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Why Would A Company Do A Private Placement?

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Why Would A Company Do A Private Placement?

The much-awaited Companies Bill, 2013 got the President’s assent on 29 August 2013. The new Companies Act, 2013 (“Act”) seeks to consolidate and amend the law relating to the companies and intends to improve corporate governance, raise levels of transparency and to further strengthen regulations for corporate. The Act has made significant changes to the provisions of law and has introduced several new concepts. This article deals with the changes made to provisions relating to private placement of securities, which has been an important route of fund-raising for companies. The tightening of private placement norms is done in the backdrop of the recent dispute between the securities market regulator SEBI and Sahara Group where the Supreme Court had ordered the Sahara Group companies to refund the amounts collected from investors. The intent behind the changes is to make the practice more transparent and to prevent misuse of the provisions.

Private placement provisions under Companies Act, 1956

As per the proviso to section 67(3) of the 1956 Act, when a company makes an offer or invitation to subscribe for shares or debentures to 50 or more persons, such offers is treated as made to public. Where an invitation in made by the management of a company to selected persons for subscription or purchase by less than fifty persons receiving the offer or invitation, the shares or debentures and such invitation or offer is not calculated directly or indirectly to be availed of by other persons, such invitation or offer shall not be treated as an offer or invitation to the public.

“Private placement” means any offer of securities or invitation to subscribe securities to a select group of persons by a company (other than by way of public offer) through issue of a private placement offer letter and which satisfies the conditions specified in this section It is to be noted that the provisions for private placement apply to issue of “securities” and not “shares”. The new provisions cover a whole host of instruments such as shares, bonds, debentures and other marketable securities. Section 42(4) provides that any offer or invitation not in compliance with the provisions of the section shall be treated as a public offer and all provisions of the Act, SCRA and SEBI Act shall be required to be complied with in such a case. Offer can be made only to 200 persons in a financial year [Section 42(2) and rule 3.12(2)] Unlike the 1956 Act, under which the number of members in a private company is restricted to 50, private companies under the Act can have members up to 200. As per rule 3.12(2)(b)the Draft Companies Rules, 2013 (“Rules”), an offer or invitation for private placement shall be made to not more than two hundred persons in the aggregate in a financial year, excluding the qualified institutional buyers and employees of the company being offered securities under a scheme of employees stock option as per provisions of section 62(1)(b) of the Act. Section 42(5) of the Act states that all monies payable towards subscription of securities by private placement shall be paid through cheque or demand draft or other banking channels but not by cash.

All securities under private placement are to be allotted within a period of 60 days from the receipt of application money. If not the securities are not allotted within the specified period, the application money is to be refunded within a period of 15 days from completion of 60 days’ time. The entire amount raised by the issue of offer or invitation will have to be parked in a separate bank account and cannot be used until allotted. The particulars of every private offer shall be filed with the Registrar within 30 days of circulation of offer letter. The companies offering or inviting subscriptions under private placement cannot advertise or utilize any marketing media.

Compliance required under the Rules

Part II of Rules deals with private placement. Rule 3.12 prescribes certain additional requirements to be complied with in case of private placement. A private placement offer letter shall be accompanied by an application form addressed specifically to the person to whom the offer is made and shall be sent to him, either in writing or in electronic mode, within thirty days of recording the names of such persons in accordance with section 42(7) of the Act. No person other than the person so addressed in the application form shall be allowed to apply through such application form and any application not so received shall be treated as invalid. The proposed offer of securities or invitation to subscribe securities must be approved by the shareholders of the company, by way of a special resolution, for each of the offers/ invitations. The offer or invitation shall be made to not more than two hundred persons in the aggregate in a financial year, excluding the qualified institutional buyers and employees of the company being offered securities under a scheme of employees stock option as per provisions of clause (b) of sub-section (1) of section 62 of the Act. The number of such offers or invitations shall not exceed four in a financial year and not more than once in a calendar quarter with a minimum gap of sixty days between any two such offers or invitations. The value of such offer or invitation shall be with an investment size of not less than fifty thousand rupees per person. The payment to be made on subscription of securities shall be made from the bank account of the person subscribing to such securities. However, monies payable on subscription to securities to be held by joint holders shall be paid from the bank account of the person whose name appears first in the application.

Penalty for non-compliance

Section 42(10) of the Act prescribes the penalty for contravention of section 42. If a company makes an offer or accepts monies in contravention of the section, the company, its promoters and directors shall be liable for a penalty which may extend to the amount involved in the offer or invitation whichever is higher. Also, the company is required to refund all monies to subscribers within a period of thirty days of the order imposing the penalty.

Position of unlisted public companies

In December2011, the Ministry of Corporate Affairs had issued Unlisted Public Companies (Preferential Allotment) Amendment Rules, 2011 (“2011 Rules”) and made the preferential allotment rules as applicable to public companies more stringent. Some of the provisions of 2011 Rules are listed below: The offer for preferential allotment cannot be made to more than 49 persons. Any offer or invitation not in compliance with provisions of section 81(1A)read with section 67(3) of the 1956 Act would be treated as public offer and provisions of the SCRA and SEBI Act will need to be complied with. The money payable on subscription should be paid only by way of cheque or DD or other banking channels but not by cash. Allotment of securities should be completed within 60 days from the receipt of application money. If not so allotted, the company should repay application money within 15 days thereafter, failing which it should be repaid along with an interest at the rate of 12% per annum. The application money should be kept in a separate bank account and should not be utilized prior to allotment. Company offering securities cannot release any public advertisements or utilize any media, marketing or distribution channels or agents to inform the public at large about the offer. The private placement provisions as contained in the Act have incorporated the provisions of the 2011 Rules. While the 2011 Rules were applicable to public companies only, the provisions of the Act on private placement will apply to all companies. Once the Act comes into force it is to be seen whether the 2011 Rules will be repealed or the public companies will be required to comply with both the Act as well as the 2011 Rules.

In to make money with stocks there are steps you need to takes, below are some of the steps:
• Conduct research before buying stocks: avoid buying the wrong shares by conducting research before buying the shares, because the worst share is the wrong shares, Before buying any shares look into the following to prevent buying a stale stock.
• Look at composition of the board of directors or management team of the company you want to buy to buy their shares. Whether the share is in the secondary or still in the primary market, ensures that they are tested and trusted, also check the stability of the board of directors and the management team for the past five years. It is advisable to buy from company that has their management team tested and trust or are known to be successful in the pass.
• Look in to the track record: check the record of the company you intends to buy the shares from, find out the financial performance, and the investor’s interest in the past years. Have they been fulfilling their promises a good company will always be exceeding its financial projection.
• Look in their dividends policy: check their dividends and bonus issuance policy, if they have being doing or not, if it is every year or two years then it is good to buy.
• Look into their institutional investors: look into the insurance companies, and fund manager and other institutional investors that buy their stocks, these companies has effective research tools and the market more than you can do if these companies can decides to do business with them then fine , you can go on to do buy their stocks.
• Contact a stock broker. You need stockbroker to start stock business. The stockbroker act as a platform through which you buy and sell shares.
Buy into private placements and initial public offers.

A private placement memorandum is an offering document, sometimes called a prospectus, offering circular, or PPM. The majority of early startups and emerging growth companies commonly raise money through what are known as private placements. It is simply a sale of stock (or debt) in the company to private investors that become shareholders in the company. The reason they are classified as private, is not because they are private investors, but because the offer and sale of stock (a security) does not involve any public advertising or general solicitation of investors.

For example, when a stock goes public, they are offering stock publicly by filing a registration statement, press releases, etc. This process of registering the securities with the SEC allows the company to utilize the media and other methods to offer its stock for sale. Since most companies don’t have the money or resources to file a registration statement with the SEC, they rely upon selling the stock through exemptions from registration. Although there are other exemptions that are used, the most common exemptions used under federal securities laws (Securities Act Section 3(b)) for startups raising money are:
• Regulation D: Private offer and sale of securities requiring compliance with manner of offering requirements and limitations on resale of securities requirements. The common categories are listed under the following 3 classes:
• Rule 504: raise up to $1 million within 12 month period; no specific information requirements for PPM
• Rule 505: raise up to $5 million in a 12 month period; unlimited number of accredited investors and only up to 35 unaccredited investors; 502(b) information disclosures required
• Rule 506: unlimited amount of money raised within a 12 month period to accredited investors; unlimited number of accredited investors and up to 35 unaccredited, but “sophisticated” investors; Rule 502(b) information disclosures required

If Rule 505 or 506 placements are only sold to accredited investors, there is no information specifically required to be provided. If there is even one non-accredited investor, the company must provide (unless they are already a reporting company with the SEC) certain financial and non-financial statement information. The term accredited investor was amended recently under the Dodd-Frank Act. There are a number of categories to qualify based upon things such as recent income and net worth, but the main change was to limit the definition for net worth to not include the investor’s primary residence as an asset and not include the mortgage on their primary residence as a liability (except for debts taken out within 60 days, for example a cash out refinance).

Rule 502(b) does also required the company to provide reasonable access to information requested by potential purchasers for Rule 505 and 506 offerings prior to their purchase. Even though a sale may be exempt from registration and have limited or no information requirements to provide to potential investors, the anti-fraud rules still apply and a company can get into a serious bind if they misrepresent, lie, omit, or misstate items about the company, its business, its management, future business, and other items. Those exemptions require that no public advertising or general solicitation is used in the offer and sale of those securities. So, the company is not able to start issuing press releases, posting website ads, or sending mass mailings to potential investors in most cases.

This does make it more difficult to get your message out there, but it must be complied with for the offering and sale to qualify for the exemption and not violate securities laws. Often this results in needing to be introduced to prospective investors through connections. When the company decides to raise money through a private placement (which can also be in the form of a loan, which is still classified as a security), they have certain rules they must follow for the placement to qualify for the exemption and comply with securities laws. A recommended list of categories for your business plan (which will also cover many of the PPM information requirements):
• Executive Summary– A brief, usually one page or so, overview of what your company does, how it is different or solves an existing problem, who your team is, and what your plans are to grow the business (i.e. how are you going to make money for the investor)
• Management Team– Name, title, and a bio on each top member of the management team (officers and directors) to show what experience or assets they are bringing to the table
• Product or Service Description– What do you do and how is it novel or better than something else out there and how do you make money from it?
• Intellectual Property Protection– How have you or will you protect your company’s ideas, brand name, developments?
• Manufacturing and Operations– How will you produce the product or provide the service, as well as manage and operate the administrative side of things?
• Human Resources– How many people do you have now and how many do you plan to bring on? Any other challenges, such as using independent contractors versus employees? Do you still need to identify and hire certain positions in the company?
• The Market– What market are you targeting and where do you fit into it? What are the landscape and current trends in the market or industry?
• Competition– You are probably not the first person to think of this, so how are you better or different than your current or future competitors?
• Sales and Marketing– How do you plan to get your message out about your produce or service?
• Company Background and Structure– things like current capitalization, how the company was formed, is it a C corporation formed in a certain state…
• Financial Information– current, historical, and future pro forma financial statements such as balance sheet, statement of cash flows, and profit and loss statement.

• Exhibits & Footnotes– At the end when you may want to attach full pro forma financial statements as exhibits, you should also think about other things related to the business. Some people add a copy of the patent filings and issued patents the company owns, research/white papers, SEC filings, license or joint venture agreements, process flow diagrams, and other information that you can summarize in the body of the business plan, but provides more detailed info if the investor wants to read more. In place of these sometimes lengthy documents, you may want to add footnotes in the body with hyperlinks to the source for your information for the investor to read through those links. Of course, you want to think about confidentiality when it comes to any documents provided, but showing your sources for information can help to show that you have done your homework.

It becomes essential for the company and management during this process to cover all bases and be sure it is protected from lawsuits and SEC or other regulatory action. When a company fails to execute what they said they would do and the investor loses their investment, the plaintiff’s lawyers start circling looking for someone to go after, like the board of directors and upper management or just about anyone involved with the investment process. This is where a private placement memorandum can be a valuable tool to help protect the company and its officers, directors, and others.

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Ascent Law LLC
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Telephone: (801) 676-5506
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