Corporate Law • Companies Act • Fundraising • Private Companies
Private placement under Section 42: why procedural compliance matters
Private placement is one of the principal routes by which an Indian company can raise capital from a selected group of investors without making a public offer. For private companies, startup founders, closely held businesses and investment transactions, it is frequently used for issuing equity shares, preference shares, convertible instruments and other securities.
The governing provision is Section 42 of the Companies Act, 2013, read with the Companies (Prospectus and Allotment of Securities) Rules, 2014. Where shares are issued on a preferential basis, Section 62(1)(c) and the Companies (Share Capital and Debentures) Rules, 2014 may also apply. The two provisions should not be treated as alternatives where the transaction attracts both.
Section 42 is compliance-sensitive. A defective offer can create consequences far beyond a late filing fee: an issue made to more than the permitted number of persons can be deemed a public offer, and contravention can expose the company, promoters and directors to statutory penalties and refund obligations.
What is a private placement?
Section 42 defines private placement as an offer or invitation to subscribe to or issue securities to a select group of persons, other than by way of a public offer, through a private placement offer-cum-application satisfying the statutory conditions.
The defining features are therefore:
- the offerees are identified in advance;
- the offer is not made to the public at large;
- the prescribed numerical limit is respected;
- the offer is made through the prescribed private-placement process; and
- subscription and allotment follow the statutory money trail and filing requirements.
Section 42 versus rights issue versus preferential allotment
| Route | Core provision | Typical use |
|---|---|---|
| Rights issue | Section 62(1)(a) | Offer to existing equity shareholders in proportion to existing holdings, subject to the statutory framework |
| ESOP | Section 62(1)(b) | Employee stock options under an approved scheme |
| Preferential issue | Section 62(1)(c) | Issue of further shares to selected persons, whether or not existing shareholders, subject to valuation and prescribed conditions |
| Private placement | Section 42 | Offer of securities to identified persons within the private-placement framework |
A preferential allotment of shares to selected investors will ordinarily require the company to examine both Section 62(1)(c) and Section 42, together with the applicable rules. Transaction documents should therefore be structured only after identifying the legal route, security type, investor class, valuation basis and corporate approvals.
Who can receive a private placement offer?
The Board must identify the persons to whom the offer will be made. Section 42 does not permit a company to circulate an open invitation and later characterise the subscribers as a private group.
Rule 14 prescribes the numerical ceiling for private-placement offers. The statutory framework generally limits offers or invitations to not more than 200 persons in aggregate in a financial year for each kind of security, excluding qualified institutional buyers and employees receiving securities under an employee stock option scheme in accordance with Section 62(1)(b).
The numerical restriction is especially important because Section 42 provides that an offer beyond the prescribed limit can be treated as a public offer, irrespective of whether subscription money has actually been received or whether the company intended to list the securities.
Can private placement be advertised?
No. Section 42 prohibits public advertisements and the use of media, marketing or distribution channels or agents to inform the public at large about the issue.
This restriction is broader than avoiding a newspaper advertisement. Founders and companies should be cautious about public social-media posts, mass email campaigns, open investor forms, public pitch links inviting subscriptions and other communications that undermine the identified-person character of the offer.
Step 1: determine the security and legal route
Before convening the Board, the company should settle:
- the type and class of security;
- number of securities proposed to be issued;
- face value and premium;
- conversion terms, if any;
- identity of proposed investors;
- amount proposed to be raised;
- purpose and utilisation of funds;
- valuation requirements;
- shareholder and investment-agreement rights; and
- whether any sectoral, FEMA, beneficial-ownership or competition-law issue is triggered.
This pre-issue legal review prevents the common mistake of treating PAS-4 as the transaction itself. The form is only one component of a wider corporate and securities-law process.
Step 2: valuation and issue price
Where the transaction is a preferential issue of shares under Section 62(1)(c), the price must comply with the applicable valuation framework under the Companies Act and rules. Depending on the investor and transaction, additional valuation rules may arise under FEMA and tax legislation.
A valuation report should be transaction-specific and contemporaneous. The company should preserve the valuation methodology, assumptions, financial information supplied to the valuer and Board material explaining the commercial basis of the issue.
For investment and acquisition transactions, valuation should also be read with legal due diligence. See M&A Due Diligence Checklist for Private Companies in India.
Step 3: Board approval and identification of offerees
The Board process should approve the proposed fundraising structure and identify the proposed offerees. The minutes should accurately record the commercial and legal basis of the transaction rather than merely reproducing form language.
Depending on the issue, the Board will also approve the notice for the general meeting, explanatory statement, valuation material, draft offer-cum-application and authorised officers for filings and banking formalities.
Step 4: shareholder approval
Rule 14 requires prior shareholder approval by special resolution for private-placement offers, subject to the specific exceptions and annual approval framework recognised by the Rules for specified securities such as non-convertible debentures.
The explanatory statement should contain the prescribed disclosures, including particulars of the offer, kind of securities, price and basis or justification for price, valuer details, proposed amount, material terms, proposed time schedule, objects of the offer and other prescribed information.
Where Section 62(1)(c) applies, the preferential-issue approval and disclosure requirements must also be satisfied.
Step 5: PAS-4 — private placement offer-cum-application
The offer is made through Form PAS-4 to the identified persons. It is not a freely transferable invitation. Section 42 expressly provides that the private-placement offer and application carries no right of renunciation.
Each offer should be specifically addressed to the identified offeree. The company should ensure that the particulars in PAS-4 are consistent with the Board papers, shareholder resolution, valuation report and transaction agreements.
Step 6: PAS-5 — record of private placement
The company must maintain the prescribed record of private-placement offers in Form PAS-5. This record is important evidence that the offerees were identified and recorded rather than sourced through a public solicitation.
Corporate secretarial records should preserve the chronology: identification of investors, approvals, circulation of PAS-4, receipt of applications and money, allotment and return of allotment.
Step 7: subscription money — no cash and no third-party funding trail
Section 42 requires the identified person to apply with subscription money paid through cheque, demand draft or other banking channel, and not in cash.
The company should be able to match the subscriber, application, bank remittance and allotment. A payment from an unexplained third-party account can create corporate-law, beneficial-ownership, tax, FEMA and anti-money-laundering questions depending on the facts.
Section 42 further requires private-placement monies to be kept in a separate bank account in a scheduled bank and restricts their use except for adjustment against allotment or repayment where allotment cannot be made.
Can the company use the money immediately?
No. A critical Section 42 safeguard is that the company cannot utilise money raised through private placement unless allotment has been made and the return of allotment has been filed with the Registrar in accordance with Section 42(8).
This is a transaction-closing control. Finance teams should not treat receipt of subscription money as unrestricted working capital.
Step 8: allotment within 60 days
The company must allot the securities within 60 days from receipt of the application money.
If allotment cannot be completed within that period, the company must repay the subscription money within 15 days after expiry of the 60-day period. Failure to repay within that additional period attracts interest at 12% per annum from expiry of the 60th day.
Where investors remit funds on different dates, the company should track the statutory clock carefully against each receipt rather than relying only on the proposed closing date.
Step 9: PAS-3 return of allotment
After allotment, the company must file the return of allotment in Form PAS-3 with the Registrar within the period prescribed under Section 42 and Rule 14. For private placement, the statutory framework requires filing within 15 days from the date of allotment.
The return should accurately capture the allottee details, security particulars, consideration and prescribed attachments. Filing PAS-3 is not merely an administrative afterthought because Section 42 links utilisation of the funds to filing of the return of allotment.
No fresh offer until the earlier offer is completed, withdrawn or abandoned
Section 42 restricts a fresh offer or invitation until allotments under the earlier offer have been completed or the earlier offer has been withdrawn or abandoned, subject to the statutory proviso concerning more than one issue to such class of identified persons as may be prescribed.
Companies conducting rolling fundraising rounds should therefore avoid overlapping private-placement processes without first checking Section 42(5) and the applicable Rules.
Private placement compliance checklist
- identify the security and legal route;
- check authorised share capital and constitutional documents;
- identify proposed investors before the offer;
- check the 200-person limit for the relevant kind of security;
- obtain valuation where required;
- approve the transaction at Board level;
- obtain special-resolution approval and make prescribed disclosures;
- complete applicable ROC filings for the resolution;
- issue PAS-4 only to identified persons;
- maintain PAS-5;
- receive subscription money only through permitted banking channels;
- maintain the required separate bank-account trail;
- complete allotment within 60 days of receipt;
- file PAS-3 within 15 days of allotment;
- do not utilise funds before allotment and PAS-3 filing;
- update statutory registers and beneficial-ownership records where applicable;
- issue or credit the securities in the legally applicable form;
- check stamp duty and securities-depository requirements;
- complete FEMA reporting if any subscriber is a person resident outside India; and
- preserve the full transaction file for future due diligence.
Foreign investors: Section 42 is only one layer
Where the subscriber is a person resident outside India, Companies Act compliance does not replace foreign-exchange compliance. The company must separately examine the Foreign Exchange Management Act, the applicable non-debt instrument framework, sectoral caps, entry route, pricing guidelines, beneficial ownership, prohibited sectors and RBI reporting.
A transaction can therefore be validly approved under company law yet remain defective under FEMA if pricing, sectoral or reporting requirements are ignored.
Private placement and beneficial ownership
The name of the immediate subscriber does not always answer the beneficial-ownership question. Companies should examine Sections 89 and 90 of the Companies Act and the applicable beneficial-ownership rules where legal and beneficial interests differ or where a significant beneficial owner exists behind an investment structure.
This is particularly important for layered holding structures, investment vehicles, nominee arrangements and cross-border transactions.
What happens if Section 42 is violated?
Section 42 contains substantial consequences. If a company makes an offer or accepts monies in contravention of the section, the company, its promoters and directors may face a penalty extending to the amount raised through the private placement or ₹2 crore, whichever is lower, together with the statutory refund consequence.
Section 42 also provides that a private-placement issue not complying with the prescribed numerical restriction can be deemed a public offer, attracting the public-offer framework and allied securities legislation.
The risk is therefore not limited to an ROC filing defect. A structurally invalid fundraising process can affect investor rights, subsequent financing, due diligence, M&A readiness and director exposure.
Common private-placement mistakes
- approaching investors publicly before identifying offerees;
- using a generic investment form accessible to anyone;
- confusing a preferential allotment with compliance only under Section 62;
- failing to obtain a legally adequate valuation;
- circulating PAS-4 before the required approvals;
- accepting cash or unexplained third-party remittances;
- using subscription money before allotment and PAS-3 filing;
- missing the 60-day allotment period;
- missing the 15-day PAS-3 filing period;
- starting a new private-placement round while the earlier one remains incomplete;
- ignoring FEMA for non-resident investors;
- failing to examine beneficial ownership; and
- keeping incomplete Board, valuation and investor records.
Why private-placement defects matter in M&A due diligence
Historical share issuances are routinely examined during investment and acquisition due diligence. A buyer or investor will typically reconcile:
- Board and shareholder resolutions;
- valuation reports;
- PAS-4 and PAS-5 records;
- PAS-3 filings;
- bank statements;
- share certificates or depository records;
- register of members;
- capitalisation tables;
- shareholders’ agreements; and
- FEMA filings where applicable.
Unreconciled capital can delay a transaction or produce indemnity, escrow, rectification or valuation issues. For a wider transaction review, see Legal Due Diligence in India: Complete Checklist for M&A, Investment and Business Transactions.
Frequently asked questions
What is the maximum number of persons for a private placement?
The Rules generally prescribe a ceiling of 200 persons in aggregate in a financial year for each kind of security, excluding the statutorily specified categories such as qualified institutional buyers and employees receiving securities under an ESOP compliant with Section 62(1)(b).
Can a private-placement offer be renounced?
No. Section 42 expressly states that the private-placement offer and application shall not carry a right of renunciation.
Can subscription money be paid in cash?
No. Section 42 requires payment through cheque, demand draft or other banking channel and excludes cash.
How quickly must shares be allotted?
The securities must be allotted within 60 days from receipt of the application money. If allotment is not completed, repayment is required within the following 15 days, failing which the statutory interest consequence applies.
When is PAS-3 filed after private placement?
The return of allotment is required within 15 days from allotment under the private-placement framework.
Can the company spend private-placement money before filing PAS-3?
No. Section 42 restricts utilisation until allotment is made and the return of allotment is filed with the Registrar.
Does Section 42 alone govern a preferential issue of shares?
Not necessarily. Where shares are issued preferentially to selected persons, Section 62(1)(c) and the applicable Share Capital and Debentures Rules may operate alongside Section 42.
What is the penalty for contravention?
Section 42 provides for a penalty on the company, promoters and directors that may extend to the amount raised or ₹2 crore, whichever is lower, together with the statutory refund obligation. Separate consequences can arise where the issue is deemed a public offer.
Primary legal sources
Conclusion
Private placement is not simply a private agreement between a company and an investor. Section 42 creates a controlled statutory pathway built around identified offerees, limited circulation, corporate approvals, banking traceability, time-bound allotment, ROC disclosure and restrictions on use of funds.
For companies raising capital, the safest approach is to treat the issue as a transaction closing process: settle the legal route and valuation first, align the Board and shareholder approvals with PAS-4, preserve the PAS-5 and banking trail, allot within the statutory period, file PAS-3 promptly and reconcile the completed issue with the company’s statutory registers and cap table.
This article is for legal education and general information only. It is not solicitation or transaction-specific legal advice. Securities issuance can also attract FEMA, tax, beneficial-ownership, depository, sectoral and SEBI requirements depending on the company, security and investor.