest post by Rishi
A
, a 5th year at Hidayatullah National Law University, Chhattisgarh]
The London Stock
Exchange (LSE) has a program that it runs for small and medium scaled
enterprises called the
ELITE
Programme
. Providing services like professional advice from
industry experts about value-creation and also assistance in issues relating to
raising of funds, it requires the enterprises to (i) sign-up with the entire programme,
(ii) be generating more than £5 million in revenue, and (iii) be able to
demonstrate progress till date as well as future growth potential. Subsequently,
LSE launched the
ELITE
Club Deal (ECD)
, which allows the registered companies to
access an online platform for private placements of their securities. By
providing connections with various investors groups like venture capitalists (VCs),
private equity (PE) firms and also individual investors, this deal provides a
huge advantage to these small-scale enterprises.
Since private
placements are negotiated between the parties before the offer is actually
made, the ECD resolves this issue by providing stream-lined processes for
obtaining the investment options. Furthermore, the
claim
that since most of the private placement transactions occur online
these
days, including the negotiation of the deal, favours the need for, and use of,
an online platform for such a purpose.
The actual
question here is whether such a platform is possible in India. It is true that
India already has
SME
Exchanges
that allow large numbers of small- and medium-scaled companies
to list and raise public funds. India also has the Institutional Trading
Platforms (ITP) that allow companies, especially start-ups, a great opportunity
to raise Indian public funds, instead of seeking foreign VCs. The
regulations
on ITPs
prescribed by the Securities and Exchange Board of
India (SEBI) are very flexible, as they require companies to have a working
capital of not more than Rs. 25 crores and they must have a minimum investment
of Rs. 50 lakhs by an alternative investment fund (AIF) or a VC or other
institutional or angel investor.
India, which ranks
third in the Global Start-up Ecosystem and has also emerged as the fastest
growing base for start-ups worldwide
, is very likely to have
numerous companies that fail to qualify the criteria imposed by the SME
Exchanges or the ITP, due to which they will face immense difficulty in
reaching out to potential investors. An online platform could be a perfect
solution for such purposes. Even SEBI considered such an approach when it came
up with its
Consultation
Paper on Crowd-funding
in 2014. An online platform for
private placements would be similar to equity crowd-funding, but one that would
be working within the regulations prescribed for private placements under the
Companies Act, and would not fall within the purview of a general offering to
the public. 
A private company
is mandated to impose a number of restrictions and limitations on the transfer
of its shares under the Companies Act, 2013 and private placement is the only
method it can deploy to issue shares. Under section 42 of the Companies Act,
2013, an offer or an invitation to offer of securities through private
placement can be made to a number of persons not exceeding 50 at one time and
to an aggregate of 200 persons in one year, as per Rule 14(2)(b) of the
Companies (Prospectus and Allotment of Securities) Rules, 2014. It will also be
important to note that the offer to the 49 persons must be targeted in nature,
and made without advertising the offer to anyone else.  In this post, I hope to provide a model that
would potentially allow such a platform to be set-up in a manner that is
consistent with existing regulations.
Model
Assume an online
platform is created, which allows a private or public unlisted company to
choose between multiple investors who are also registered on the platform. For
such a purpose, apart from making the registration of the companies and the
investors compulsory, the platform would also have to take precautionary steps
like imposing eligibility criteria on the investors, like net worth, experience
in investing in the stock market, etc. and for obvious reasons only institutional
investors, VCs, PE firms and high net worth individuals (HNI) must be allowed
to register as investors on this platform.
Since the
companies registered on the platform have done so for the purposes of obtaining
funding, the same need not be advertised. The companies would instead be
required to list their company details, official website and the sector in
which it conducts its business. Thus, none of this would be considered as an advertisement
or offer being made to any investor.
Following these procedural
formalities, the first step would require a registered investor to show
its interest to fund the company online by either clicking on it or by any
other mechanism that can be devised. This interest would be shown on the basis
of the public profile provided by the registered company on the platform.
Following this, the company would be able to view the final list of all the
investors who have shown interest in funding it. Now keeping in mind the fact
that the company is allowed to make a private placement offer to the maximum permissible
number of persons at once, while deciding on the list of the investors to make
private placement offer to, as the second step the Company’s board of
directors would then review the list of the interested investors and select the
investors to whom it would send its private placement offer letter, or the
invitation of such an offer.
Finally,
once such an offer is made by the company, and an acceptance would be required
to be communicated by the investors within a prescribed time limit, the shares
could be deposited in their respective demat accounts. The payment for the
shares could be made directly to the company’s account from the investors
account. The platform could also provide for a payment gateway that would allow
the investors to execute the payments on the platform itself. However, to
provide the facility for such a payment gateway an AD-I Bank would have to be brought
in as a partner and the bank would be required to report this transaction to the
Reserve Bank of India.
Conclusion
Some might argue
that, in accordance with the model suggested above, an investor showing
interest in a company on the first instance may be considered as an offer made.
Alternatively, it may be argued that the fact that a company is registered on
the platform might itself be reflective of its intention to potentially offer
securities. On the emergence of similar start-ups,
questions
relating to its legality
have been raised. Even SEBI
has cautioned investors
against dealing with such electronic
platforms. However, under the first step in the model proposed, an investor
would be able to show interest in the registered company on the basis of its
public profile only. No details of the funding will be disclosed to any prospective
investor until after the second step in the model, i.e., the finalisation of
the list of investors to whom the offer of securities is to be made. In such a
manner, the platform would be able to function while respecting the securities
regulations that apply to it.
As I had mentioned
earlier in this post, logistics is also one of the major issues that arises in
such a situation. However, by streamlining the process, the issues of logistics
can be solved. Providing standardised contracts, allowing parties to
communicate smoothly online and allowing easy modification of these
standardised contracts based on their negotiations is quintessential for the
success of such a platform, but providing such facilities should not be very
difficult either with the introduction of numerous smart-contracting companies.
Finally, under the
ITP Regulations, companies older than 10 years and making more than 100 crores
in revenue have been restricted from accessing the ITPs. Providing a
transparent electronic platform for private placement of securities may prove
to be beneficial to older but smaller conventional businesses in India.
– Rishi A

About the author

Umakanth Varottil

Umakanth Varottil is a Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

5 comments

  • Well the ITP framework may ostensibly appear to be (very) flexible. However,the regulations do not require eligible companies to have:

    (i) a working capital of not more than Rs. 25 crores
    (ii) minimum investment of Rs. 50 lakhs by an alternative investment fund (AIF) or a VC or other institutional or angel investor.

    The reference and link to the 2013 ITP framework which has been included in this post has resulted to a flawed analysis. Kindly refer to ICDR 4th amendment of 2015 (http://www.bsehitech.com/downloads/New_ITp_Guidelines.pdf) which revamped the erstwhile ITP framework.

    Also, I don't think that under the 2013 framework there was any cap on the working capital borrowings by ITP issuers. On the other hand, one of the eligibility conditions under the old framework permitted a class of companies to list on ITP which had received WC/ project finance from a scheduled bank and 3 years should have passed from such borrowing date and the borrowed sum should have been utilised.

  • I think it is important clarify to the blog readers, that:

    (i) Private Placement is not the only way for private companies to raise share capital, rights issues/ shares under ESOPs are also the permissible modes.

    (ii) Under the section 42 of the Companies Act, 2013, there is no one-time limit of 50 offerees. However, there is a condition that an offer can be made to up to 200 persons in a FY, subject to exceptions such as offers to QIBs/ shares under ESOPs are outside the 200 count. The magical number of '50' existed under the 1956 regime (S. 67(3)).

    (iii)The current ITP framework is age/ revenue neutral , companies old than 10 years/ having a billion USD revenue can also apply for ITP listing.

    • I apologize for not incorporating the amendment into the article. However, the ITP still has restrictions on kind of business or minimum QIB requirements which wouldn't cover all kinds of small companies. This platform could allow access to all kinds of private companies, start-ups as well as other small businesses.

  • Very well written article with a simple model shown as an alternative. The above mentioned points by Anonymous changes some of the points made in the article.

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