Lakshay Garg and Ashika Jain are 3rd-year and 2nd-year students respectively of Gujarat National Law University, Gandhinagar.
In the backdrop of the pandemic, Securities and Exchange Board of India (SEBI) has drafted new policies and restructured the existing framework in an attempt to push the cart of a decelerating economy forward. In an unprecedented measure, SEBI has announced a new price formula for the preferential allotments, which have otherwise survived the dynamics of the market since the last 20 years, without undergoing any major changes. This piece gives microscopic scrutiny of the new policy framework and analyses the viability of preferential allotment over other means of raising capital.
Need for liberating the preference share allotment
Generally, there are three ways through which a company can raise capital- through an Initial Public Offering, which involves an open offer to the public to subscribe to shares, through a rights issue, and lastly by the issuance of preference allotment. The global crisis in the wake of the pandemic has dried out the capital of the companies, which are striving to resuscitate from the impact of the economic slowdown due to the same. In the backdrop of this scenario, preference allotment may prove to be the most viable means to emerge from the slump due to the following reasons-
It enables the company to raise capital without risking its assets as a collateral, putting no charge on its assets.
Once allotted, they add on to the company’s net worth and significantly reduce the company’s debt-equity ratio.
It is considered to be one of the fastest ways of mobilising resources, which is the need of the hour.
Changes in the existing framework
The new framework of SEBI on the preferential allotment has provided a ray of hope to the investors as well as the companies which are in dire need of investments. Initially, the floor price for the issuance of preferential allotment was set at the higher of the two-
The average of the weekly high and low of the closing prices of the related shares quoted on the stock exchange during the six months preceding the relevant date; or
The average of the weekly high and low of the closing prices of the related shares quoted on a stock exchange during the two weeks preceding the relevant date.
Given the slowdown in the corporate sector due to the pandemic, the SEBI has temporarily offered that the companies can choose between the higher of the 2 weeks average or the 12 weeks average, which is likely to attract investment due to lower prices and will pump in the much-needed capital in this sector. Earlier, the 26-week period often showcased a higher average, which made it an unfavourable crapshoot for the investors. The pricing alignment makes the entire process more viable as compared to the previous 26 weeks look back period. The reason for the same is that the previous process was more expensive as compared to the hostile acquisition through secondary stake acquisition.
However, another aspect of the change brought in by the SEBI includes the mandatory lock-in period of 1 year extending to 3 years in case of non-promotor allotments or promotor allotments exceeding 20% of the company’s shares under the 6 months pricing formula. This extended lock-in period has made the transfer of shares a slightly difficult venture, which may create second thoughts in the investors’ mind.
Rights issues or preferential issues- which is a better venture for investors
Through rights issues, the existing shareholders can purchase existing securities at discounted rates to the market price at a future date. On one hand, it consolidates the shareholding of the promotors, and on the other hand, it also acts as an effective mechanism for a cash-strapped company to raise additional capital. Until the applicability of the 26-week formula, a cost-benefit analysis favoured rights issues over preferential allotments due to advantages like free pricing. However, reduced investment costs due to the changed policy framework of the preferential allotments may attract investors in this direction. However, from the regulatory perspective, the government may have to act cautiously while liberating the preferential allotment process, since rights issues are considered as a better and fairer way of raising capital because it offers a more democratic approach by giving preference to the existing shareholders to invest in the company.
The Supplementary Privileges Along-With The Future Aspects:
The new pricing scheme will aid in administering the acquisitions by confirming to the gap created between the floor price of the preferential allotments and open offer floor price. It is an unvarnished truth that the formula for the calculation of floor price (for preferential allotments) and the open offer floor price (SAST Regulations, 2011 read with Regulation 22(1) of Takeover Regulations 2011) is completely different, but now that both are covered by the same lookback period, it will remarkably lessen the discrepancy in the price range. Henceforth, controlling acquisition by commercially viable means will become a reality. Today, the country is grappling with the situation of high cash crunch and liquidity concerns and in these times, the new alignment that has been offered through this notification will make deals more attractive for the acquirers.
Another aspect which will be an upshot of the new alignment in floor price for preferential allotments and open offers is the potential of it being a takeover defence. With the help of this new framework, a company will now be in a position to launch its own takeover defence. This process could be done by a significant preferential allotment to a friendly acquirer in the face of a hostile acquirer proposing to acquire a significant stake in the company at the open floor price. It is true that due to inherent regulatory and culture poison pills, the hostile takeovers were not prevalent in the country up until now but given the new pricing alignment, a white knight defence will now become much more expensive as compared to the hostile acquisition through secondary stake acquisition.
The By-Products Of The Framework
SEBI has also cleared the situations pertaining to the indirect acquisitions where public pronouncements of the offer have been made. In those cases, an amount which will be 100% of the consideration payable under the open offer can now buy deposited before the detailed public statement. This escrow account could be in the form of cash or a bank guarantee. Simple interest of 10% will be paid to all the shareholders (who tended the shares in the open offer) in case of delays attributable to the acts of omission or commission of the acquirer.
In these times, Non-promoters will try to come in as saviours and might try to look for an exit after the company stabilizes and the prices of the shares go up. The aim of the SEBI is to stop the investors from using the relaxed pricing scheme in order to make profits for the short term. Henceforth, the foreign portfolio investors will be kept at a distance along-with the ability of the company to take advantage of the new pricing option.
Conclusion
It is true that due to the severe impact on the global economy, there were many deals that were struck due to pricing misalignment. The new pricing guidelines will be a boon for the promoters as well as the investors and since the new alignment between the regulatory minimum and current market conditions are pragmatic, they will be welcomed by the investors. Moreover, this step by the SEBI provides leniency to the promoters by providing them with the belief that when it comes to the subscription of shares under preferential allotment mechanism, they are outside the ambit of insider trading. The intention behind this kind of change is to benefit the company’s promoters who would otherwise have paid a much higher fee.
Henceforth, it could be concluded that the new pricing scheme will prove to be a reassurance by providing a significant boost to the funding of listed companies. The increase in the lock-in period will provide a nudge to the companies towards the long-term capital. The same could be made possible through promoters or strategic investor consolidations. Although the change has been introduced until the end of the current calendar year, the better market dynamics, increased deal-making and positive impact might help in the extension of the same.
The opinions expressed herein are those of the author in their personal capacity and are not intended to be construed as legal, financial or investment advice.