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Preferential Allotment of Shares: Uses, Abuses, and Corporate Governance

When companies need to raise capital, one efficient way is through the preferential allotment of shares. This process, governed by The Companies Act of 2013 and SEBI Regulations, allows companies to issue shares to select individuals or entities. Let's delve into this method, understand its mechanisms, benefits, potential for misuse, and how corporate governance plays a role in ensuring fairness.

Understanding Preferential Allotment

Preferential allotment is akin to a company inviting specific friends to invest, rather than opening the invitation to the public. It is governed by several sections of the Companies Act, 2013:

• Section 62(1)(c): Allows companies to issue shares to anyone if approved by a special resolution.
• Section 42: Permits companies to invite select individuals to subscribe to securities via a preferential offer.
• SEBI Regulations: Mandate additional compliance for listed companies.

How Preferential Allotment Works

Think of a company needing funds. Instead of borrowing money or issuing shares to the public (which involves lengthy procedures and regulations), the company chooses a simpler path: preferential allotment. Here's how it proceeds:

1. Authorization: The company's Articles of Association (AoA) must authorize the issuance.
2. Special Resolution: A special resolution must be passed by the shareholders.
3. Valuation: The price of the shares is determined based on a valuation report by a registered valuer.
4. Disclosure: Details about the allotment are disclosed to shareholders, ensuring transparency.

Benefits of Preferential Allotment

Preferential allotment has several advantages:

• Quick Capital: It is a faster way to raise capital without extensive public procedures.
• No Asset Charge: Companies can raise funds without mortgaging assets.
• Control: Promoters can increase their stake and control in the company.

Misuse of Preferential Allotment

Despite its benefits, preferential allotment can be misused:

• Insider Benefits: Promoters and insiders might issue shares to themselves at favorable prices.
• Market Manipulation: Some may manipulate share prices for personal gains.
• Dilution of Minority Shareholders: Preferential allotment can dilute the shareholding of minority shareholders, reducing their influence.

Corporate Governance and Preferential Allotment

Corporate governance refers to the systems and processes by which companies are directed and controlled. It emphasizes:

• Transparency: Clear and honest communication about the company’s actions and plans.
• Accountability: Holding the company’s board and management responsible for their actions.

When applied to preferential allotment: