[Pammy Jaiswal is a Partner at Vinod Kothari and Company]
Several well-known digital platforms have been showcasing the immense potential to raise funds for start-ups from private equity investors, reaching very often to retail investors too. However, one needs to note the provisions of section 42 (7) of the Companies Act, 2013 (‘CA 2013’), and several recent penalty orders which, with detailed reasoning, have imposed stiff penalties running into crores of rupees for breach of these provisions.
This post deals with requirements for private placements, situations of breach and cases where the practices were legally untenable. It also discusses a potential mid-way which should be taken to be within the periphery of the legal requirements of private placement.
Explicit Stipulations and Restrictions under Private Placement Norms
Following the uncontrolled and misguided actions in the issuance of securities on a private placement basis and the decision rendered by the Supreme Court in Sahara India Real Estate Corporation Ltd. v. SEBI, the scope of private placement was substantially modified under the CA 2013 regime when compared to the erstwhile Companies Act, 1956. Section 42 of the CA 2013, corresponding to section 67 of the Companies Act, 1956, further underwent several changes pursuant to various amendments brought in by the Companies (Amendment) Act, 2017.
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Stipulations / Conditions |
Absolute Restrictions |
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Offer or invitation to a select group of persons not exceeding 200 |
Use of any public advertisements or any media, marketing or distribution channels or agents to inform the public at large about such an issue. |
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Circulation of PAS-4 only after filing of form MGT-14 |
A subsequent offer of private placement cannot be made unless the allotment under the previous offer has been completed or has been cancelled. |
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Application to made along with subscription money paid either by cheque or demand draft or other banking channel and not by cash |
Restriction on utilization of funds raised till allotment is filed with the Registrar of Companies (‘RoC’) |
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Funds received on application under this section shall be kept in a separate bank account in a scheduled bank |
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Recent Cases: Private Placement Norms Flouted
There have been several cases where the provisions of private placement were found to be violated either explicitly or by the use of certain devices like stopover investor agreements, use of open-ended electronic media or other nuanced structures. However, the use of devices cannot beat the law; whether it is raising of equity or debt does not make any difference. The major issues for which the MCA has penalized the companies as well as their officers are as follows:
Use of media, advertisement and distribution channels to inform the public at large about private placement
In the matters of Septanove Technologies Private Limited and Anbronica Technologies Private Limited, the Tyke platform was used to inform the public at large about private placement of compulsorily convertible debentures. The argument of the company that the allotment is made to less than 200 persons does not hold any merit as the first restriction by itself has been flawed by these companies.
Structuring of the instrument in a manner that makes it fall outside the meaning of securities as well as other violations (usage of media/ advertisement, non-filing of PAS-3)
In the matter of Solargridx Ventures Private Limited, the company came out with a community stock option plan (‘CSOP’) and offered and issued community stock options on digital platform wherein the investors may be rewarded based on the future valuation of the company. These options also gave a chance to receive share appreciation rights (‘SARs’) as communicated by the issuer entity to the investor. The issuer referred to the ruling of the Supreme Court in SEBI v. Rakhi Trading Pvt. Ltd. and of the Bombay High Court in Percept Finserve Pvt Limited v. Edelweiss Financial Services Limited [2023 (2) TMI (Bom HC) ] to state that the CSOP is not deriving its value from any underlying variable like shares. However, based on the evidence, the regulator clearly concluded that since the value of these options are linked with the valuation of the equity shares, these are nothing but derivatives and, hence, securities.
Offer to subscribe to one allottee which in turn uses the digital platform for downselling the securities so acquired
In the matter of Planify Capital Limited, equity was offered to one of the group entities, which in turn used the platform of the same issuer entity to down-sell the shares so acquired. The regulator came down heavily by calling the transaction as a ‘nuanced structuring’ by clearly indicating the following:
- offer was made to large section of people and not limited to 200; issuing securities in open forum is considered as a non-compliance;
- the use of Planify platform for raising securities, putting pitch information, and raising money from general public through the platform amounts to the issuance of public advertisements or utilization of media, marketing or distribution channels or agents to inform the public at large about such an issue;
- there was a clear nexus between the first issuance and the downselling; it is nothing but an offer to those to whom the securities have been sold and, therefore, filing of the details in PAS-3 will also be required within the time frame given in section 42(8);
- website of the issuer shows that 1 crore rupees was raised from 76 investors; on the other hand, the company alleges that it has issued the same to only one investor;
- crucial financial information as well as pitch used for collecting funds; and
- intention was always to offer the securities at large to the public at large and the stopover entity was used only as a smokescreen.
Execution of agreement with the first allottee which owns the digital platform to act as an exclusive partner to find potential investors
In the matter of Mayasheel Retail India Limited, the issuer entity under a specific brand name contended that it has offered and issued shares to only one entity (platform entity). However, it was found that the said allottee was used as a stopover to actually offer securities to the public at large through the platform. It was also found that an agreement was entered into between issuer and the platform entity to state that the platform entity may approach the potential investors with whom the platform entity already has established a substantive and pre-existing relationship. With this, the issuer entity ended up in having 1806 investors.
Critical Analysis
As discussed above, it is clear that private placement of securities involves making a private offer or invitation to a select group of persons by circulating an offer letter which contains the details about the proposed issuance. It is imperative to note that the stipulations and restrictions under section 42 are clearly laid down so that the issuers can ensure compliance with the same. However, given the cases adjudicated by the regulator, it was observed by the RoC that companies are seeking to to avoid or overcome the conditions as well as the restrictions under the private placement norms.
Secondary transfers
Compliance with section 58(2) of the CA 2013 has to be seen subject to the protection of the norms of private placement and not be read in isolation.
Deemed public issuance – section 25(2)
Section 25(2) of the CA 2013 is an extremely underrated provision which automatically brings an issuance at the level of deemed public issue . The said provision begins with the deeming clause to be proved otherwise, if specified events take place. One of these events is to offer the securities or any of them for sale to the public within six months after the allotment or agreement to allot. Having said that, this restriction is not to be applied for listed debt being sold on online bond platforms.
Way Forward
After going through the provisions of section 42 and the non-compliances pointed out by the RoC in all these cases, it becomes clear that as long as the issuer company complies with the stipulations and restrictions of the said provisions, the regulators will not pursue the concerned entities.
Having said that, we also need to consider that for entities with no track record of capital raising but with promising business ideas, absolute closure of access to potential investors will create an environment to kill the budding enterprises. This cannot surely be the intent of private placement norms where the idea is to curb disguised public issuances under the banner of private placement to dodge the compliances requirements. In doing so, there is a lack of information about the issuer which may lead to misguided investment decisions for those wanting to invest. The public issuances are anyway either on the main board or the SME board of the exchange; therefore, one may look at a proposed framework which does not close the door for fund raising from a closed group of investors and, at the same time, is within the periphery of section 42 of the CA 2013.
A possible way forward has been discussed below which may be considered, however, with caution to allow private placements without contravention of the provisions. Consider a closed group of potential investors with certain specified eligibility criteria. Any new person who happens to meet the criteria can join the group for looking out for promising startups or investment avenues. A platform may be floated where this group of investors may be registered. Such platforms may be that of the government like parallel to the online bond platforms for listed debt or private platforms which have been registered with authorities (where required by law). Similarly, a start-up which is looking to raise funds provides all the necessary information to the said platform. The said platform may consider sharing of the investment opportunity with only limited number of those participants who meet the eligibility criteria for such investment and, in doing so, take care of the provisions of section 42, especially with respect to the following:
- engage on one-to-one discussion or arranges discussion between the issuer and the investor rather than advertising on its platform;
- offer (post discussion) is made individually by the platform to such proposed investors, which is within the limits of 200 offerees for each issuance and with the express authority of the issuer entity;
- specific and mandatory requirement for both potential investors as well as start-ups to be allowed to register only if both the parties feed all required details like:
- for investor, some indicative information like minimum net worth, minimum past investment criteria, and risk appetite;
- for the issuer, some indicative information like business plan, projections, and existing market share.
- express restriction to down sell such securities within the next six months in conformity with section 25(2) of the CA 2013.
Concluding Remarks
In 2016, the Securities and Exchange Board of India issued a cautionary notice to the investors who are accessing unregistered electronic platforms for making investment. Globally, the crowdfunding norms have already been made a part of the regulatory framework; for example, the United States already have Regulation Crowdfunding Rules and the United Kingdom also has Crowdfunding Rules issued by the Financial Conduct Authority. However, India has not yet made any specific regulations around the same. In the current environment, having access to funds is fundamental to any organization; therefore, to curb such cases in India, it is important to consider if some sort of specific review is needed in the policy framework itself so as to make it fit into the present day funding and investment matrix.
– Pammy Jaiswal