Section 42 (private placement) vs preferential allotment: which to use and when

Section 42 private placement and Section 62(1)(c) preferential allotment are two routes to issue shares to identified persons. They overlap enough that founders sometimes choose between them based on the legal counsel's preferred template rather than the substantive difference. The two routes diverge on five dimensions: the number and type of offerees, the offer mechanics, the pricing framework, the shareholder approval, and the filing chain.

This article walks through each route and the practical decision rule we use with clients raising capital from a small group of investors or a single strategic investor.

What each route is for

Section 42 is the private placement framework. It permits an offer of securities to a select group of persons, up to a maximum of 200 in a financial year per kind of security (the count excludes qualified institutional buyers and employees under ESOPs). The minimum offer size per person is ₹20,000 of face value. The offer is made through a private placement offer letter in Form PAS-4.

Section 62(1)(c) is the preferential allotment framework — strictly, the route to issue further shares to persons other than existing shareholders pro rata or to employees under an ESOP. The allotment requires a special resolution of shareholders, supporting valuation report, and compliance with Rule 13 of the Companies (Share Capital and Debentures) Rules, 2014.

The two routes are not mutually exclusive in the abstract — a single allotment can be both a Section 42 private placement and a Section 62(1)(c) preferential allotment, with both sets of compliance running in parallel. In practice, this is what most allotments to outside investors actually require.

When Section 42 alone is enough

If the issuer is a private company and the allotment is to existing shareholders pro rata, Section 62(1)(a) governs and neither Section 42 nor Section 62(1)(c) is strictly required.

If the issuer is a private company and the allotment is to a small group of identified outside investors who have committed in advance — a friends-and-family round, a single seed investor, an inter-corporate investment from a parent or sister entity — Section 42 governs and Section 62(1)(c) does not, provided the AOA permits the allotment without further shareholder action.

The condition is the AOA wording. Many private-company AOAs contain a pre-emption right in favour of existing shareholders. If pre-emption applies, the existing shareholders must waive their rights in writing before the allotment to an outside investor proceeds. This waiver is not the same as a Section 62(1)(c) special resolution but it serves a parallel function.

When Section 62(1)(c) is required in addition

For public companies, Section 62(1)(c) applies to any further issue not made pro rata to existing shareholders or under an ESOP. The special resolution is mandatory.

For private companies, Section 62 was relaxed by the 2015 amendments — Section 62(1)(c) is not strictly applicable to private companies unless the AOA so provides. In practice, well-drafted private-company AOAs (especially those reviewed by VC counsel during a funding round) typically pull the Section 62(1)(c) framework in by reference, so the special resolution is required as a matter of contract even if the Act would not require it.

The pragmatic rule: if the company is a private company with a clean AOA that permits the allotment without further approval, Section 42 alone is enough. If the AOA pulls in Section 62(1)(c) or the company is a public company, both frameworks apply.

The offer mechanics

Under Section 42

The board approves the private placement offer letter (PAS-4) and the list of offerees. The offer letter is despatched to each offeree. The offerees have 60 days from receipt to subscribe. Subscription monies are paid into a separate bank account opened for the purpose. The board passes a separate allotment resolution and shares are allotted within 60 days of receipt of subscription monies.

The 60-day windows are both hard. Money received but not allotted within 60 days must be refunded with interest at 12% per annum from the 75th day from receipt.

Under Section 62(1)(c)

A special resolution is passed at a general meeting (or by postal ballot or electronic ballot in eligible cases). The resolution authorises the issue, names the offerees, sets the price, and references the valuation report. The valuation report is by a registered valuer under Section 247.

Subscription monies are received and shares are allotted within 12 months of the special resolution. The 12-month outer limit gives more flexibility than the Section 42 60-day window for the allotment side but the 60-day Section 42 window still controls if Section 42 is also being run.

Pricing

Both routes require a valuation. Under Section 42 for allotment to a non-resident, the price must be at or above the fair value determined under FEMA pricing guidelines. Under Section 62(1)(c), the registered valuer's valuation report establishes the floor.

A single registered valuer's report can support both Section 42 and Section 62(1)(c) requirements simultaneously, provided the report covers the valuation methodology required by each framework. For allotments to non-residents, the report also covers the FEMA pricing requirement, which uses internationally accepted pricing methodology — typically discounted cash flow, comparable company analysis, or comparable transaction analysis, weighted as appropriate.

We engage the valuer at the start of the offer process so that the report is in hand before the PAS-4 is drafted and before the special resolution is moved.

The filings

Section 42 filing chain

PAS-3 — return of allotment. Filed within 15 days of allotment, supported by the list of allottees, the PAS-4 offer letter, the PAS-5 record of private placement (signed by a director), and the bank statement of the subscription account.

PAS-4 — the private placement offer letter. Not separately filed but attached to PAS-3.

PAS-5 — record of private placement. Maintained in physical form, signed by the company secretary or a director. Not filed but available for inspection.

Section 62(1)(c) filing chain

MGT-14 — special resolution filing. Filed within 30 days of the special resolution.

PAS-3 — return of allotment. Same as above, filed within 15 days of allotment.

Valuation report. Not separately filed but available for inspection and required to be referenced in the explanatory statement to the special resolution notice.

Where both Section 42 and Section 62(1)(c) apply, MGT-14 and PAS-3 are both filed. The PAS-3 references both routes and attaches both the PAS-4 and the special resolution.

When each route fits in practice

Section 42 fits

Small founder-funded rounds. Two or three identified investors, total capital below ₹5 crore, no PE or VC participation, and the AOA permits the issue without pre-emption complications.

ESOP allocation to specific senior hires where the ESOP scheme permits issue to identified employees on direct allocation rather than option exercise.

Inter-corporate investments between a parent and a subsidiary or between sister entities under common control.

Strategic single-investor rounds where the investor is identified, due diligence is complete, and the closing can proceed within 60 days of the offer.

Preferential allotment fits

Institutional rounds with a lead investor and multiple co-investors. The special resolution makes the round visible to all shareholders, the valuation report establishes a defensible price, and the documentation is consistent with how the VC industry transacts.

ESOP waves to a larger group of employees where the issue is part of a broader compensation cycle.

Swap consideration in M&A. The acquirer issues its own shares as part of the consideration. The preferential allotment framework is the conventional route, especially when the acquirer is a public company.

Where pre-emption rights need to be over-ridden by a special resolution rather than by individual waivers.

Where allotments go wrong

Money in before allotment is approved. The 60-day clock under Section 42 starts on receipt of subscription monies, not on the date of the offer letter. Companies that receive money in early without a clear path to allotment within 60 days are accumulating refund obligations.

Subscription monies in the wrong account. Section 42 requires a separate bank account. Money received in the operating account does not satisfy the requirement and the allotment is defective.

PAS-4 not despatched in advance of the subscription. The offer letter is the basis of the offer. Despatching it concurrent with or after the subscription means the offer was not made — the allotment is a different kind of issue.

Valuation report dated after the special resolution. The report must precede the offer. A report dated after the resolution suggests the price was set without valuation support, even if substantively it was.

A simple decision rule

We use a one-line test. If the allotment is to one or two identified persons, the AOA is clean, and the timing can be controlled within 60 days, run Section 42 alone. In every other case — multiple investors, PE/VC involvement, ESOP wave, M&A consideration, public company, or AOA complexity — run Section 42 and Section 62(1)(c) in parallel.

The cost of running both routes when only one is strictly required is one MGT-14 filing and one special resolution. The cost of running only Section 42 when Section 62(1)(c) was also required is a defective allotment that surfaces in diligence. The asymmetry is one-sided.