Private Placement of Securities: The Section 42 Compliance Process

Strip away the term sheet language, and almost every equity or convertible instrument round an Indian startup raises is legally the same thing: a private placement of securities under Section 42 of the Companies Act, 2013. It does not matter whether the investor is a single angel or a fund leading a priced round, the company is offering securities to a defined, identified group of people rather than to the public, and that offer has to follow a specific procedural sequence to stay valid. None of this is paperwork bolted onto the deal. It is what makes the round a private placement in the eyes of the law, rather than something that could later be challenged as a defective offer.

What Private Placement Actually Means Under Company Law

A private placement is an offer or invitation to subscribe to securities made to a select group of persons identified by the company, rather than an offer made to the public at large. The mechanics are set out in Section 42 of the Companies Act, 2013, read with the Companies (Prospectus and Allotment of Securities) Rules, 2014. That distinction, a select group versus the public, is the whole point of the section: a public offer comes with prospectus requirements and a compliance burden built for raising money from the general investing public, plus SEBI oversight where a listed company is involved. A private placement is the exception carved out for companies raising from a defined set of investors they have actually chosen, with a lighter process precisely because the audience is limited and known in advance. A private limited company cannot invite the public to subscribe to its securities at all, so for most startups, private placement is not one option among several, it is effectively the only route available for issuing equity shares, CCPS, or convertible debentures to outside investors. A rights issue to existing shareholders under Section 62 is a separate route with its own process, relevant when existing shareholders get more shares in proportion to what they already hold. A new investor coming into a round is brought in through a private placement instead.

The Core Procedural Sequence

Section 42 lays out a specific sequence, and skipping or reordering steps is where avoidable problems usually start. In practice, a typical funding round moves through the following.

1. The board identifies the proposed allottees, the specific investors the company intends to approach, and approves the terms of the offer at a properly convened board meeting, since issuing securities is one of the matters the law reserves for an actual meeting rather than a circular resolution, before any invitation goes out.
2. Shareholders pass a special resolution approving the offer to those identified persons, which is what the Act actually requires, and the resolution itself is separately filed with the Registrar on Form MGT-14. Treating a board resolution alone as sufficient, because the round feels informal among people who already know each other, is a common and avoidable mistake. A narrower board-approval route exists in specific circumstances, mainly around debt securities issued within limits shareholders have already approved, but a startup raising an equity or convertible round should default to assuming a special resolution is required unless a CA or CS has confirmed otherwise.
3. A private placement offer letter, Form PAS-4, is issued only to the identified persons, by name. It cannot be advertised or forwarded to anyone outside the approved list, and the company keeps its own record of exactly who was approached.
4. The offer is subject to a numerical cap the Companies Act imposes on the number of offerees for a single kind of security in a financial year. Confirm the current figure before finalising an allottee list, rather than relying on memory or an old template, since exceeding it is what triggers the deemed-public-offer risk covered below.
5. Application money is accepted only through banking channels, cheque, demand draft, or another recognised banking mode, never cash, and is kept in a separate bank account rather than mixed into the company's regular operating funds.
6. Once the round is ready to close, the board allots the securities to the identified applicants, and the company files a return of allotment, Form PAS-3, with the Registrar within a prescribed short window. The company also keeps a complete record of the offer, typically on Form PAS-5, updated to reflect what was actually allotted.

The offeree cap deserves special attention because getting it wrong is not a technical breach, it changes the nature of the offer entirely. Exceed the permitted number of persons for that kind of security in a financial year, and the offer is treated as a deemed public offer, pulling in the full public-offer compliance framework, and potentially SEBI regulations, that a private placement was designed to avoid in the first place. That is a materially heavier burden than anyone structuring an informal round is prepared for, and it can affect the validity of the whole offer, not just the allotments beyond the cap. This is the most practical reason to treat the offeree list as a number worth counting carefully, particularly once a pitch deck has been circulating informally before the round is formally structured.

Money In: Banking Channels, a Separate Account, and When It Can Actually Be Used

This is one of the more stable and unambiguous rules in the whole process, so it is worth stating plainly: subscription money for a private placement must come in through banking channels, never cash, and it has to sit in a separate bank account rather than the company's regular current account. More importantly, the company cannot use that money, not for payroll, not for a vendor payment, not for anything, until two things have both happened: allotment has actually been made, and the return of allotment has been filed with the Registrar. Money sitting in the company's account before allotment is not yet the company's money to spend, whatever the term sheet says about when the round has 'closed.' Treating investor funds as usable the moment they land is one of the most common and avoidable mistakes founders make, particularly in a bridge or extension where everyone already trusts each other and the paperwork feels like something that can catch up later.

Closing the Loop: The Return of Allotment

Allotment is the point at which the company actually issues the securities to the investors whose applications it has accepted, and it is the board's decision, recorded in its own resolution. That is not where the process legally ends, though. The company still has to file a return of allotment, Form PAS-3, with the Registrar within a prescribed short window after allotment, and this filing is what actually completes the round from a company law standpoint. Until it is filed, the round is not properly closed, the money is not free to use, and the allotment sits on top of an incomplete compliance record that a future investor's due diligence team will eventually ask about. If the exact number of days in that filing window is not something you can confirm off the top of your head, do not guess. Check it against the current Act and rules before the deadline, rather than assuming a figure from an old checklist.

What Goes Wrong in Practice

The mistakes that actually surface in practice are rarely exotic. They are usually one of the following.

• Spending investor money before allotment and the PAS-3 filing are both complete, often because the round is treated as 'closed' the moment funds land rather than when the compliance steps are actually finished.
• Offering securities informally to more people than the round was structured for, sometimes nothing more deliberate than forwarding a pitch deck or a data room link too widely, which can push the offer past the numerical cap without anyone intending it to.
• Skipping or backdating the special resolution because the round felt informal or the money moved faster than the paperwork. A resolution passed properly after the fact is far safer than one dated to look like it happened earlier than it did.
• Treating the offer letter and allottee list as internal formalities rather than binding constraints, so the people actually approached are never reconciled against what the special resolution and PAS-4 actually covered.
• Assuming the round is done once money and shares have both moved, without confirming the PAS-3 return of allotment was actually filed and accepted by the Registrar.

Private placement is procedurally strict for a specific reason: it is an exception to the default rule that offering securities to anyone requires a full public-offer process, prospectus and all. A company gets to use a lighter, faster route precisely because it sticks to a defined group of identified investors, follows the approval sequence, and respects the cap. None of the steps above are paperwork for its own sake. They are what keeps a funding round legally a private placement rather than something that could later be reclassified or unwound as a defective offer, and that distinction matters most the first time someone outside the room, an auditor, a future investor, a regulator, actually asks to see the file.