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The Capital Structure of a Private Limited Company in India

The Capital Structure of a Private Limited Company in India

by Sanjeev Archak

In our previous posts, we have examined the pros and cons of registering a private limited company in India. In this post, we shall examine the capital structure of a private limited company.

Kinds of Share Capital:

A private limited company can have –

1. Equity Share Capital with voting rights  and equity share capital with differential rights as to dividend, voting or otherwise

2. Preference Shares

Issuing Shares with Differential Voting Rights:

Issuing shares with differential voting rights have now become difficult under the Companies Act, 2013. The Act now imposes conditions which have to fulfilled by a Company. Any company, public or private will have to now comply with the below-mentioned requirements:

1. Share have to be of “equity class”
2. Existing share capital cannot be converted to a differential voting class
3. Issuance requires prior shareholders’ approval through ordinary resolution.
4. Shares shall not exceed 26% of total post issue paid up equity share capital
5. The company should not have defaulted in filing financial statements & returns for 3 financial years
6. The company should not have subsisting default in the payment of the following –

a) Declared dividend to its shareholder
b) Repayment of matured deposits
c) Redemption of preference shares or debentures
d) Payment of interest on debentures or deposits
e) Repayment of loans from banks and public financial institutions
f) Payment of dividend to preference shareholders
g) Payment of statutory dues to employees
h) Depositing money into Investor Protection & Education Fund

Preference Shares

Preference shares issued by private companies cannot have voting rights. The Companies Act 2013 has removed the distinction between cumulative and non-cumulative preference shares.

The Issue of Shares:

A private limited company can raise further capital by issuing shares through:

1. Private placement of shares
2. Rights & Bonus issue of shares

Private Placement of Shares:

The Companies Act 2013 defines private placement as any offer of securities or invitation to subscribe to securities to 200 people or less in a financial year. The offer of securities made to existing shareholders is termed as “Rights Issue” and does not fall within the ambit of the private placement. A reading of Sections 42 and 62 of Companies Act leads to the conclusion that both private placement & preferential allotment are synonymous.

Key points to be noted:

1) Offer Letter:

Private placement must be made through an offer letter. The prescribed format of an offer letter is as per the Form PAS-4. The offer letter contains the following:
a) General information about the company
b) Note on the business activities
c) Management of the company
d) Risk factors
e) Defaults, if any, committed by the company
f) Particulars of the offer viz, kinds of security, price per security etc.
g) Purposes and objects of the offer
h) Disclosure of interest of directors, litigation etc.
i) Financial position of the company
j) Pre & post issue capital structure

2) Offer Size:

The value of offer or invitation per person must be with an investment size of not than INR 20,000 of the face value of the securities. The requirement of the offer being of a minimum of INR 20,000 of the face value per person seems stringent. The private placement rules are silent on whether the offer can be of Rs 20,000 and above with actual investment made being lower than Rs 20,000.

However, if the investment must be for a minimum of Rs 20,000 it may be impractical for angel & VC investors who prefer investing with a substantial premium.

3) Pricing:

The price of the security has to be decided by a Registered Valuer. A valuation report certified by the Valuer must be part of the offer documents. The Companies Act has defined a list of persons who qualify as Registered Valuers.

4) Share Application Money:

The share application received from the applicant must be held in a separate bank account maintained with a scheduled bank. Such money cannot be utilized for any other purpose other than the allotment of shares. The shares must be allotted within 60 days of receiving such money. If the shares are not allotted within 60 days then it must be returned within 15 days along with interest of 12%.

 

Rights Issue:

Right Issue’ means offering shares to existing members in proportion to their existing shareholding. The object is, of course, to ensure equitable distribution of Shares and the proportion of voting rights is not affected by the issue of Fresh shares.

Key Points to be noted:

1) Offer Letter

The rights issue is made through an offer letter. The offer letter contains the following:

a) Number of shares issued
b) Price of shares
c) Record Date fixed by the Board of Directors
d) Duration of the offer i.e., date of opening & closing of the offer

2) Acceptance/Renunciation/Rejection of rights issue:

The members of the company are free to either accept or reject the rights issue. In the case of acceptance, the members are required to submit the application form within specified dates. In the case of rejection, the members are required to submit a rejection form within dates specified in the offer letter. Upon rejection by a member, the shares revert to the custody of the Board of Directors who are authorized to dispose of the shares in a manner most beneficial to the company.

3) Share Application Money:

The share application received from the applicant must be held in a separate bank account maintained with a scheduled bank. Such money cannot be utilized for any other purpose other than the allotment of shares. The shares must be allotted within 60 days of receiving such money. If the shares are not allotted within 60 days then it must be returned within 15 days along with interest of 12%.

Bonus Issue:

Bonus shares, as the name suggests, are allotted to existing shareholders at no cost. The additional shares are issued in proportion to their existing shareholding. Bonus shares are issued out of:

a) Free Reserves ( accumulated profits of the company)
b) Securities Premium account (share premium)
c) Capital Redemption Reserve ( reserve created for redemption of preference shares or debentures)

Bonus shares are issued to bring the capital in line with the assets employed in the business. This is also useful to bring down the price of a share. Further, the number of shares held by a shareholder increases but the shareholding remains the same before the bonus issue.

The bonus issue is similar to a rights issue with the exception that no money changes hands. Bonus shares are created out of company reserves.

 

If you are a company looking to raise capital and want to know more about the capital structure of a private limited company, then get in touch with Integra Books. Our experts shall guide you through this complex process.

 

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