Whether a Valuation Report is required for the Private Placement of Shares

If your organization is looking to issue the shares on a private placement basis to a handful amount of investors and you are unsure of its process and confused about whether you are required to draw a valuation report then you need to take the right guidance from the desk of our experts who will help you in understanding the process of private placement in a great detail. 

Introduction to Private Placement 

As the name implies Private Placement is the private placing of the organization’s shares to a certain group of individuals. In the private placement, the offer to subscribe to the organization’s securities is made to a certain group of people. 

This type of issuance of securities is an alternative for companies to raise capital instead of going through the conventional method of Initial Public Offer (“IPO”). Private placement offers are generally made to private insurers, pension plans, and venture capital. Private Placement is opted as an alternative method of securing the funds by an IPO because it offers low costs and lesser regulatory burden on the organizations. 

What is the Threshold for making the Private Placement?

• A Private Placement offer can be made to a maximum of 200 persons

• The number of 200 is exclusive of the Qualified Institutional Buyers and the employees under the Employee Stock Option Plan (ESOP)

• If the offer is made to more than the prescribed number of individuals then the offer will be treated as the Public Offer. 

Requirements for Private Placement

The organisation is required to follow some conditions before going for a private placement of the shares and these conditions are as follows:

• Bank Account: The first and foremost conditional requirement for issuing the private placement of the shares is opening a separate account with a Scheduled bank. The money from the investors will be deposited in this bank account and will continue to be so until allotment. 

• Advertisement: The organisation is not required to make an advertisement to the general public or any other ways to make the general public aware of the private placement offer. 

• Resolution: The special resolution passed by the organisation for the issuance of the private placement is valid for 12 months from the date of its passing. 

• Valuation Report: The organisation is required to obtain the valuation report from a registered valuer to issue the private placement. 

• Price of the Share: The price of the share should not be less than the value derived in the Valuation Report by the registered Valuer. 

Special Resolution for Private Placement 

The organization is required to take the approval of the company before approving any issuance of the securities and this approval can be obtained with the passing of a Special Resolution to this effect. 

Advantages of Private Placement

Raising funds by an organization is an essential decision because funds act as a bloodline to the organization.  An organization only functions properly and efficiently once it knows the perks of its chosen funding option. Hence, the advantages of private placement are as:

• Low Costs: The most important advantage of choosing private placement as a method of raising funds as compared to an IPO is the lower costs because of its lesser expense in marketing and regulatory measures. 

• No Public Disclosure: With the private placement of shares the organization is not required to make any sort of disclosures about the financial or operational details of an organization to the general public as it is required at the time of an IPO. 

• Attract more Investors: With the private placement of shares, different types of investors can be counted upon. Even institutional investors such as Venture Capitalists, and Private Equity Investors can get on board with the help of private placement of shares. 

• Shorter Time: Going through the process of an IPO takes more time while a private placement is a quicker process because it is streamlined. 

• Customization of Security: The private placement gives the organizations an upper hand in customizing the securities as per the whims of the investors.  

• Flexibility: Private Placement gives organizations flexibility in choosing the right kind of investors for them which makes the process easier, quicker, and streamlined. 

Disadvantages of Private Placement

As every coin has two sides the same goes with Private Placement. It has some disadvantages that an organization is required to keep in mind while going for a Private Placement instead of an IPO. The disadvantages run as: 

• No Transparency: With the issuance of an IPO there are various disclosures required to be made by an organization which does not apply to the case with a private placement. This is why it becomes difficult for an investor to evaluate the investment in a nutshell.  

• Limited Investors: Private Placements allow a small number of investors to be added to the organization as compared to an IPO. 

• Liquidity: The investors of Private Placement shares have to face lower liquidity issues as the selling and buying of these securities are difficult in an open market. 

• Higher Risk: The investors of a Private Placement carry a higher risk on their investments as compared to an IPO because there are very less amount of disclosures that an organization going for a Private Placement is required to make. 

• More Regulations: Private Placement has to go through the difficult process of more stringent regulations requiring expertise and navigation. 

Thus, these are the advantages and disadvantages that an organization must keep in mind in choosing whether to go for Private Placement or not. 

Who are the group of persons under Private Placements?

Private Placement of shares is made to the individuals who meet the eligibility criteria of being an accredited investor and are exempt from registration under Regulation D of the Securities Act, 1933. 

Types of Private Placement

Private Placements are of two kinds which can be offered by an organization to its investors. The investor must keep track of the pros and cons of each private placement to arrive at the conclusion on which type of security they should go for. These are as follows:

• Qualified Institutional Placement: This type of Private Placement is an offer made by the listed companies to its investors. Qualified Institutional Placement (“QIP”) is a cost-effective and time-saving method as it allows the organization to raise funds quickly and with fewer regulatory procedures. QIP was developed by the Securities and Exchange Board of India to reduce the dependency of organizations on Foreign Capital Resources for raising further capital in comparison to a Follow-Up Public offer. 

• Preferential Allotment: As the name implies it is a method of raising funds by offering the securities to a certain group of investors at a predetermined price. The investors are chosen based on their net worth and their investment experience. Securities under Preferential Allotment are sold to institutions rather than the general public. 

Reason for choosing Private Placement 

There are broadly two reasons that make Private Placement the best alternative to go for an IPO or FPO. These reasons are as follows:

• No Stringent Rules: With the help of Private Placement organizations are not required to follow the stringent rules as applicable to a normal IPO. 

• Versatile Funding: As we have already discussed the issuance of the private placement of shares to the specified group of investors who are experts in their fields makes it easier for the organizations to use the funds more constructively. Also, organizations can any time opt for the issuance of the shares via Private Placement. 

These are the reasons that make Private Placement a better option for the organizations to raise further funds. 

Maximum Limit for the Issuance of Private Placement 

The offer for private placement is required to be made to only 50 persons. This number of 50 persons does not include the qualified institutional buyers and the employees of the organization to whom the shares have already been issued under a different scheme of the organization. 

The offer or invitation for the private placement of the shares shall not be more than 200 persons in a financial year. The capping of the maximum number of persons shall not apply to: 

• Housing Finance Companies registered with the National Housing Bank under the National Housing Bank Act, 1987

• Non-Banking Financial Companies registered under the Reserve Bank of India Act, 1934. 

Valuation of the Private Placement Security

It is a process that determines the fair value of the securities issued in the Private Placement including equity, debt, or convertible securities. The process usually involves a negotiating process between the investors and the organization to arrive at the true valuation of the securities. It takes into account factors such as the terms and conditions of issuing the securities, market trends, and the financial position of the organization. The valuation report is prepared in consultation with the esteemed investors of the organization. 

Need for preparing Valuation Report for Private Placement 

Some reasons make it essential to prepare a Valuation Report for Private Placement and these reasons run as under:

• Fair Value of the Securities: With the help of a Valuation Report a fair market value of the securities offered to the general public is revealed along with the actual financial position of the organization in terms of its finances, assets, liabilities, and the business prospectus. 

• Transparency and Credibility: To be more transparent and credible in their dealings the organizations must prepare proper Valuation Reports for Private Placement of the shares. 

• Statutory norms: It is an essential requirement by the Securities and Exchange Board of India to check that the price at which the securities are issued is fair and reasonable and this is why it is required to have a Valuation Report.

Mode of Payment for Private Placement 

The investor is required to apply for private placement along with the application form and the subscription money either via demand draft, cheque, or any other banking channel but not cash. An organization is required to keep track of the bank accounts from which the subscription money is being received. 

Maintaining the records for Private Placement 

An organization is obliged to maintain the record for the private placement offers in FORM PAS-5 and copies of the record and the offer letters are required to be filed with the Registrar of the Companies under FORM PAS-4 within 30 days from the circulation of the Private Placement Offer. 

If the organization is a listed entity,  the private placement offer along with the private placement offer letter must be filed with the Securities and Exchange Board of India within 30 days of circulation of the Private Placement Offer. 

Allotment of Private Placement 

An organization is required to allocate the securities within 60 days after receiving the subscription money. If the organization is unable to allocate the securities after 15 days from the date of passing of the 60 days the organization is required to repay the subscription money to the applicant. The organization is under an obligation to keep the application money in a different account with a scheduled bank. 

If the organization is unable to pay back the application money to the applicants with the completion of 15 days after 60 days, an interest of 12% is required to be paid by the organization on such an amount. 

Steps for the Issuance of Private Placement Securities

The steps for the issuance of the private placement of the securities are as follows:

• Convene the Board Meeting: The meeting of the Board of Directors is required to be called upon. The call for this Board Meeting shall be served with prior notice of 7 days along with the agenda of the meeting and the notes to the agenda. Though an earlier meeting can be fixed to call upon the Directors and discuss an agenda. The offer for the private placement, valuation report, and the notice for the general meeting shall be approved in the Board Meeting of the Directors. 

• Convene General Meeting: The General meeting of the members is required to be called upon to obtain the approval of the private placement utilizing a special resolution. The members are required to be intimated of the meeting at least 21 days before it. 

• MGT-14: The organisation is required to file the MGT-14 with the registrar of the companies within 30 days after the passing of the resolution. 

• Private Placement Offer Letter: The offer letter of the private placement is required to be circulated in the form PAS-4 to the selected group of investors. 

•  Application Money: The application money from the investors will be received in a separate account and the organisation is required to issue the securities within 60 days if the organisation fails to issue the shares the organisation will be liable to return the application money at the rate of 12% interest.

• Board Meeting: The Board of Directors convenes a board meeting to authorising the allotment of the shares and a Director is authorized to file the return on the allotment with the ROC, issuing of the shares, and the payment of the stamp duty on the issue. 
• Filing with ROC: The organisation is required to file the return of allotment with the Registrar of the Companies under FORM PAS-3 within the completion of 30 days of the allotment. 

• Issuance of the Share Certificates: The organisation is required to issue the share certificates to the investors. The Share Certificate is required to be signed by two directors and bears the common seal of the organisation. 
• Stamp Duty: The organisation is required to pay the Stamp Duty on the shares as per the prevailing rates of the State in which the organisation is situated. 

What is the Return of Allotment of the Private Placement?

The organization is required to file the return of the allotment of the securities with the Registrar of the Companies. The return is filed under FORM PAS-3 within the completion of 30 days from the allotment. 

Methods for Valuation of Private Placement 

There are two types of valuation of the private placement. These methods have been derived to present the accurate valuation of the securities as an element of transparency is missing in the issuance of the securities under Private Placement. The methods of valuation are as follows:

• Market Valuation Method: As the name implies a thorough evaluation of the market dynamics is required to be taken into consideration for arriving at the true valuation of the securities. In the Market Approach method the value of similar securities recently sold in the market is taken into consideration. This is because it allows the organization to know and examine comparable prices of the comparable securities in the market. 

• Income Approach: In this type of approach the present value of the future securities and the cash flow are taken into consideration to arrive at the true valuation of the securities being issued in the Private Placement. It takes into account the demand of the market, the financial performance of the organization, future prospectus, etc. 

Penalty in case of the Non- Compliance

If an organisation makes an offer for the Private Placement of the Securities against the rules and regulations of the Companies Act, 2013 then a penalty equivalent to the offer value of the securities or Rs. 2 crore whichever is higher can be charged. If the organisation is unable to proceed with the issuance of the securities in such a case the organisation is required to return all the monies within 30 days of the order which imposes the penalty. 

If the organisation defaults in the filing of the return on allotment then the company, its directors, and the promoters will be liable to pay Rs. 1000 per day which may go maximum to Rs. 25 lacs. 

Conclusion 

Private Placement of shares is a famous and one of the most used methods of organizations for raising funds. An organization cannot make any kinds of advertisements, or use any marketing or distribution techniques to offer their securities. Private Placement offers can only be made to qualified institutional investors, or small group of individuals, etc. 

FREQUENTLY ASKED QUESTIONS 

Q1. What is the validity of the Valuation Report for Private Placement under FEMA?

Ans1. The Valuation Reports have a validity period of 90 days for private placement under the FEMA. 

Q2. Is a valuation report mandatory for private placement for private companies?

Ans2. Yes, the details of the Valuer and the Valuation Report are required to be mentioned in the Offer Letter for Private Placement

Q3. What is the minimum value for Private Placement?

Ans3. The value of per person security shall be an investment size of Rs. 20,000 of the face value of the securities. 

Q4. Is  Private Placement Risky?

Ans4. Yes, due to lesser liquidity and transparency Private Placements are risky. 

Q5. What is the time limit for the Valuation Report for Private Placement?

Ans5. The Valuation report should be 30 days before the General Meeting for issuance of the Private Placement shares.