A Study on Preferential Allotment in lndian Context

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A Study on Preferential Allotment in lndian Context

Wednesday, |une 02, 2010
By Saurabh Ra|a, Nava K. Prathasth & Renu Agarwa


preferenta ssue means aotment of equty to some seected peope by a company whch has ts
share aready sted.

Every frm needs capta for nvestment. They need capta to meet expendture ke expanson,
dversfcaton, modernzaton, M&A, etc., from tme to tme.

When a sted company doesn't want to go for further pubc ssue and the ob|ectve s to
rase huge capta by ssung buk of shares to seected group of peope, preferenta aotment s a
good opton.
A prvate pacement s an ssue of shares or of convertbe securtes by a company to a seect group
of persons under Secton 81 of the Companes Act, 1956, whch s nether a rghts ssue nor a pubc
ssue. Ths s a faster way for a company to rase equty capta.

A prvate pacement of shares or of convertbe securtes by a sted company s generay known by

name of preferenta aotment. A sted company gong for preferenta aotment has to compy wth
the requrements contaned n Chapter XIII of SEBI (DIP) Gudenes, n addton to the requrements
specfed n the Companes Act. In short, preferenta ssue means aotment of equty to some
seected peope by a company whch has ts share aready sted.

Example
On Apr 20 ths year, ACC has entered nto a Share Subscrpton Agreement wth Shva Cement
Lmted (SCL), Rourkea, Orssa, by whch ACC woud be nducted as a sharehoder of ths company.

Accordng to ths Agreement, ACC w subscrbe Preferenta Aotment of 1,45,00,000 Equty Shares
of Shva Cement Lmted wth a face vaue of Rs. 2/- and a premum of Rs. 9/- per Equty Share n a,
aggregatng to Rs. 15.95 crore and further Subscrbng to Preferenta Aotment of 2,27,00,000
warrants of Shva Cement Lmted, whch has an opton to convert nto correspondng number of
Equty Shares at a face vaue of Rs. 2/- and a premum of Rs. 9/- per Equty Share wthn 18 months
from the date of aotment.
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A Study on Preferential Allotment in lndian Context
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Ths s a strategc move by ACC as they have suppy agreement wth SCL whch operates a mn
cement pant wth a cnkerng capacty. It has the scope of beng expanded further. ACC s hopefu
that after ths they can ncrease ther producton capacty n Orssa.

Advantages
One advantage of rasng money va a preferenta ssue s that t heps save costs and tme nvoved
n a pubc ssue. More mportant, f the concerned company s not dong too we at that pont n tme
but requres capta, then reta nvestors may not want to partcpate n an ssue.

At the same tme, there coud be some nsttutons whch vew the company's troubes as beng
temporary and fee that some n|ecton of capta coud hep t out of the trough.

In fact, promoters need such nvestors n tmes when the market sentment s weak and a pubc
ssue coud fa. Moreover, f promoter s beng aotted preferenta ssue and they acqure more
shares n the company, t s a good sgn because t shows that the corporate shp s not snkng and
they have abdng nterest n the company.
There s no requrement of fng any offer document / notce to SEBI n case of the preferenta
aotment and even no egbty norm for the company for the preferenta aotment.

Apart from ths, n the preferenta aotment, the shares are ssued n buk and, hence, when huge
fund requrement s there wthout ncurrng much cost and wthout nvestng much tme.

In current scenaro, where there s ots of takeover n preferenta ssues, the shares are ssued to
frendy nvestors ke promoters to ward-off the rsk of take over. If shares are ssued to pubc, there
s a chance that ater they can se t to a frm whch has an ntenson of take over.

Pitfalls
The preferenta aotment s often msused by the promoters as they coud secure t because of
ma|orty hodng by them and they consodate ther hod on the company wthout payng a far prce
for t. As per Secton 81 (1A) of the Companes Act, t s merey a formaty though speca resouton
need to be passed but ony members present n person and through proxy are counted.

There s a possbty of nsder tradng. It was a case wth Hndustan Lever (HLL)'s purchase of eght
akh shares n Brooke Bond Lpton Inda Ltd. (BBLIL) before the pubc announcement of the merger
between HLL and BBLIL n 1998. Because of the fact that HLL as a subsdary of Unever knew about
merger; they had nformaton and they acquredshares at consderaby ower prce before
announcement of merger.

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A Study on Preferential Allotment in lndian Context
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There have been vews of t beng ant-democratc as ony a few payers are offered to buy the share,
that too at a much cheaper prce.

But the man probem whch has rased the eyebrows of SEBI s more serous. Apparenty, promoters
take advantage of bu-run by offoadng shares at rung market prces (whch used to be hgher) and
gong n for preferenta aotment at mnmum prce as per the formua gven n SEBI (DIP) Gudenes
(whch are ower than current market prces). As such, promoters are profteerng from the bu-run
and are aso n a poston to mantan ther stake through preferenta aotments to themseves.

Regulations for Preferential Allotment as per Chapter Xlll OF SEBl DlP (Disclosure &
lnvestor Protection) Guidelines, 2000

1. No preferenta aotment shoud me made aong wth the rghts ssue.

2. A speca resouton needs to be passed, but f |ust an ordnary resouton s passed, preferenta
ssue of shares may be done provded sancton of the Centra Government s obtaned.
3. Prcng - The prce at whch the preferenta shares are to be offered are governed by the SEBI
gudenes n case of sted companes. Such shares cannot be ssued at a prce whch s ess than the
hgher of the foowng: -

The average of the weeky hghs and ows of the cosng prces of the shares on the stock
exchange durng 130 tradng days precedng the reevant date; or
The average of the weeky hghs and ows of the cosng prces of the shares on the stock
exchange durng 10 tradng days precedng the reevant date.
Reevant date means the date 30 days pror to the date on whch genera meetng of the
sharehoders s hed.

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A Study on Preferential Allotment in lndian Context
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4. Instruments ssued on preferenta bass to the promoters are sub|ect to a ock-n of 3 years from
the date of aotment, and for other groups, ock-n s 1 year.

5. In case, promoter(s) of a company ses hs shares durng ast sx months from the reevant date,
he w not be egbe to acqure shares through preferenta aotment.

6. In case, the company s makng a preferenta aotment of shares to promoters, the entre
sharehodng of the promoter(s) sha necessary be n demat mode.

Current Trends in lndia

Preferenta aotments are currenty used n Inda n varety of ways. Mutua fund, venture capta
frms, FIs, etc., due to there barganng power, are bg buyers of these ssues. Reason s that they get
t at dscount and en|oy capta apprecaton n short perod. In 2005, Centuron Bank of Pun|ab rased
Rs. 384 crore through a preferenta ssue of equty to funds managed by GW Capta, ChrysCapta
and Ctgroup Venture Capta Internatona Growth Partnershp, Maurtus.

In Inda, arge numbers of companes are pannng to ssue shares to promoters through preferenta
aotment and some of them have aready done so n past.

For exampe, Promoters of TV 18 sod ten akh shares at Rs. 168.35 per share on November 07, 2003
to a mutua fund, and after one week, approved a preferenta ssue at Rs. 152/- per share, wth a net
proft/dfference of Rs. 1.4 crore between the two prces.
The market prce of the scrp on December 5, 2003 was Rs. 195/-. Promoters got dscount of about
22% of the prevang market prce.

And, ths s not the ony case. There are ots of such nstances, where promoters sod there stake n
the market |ust before the preferenta aotment and earned unscrupuous profts despte of a the
reguatons. Due to these cases of msuse of preferenta aotment by promoters, SEBI has made
many amendment to DIP gudenes.
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