Parth Shah
on
Parth Shah
Register Valuer | CA | CPA | 15+ Years of Experiance
Parth Shah is the Founder and Team Leader of the company, bringing extensive expertise in business valuation and financial advisory.
Introduction
Preferential allotment of shares is the issue of shares or convertible securities by a company to a select group of identified investors, rather than to the public or to all existing shareholders. It is one of the fastest and most flexible ways for an Indian company to raise capital and bring in strategic investors.
For unlisted companies, which include most startups and SMEs, preferential allotment is governed by Section 62(1)(c) and Section 42 of the Companies Act, 2013, read with Rule 13. For listed companies, an additional layer applies: Chapter V of the SEBI ICDR Regulations, 2018.
The single most misunderstood part of the process is pricing. Get it wrong, and you risk a rejected valuation, a tax notice, or a FEMA violation. This guide walks you through the full 2026 framework: the legal basis, the step-by-step process, the pricing formulas, the mandatory valuation report, lock-in rules, and the tax and FEMA angles that most guides skip. Whether you are issuing shares or subscribing to them, you will finish knowing exactly what a compliant preferential allotment looks like.
Key Takeaways
- Preferential allotment of shares is the issue of securities to a select group of identified persons under Section 62(1)(c) of the Companies Act, 2013, and is neither a public issue nor a rights issue.
- Every preferential allotment requires prior approval by a special resolution of shareholders, passed at a general meeting with a 75% majority.
- For unlisted companies, the issue price must be backed by a valuation report from an IBBI-registered valuer under Rule 13(2)(g) of the Companies (Share Capital and Debentures) Rules, 2014.
- For listed companies, the floor price is the higher of the 90-trading-day VWAP or 10-trading-day VWAP preceding the relevant date, as per Regulation 164 of the SEBI ICDR Regulations, 2018.
- An offer under Section 42 cannot be made to more than 200 persons in a financial year, excluding qualified institutional buyers and employees under ESOP.
- Shares must be allotted within 60 days of receiving the application money, and the return of allotment must be filed with the Registrar of Companies.
- Where a non-resident subscribes, the price must be at or above the FEMA fair value under the Non-Debt Instruments Rules, 2019, adding a cross-border compliance layer.
- My Valuation provides IBBI-registered valuation reports that satisfy Companies Act, SEBI, FEMA, and Income Tax requirements in a single, defensible document.
Need a Certified Valuation Report for Your Preferential Allotment?
My Valuation’s IBBI-registered valuers deliver defensible, audit-ready valuation reports for preferential allotments in just 5 to 7 business days. Speak with our experts today for a free initial consultation and ensure your transaction is fully compliant with Companies Act, SEBI, FEMA, and tax regulations.
Book a Free Valuation ConsultationWhat Is Preferential Allotment of Shares?
Preferential allotment of shares is the allotment of equity shares or convertible securities to a pre-identified group of investors at a determined price. It allows a company to raise funds quickly and to onboard specific strategic partners without opening the issue to the public or to every existing shareholder.
The word “preferential” refers to the preference given to selected allottees in the offer, not to preference shares specifically. In practice, the securities issued can be equity shares, fully or partly convertible debentures, or any other instrument convertible into equity at a later date.
Any company can use this route, whether public or private, listed or unlisted. The only exception is a Nidhi company, which is excluded from Section 62 by a notification dated 5 June 2015.
Why do companies choose preferential allotment?
Companies choose preferential allotment because it is the quickest compliant way to raise equity from chosen investors. It typically completes in 2 to 3 months, against 6 or more months for a public issue.
Common reasons include bringing in a venture capital or private equity investor, onboarding a strategic partner who adds domain expertise or distribution, converting debt into equity, or issuing shares to promoters to strengthen their stake. The company retains control over who becomes a shareholder, which a public issue does not allow.
How is it different from a rights issue and private placement?
A preferential allotment issues shares to selected investors; a rights issue offers shares proportionally to all existing shareholders. Private placement under Section 42 is the procedural framework that a preferential allotment must also comply with.
The three concepts overlap, which causes confusion. The table below clarifies the distinction.
Preferential Allotment vs Rights Issue vs Private Placement
Here is how the three main capital-raising routes under the Companies Act, 2013 compare for an Indian company.
| Feature | Preferential Allotment | Rights Issue | Private Placement |
| Governing provision | Section 62(1)(c) + Section 42 | Section 62(1)(a) | Section 42 |
| Who receives shares | Select identified investors | Existing shareholders, pro-rata | Select identified investors (up to 200/year) |
| Shareholder approval | Special resolution (75%) | Board resolution (usually) | Special resolution |
| Valuation report needed | Yes, IBBI-registered valuer (unlisted) | Generally not for issue at par to members | Yes, registered valuer |
| Best for | Onboarding strategic or PE/VC investors | Raising capital while preserving ownership ratios | The procedural backbone of most selective issues |
A preferential allotment is a private placement to selected investors that also satisfies Section 62; the two provisions work together rather than as alternatives.
What Is the Legal Framework for Preferential Allotment in India?
The legal framework for preferential allotment differs sharply between unlisted and listed companies and confusing the two is the most common mistake founders make.
For unlisted companies, the applicable law is Section 62(1)(c) and Section 42 of the Companies Act, 2013, read with Rule 13 of the Companies (Share Capital and Debentures) Rules, 2014, and Rule 14 of the Companies (Prospectus and Allotment of Securities) Rules, 2014.
For listed companies, all of the above applies, plus Chapter V of the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018, read with the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015.
What are the SEBI ICDR pricing rules for listed companies?
For a listed company, the preferential issue floor price is the higher of the volume-weighted average price (VWAP) over the 90 trading days or the 10 trading days preceding the relevant date, under Regulation 164 of the SEBI ICDR Regulations.
This is an important correction to older guidance. Until January 2022, the formula used a 26-week and 2-week average. SEBI replaced it with the 90-day and 10-day trading-day VWAP method to reduce distortion from volatile markets. Any content still quoting the “26 weeks” formula is outdated.
Two further points matter as per the SEBI ICDR framework:
- For infrequently traded shares (turnover below 10% over 240 trading days), the price must be certified by an IBBI-registered independent valuer under Regulation 166A.
- Where a preferential allotment results in a change of control, or the allottee crosses a defined stake, a valuation report and a committee of independent directors’ recommendation are required under Regulation 166A.
What is the valuation rule for unlisted companies?
For an unlisted company, the price of shares issued on a preferential basis must be determined on the basis of a valuation report from a registered valuer, as per Rule 13(2)(g) of the Companies (Share Capital and Debentures) Rules, 2014.
This registered valuer must be registered with the Insolvency and Bankruptcy Board of India (IBBI) under Section 247 of the Companies Act, 2013. A chartered accountant without IBBI registration cannot sign this valuation certificate. This is where firms like My Valuation, led by an IBBI-registered valuer, are legally essential rather than optional.
Confused About Which Valuation Applies to Your Preferential Allotment?
Listed and unlisted companies follow entirely different pricing rules, and one wrong assumption can invalidate the issue. My Valuation’s IBBI-registered valuers can determine the correct valuation method for your preferential allotment and help ensure full compliance.
Talk to a Valuation ExpertWhat Is the Step-by-Step Process for Preferential Allotment?
The preferential allotment process for an unlisted company follows a defined sequence of board, shareholder, and regulatory steps. Missing a timeline can invalidate the entire issue, so each stage below is time-bound.
Step 1: Convene a board meeting. The board approves the preferential issue in principle, finalizes the list of proposed allottees, obtains the valuation report from an IBBI-registered valuer, and fixes the date of the general meeting.
Step 2: Obtain the valuation report. An IBBI-registered valuer determines the fair value of the shares. This report justifies the issue price and is the anchor document for the entire transaction. It must be current, as a stale valuation is a frequent cause of rejection.
Step 3: Pass a special resolution. Send the general meeting notice with an explanatory statement (21 clear days for the EGM), then pass a special resolution with a 75% majority. File Form MGT-14 with the Registrar of Companies within 30 days.
Step 4: Issue the PAS-4 offer letter. After filing MGT-14, issue the private placement offer letter in Form PAS-4 to the identified allottees. The offer must not exceed 200 persons in a financial year, excluding QIBs and ESOP employees.
Step 5: Open a separate bank account. Application money must be received only through banking channels into a separate designated bank account, and cannot be used until allotment is complete.
Step 6: Allot the shares. Allot the shares within 60 days of receiving the application money. If the company fails to allot within 60 days, it must refund the money within 15 days, failing which interest at 12% per annum applies.
Step 7: File the return of allotment. File Form PAS-3 (return of allotment) with the Registrar of Companies within 15 days of allotment, along with the list of allottees and the valuation report.
What documents are required for preferential allotment?
The core documents for a preferential allotment include the board resolution, the special resolution, the IBBI-registered valuer’s report, and the statutory filings.
For the company, the essential set is: board resolution, valuation report from an IBBI-registered valuer, explanatory statement under Section 102, EGM notice, special resolution, PAS-4 offer letter, PAS-5 record of the offer, and Forms MGT-14 and PAS-3. Investors provide KYC documents, PAN, source-of-funds declaration, and a confirmation that they are not a wilful defaulter.
How Is the Price Determined in a Preferential Allotment?
The pricing method depends entirely on whether the company is listed or unlisted, and whether any allottee is a non-resident. Getting this wrong is the single biggest compliance risk in the entire process.
The table below summarizes the three pricing regimes an Indian company may face.
Preferential Allotment Pricing Rules: Listed vs Unlisted vs Non-Resident
| Scenario | Pricing Basis | Who Certifies | Governing Law |
| Listed company | Higher of 90-day or 10-day VWAP before the relevant date | Company/merchant banker; IBBI valuer if infrequently traded | Regulation 164, SEBI ICDR 2018 |
| Unlisted company | Fair value per a valuation report | IBBI-registered valuer | Rule 13(2)(g), Companies Act 2013 |
| Non-resident allottee | At or above FEMA fair value (floor) | CA or SEBI-registered Merchant Banker | Rule 21, NDI Rules 2019 |
A single deal can trigger more than one pricing rule at once. An unlisted startup raising from a foreign VC must satisfy both the Companies Act valuation and the FEMA floor price simultaneously.
A worked example: pricing an unlisted preferential allotment
Consider a hypothetical Bengaluru SaaS startup, “CloudLedger Pvt Ltd,” raising ₹10 crore through a preferential allotment to a domestic PE fund.
The IBBI-registered valuer applies the Discounted Cash Flow method and arrives at a fair value of ₹500 per share. The company therefore issues 2,00,000 shares at ₹500 each to raise the full ₹10 crore. The special resolution and PAS-4 offer letter both reference this ₹500 price, and the valuation report is filed with Form PAS-3.
If the same round instead came from a US-based fund, the ₹500 price would also need to clear the FEMA floor. Because the FEMA fair value under the NDI Rules also worked out to ₹500, the price is compliant. Had the company tried to issue at ₹450 to the foreign investor, it would have breached FEMA, exposing the company to Enforcement Directorate scrutiny.
What Are the Lock-In and Dilution Rules?
Lock-in rules apply mainly to listed companies and restrict when preferential allottees can sell their shares. They exist to ensure investor commitment and prevent short-term speculation.
Under the SEBI ICDR Regulations, the current lock-in position for listed preferential issues is:
- Promoter and promoter-group allotment: locked in for 18 months.
- Non-promoter (public) allotment: locked in for 6 months.
- The pre-preferential shareholding of allottees is also subject to a 90-trading-day lock-in from the date of trading approval.
For unlisted companies, the Companies Act does not impose a statutory lock-in in the same way. Restrictions, if any, come from the shareholders’ agreement or Articles of Association. Founders should still model the dilution impact carefully, because a preferential allotment permanently increases the share capital and reduces existing shareholders’ percentage ownership.
What Are the Tax and FEMA Implications?
Preferential allotment carries distinct tax consequences for the company and the allottee, and an additional FEMA layer when a non-resident is involved.
For the company, funds raised through a fresh issue are a capital receipt and are not treated as income. The abolition of “angel tax” is significant here: Section 56(2)(viib) of the Income Tax Act, which taxed share premium above fair value, was withdrawn by the Finance (No. 2) Act, 2024, with effect from Assessment Year 2025-26. This removes a major historical risk from over-valued issues.
However, valuation discipline still matters. As per Rule 11UA of the Income Tax Rules, 1962, and Section 56(2)(x), an allottee receiving shares below fair value can still face tax on the difference where the statutory threshold is crossed.
For non-resident allottees, the FEMA Non-Debt Instruments Rules, 2019 require the issue price to be at or above the fair value certified by a chartered accountant or SEBI-registered merchant banker. The RBI’s Master Direction on Foreign Investment, substantially updated in January 2025, tightened documentation and reporting obligations for these transactions, and a valuation certificate older than 90 days at the time of allotment is a direct violation.
A common and costly error is assuming one valuation report covers every framework. A FEMA-compliant DCF value may not equal the Rule 11UA figure for tax, and Ind AS may require yet another fair value. Reusing a single report across purposes is a frequent trigger for regulatory notices.
Conclusion
Preferential allotment of shares remains one of the most efficient ways for Indian companies to raise capital and welcome strategic investors, but its power depends entirely on precise compliance. The process hinges on three things: a valid special resolution, a defensible valuation, and adherence to strict timelines under the Companies Act, SEBI ICDR, and FEMA.
The valuation report is the foundation of the whole transaction, and for unlisted companies it must come from an IBBI-registered valuer. My Valuation is one of India’s trusted IBBI-registered valuation firms, providing preferential allotment valuation, SEBI and Companies Act valuation, and FEMA valuation services with a 95%+ acceptance rate by investors and regulators. Whether you are a startup onboarding a VC or a listed company planning a strategic issue, our team delivers audit-ready reports in 5 to 7 business days. Request your free valuation consultation today.
Frequently Asked Questions (FAQs)
1. Is a valuation report mandatory for preferential allotment?
Yes. For unlisted companies, a valuation report from an IBBI-registered valuer is mandatory under Rule 13 of the Companies (Share Capital and Debentures) Rules, 2014. Listed companies need one for infrequently traded shares or change-of-control cases under Regulation 166A.
2. Who can issue shares through preferential allotment?
Any company can, whether public or private, listed or unlisted, except a Nidhi company. The company must pass a special resolution and, ideally, be authorized to do so under its Articles of Association.
3. What is the maximum number of allottees in a preferential allotment?
An offer under Section 42 cannot be made to more than 200 persons in a financial year. Qualified institutional buyers and employees receiving shares under an ESOP are excluded from this limit.
4. How long does preferential allotment take in India?
The process usually takes 2 to 3 months from initiation to allotment. Shares must be allotted within 60 days of receiving the application money, or the company must refund it within 15 days.
5. Can foreign investors participate in a preferential allotment?
Yes, subject to FDI rules and sectoral caps. The issue price to a non-resident must be at or above the FEMA fair value under the Non-Debt Instruments Rules, 2019, certified by a CA or SEBI-registered merchant banker.
6. Is angel tax still applicable to preferential allotment?
No. Section 56(2)(viib), the angel tax provision, was abolished by the Finance (No. 2) Act, 2024, with effect from Assessment Year 2025-26. However, valuation discipline still matters for FEMA and other tax provisions like Section 56(2)(x).
7. What happens if shares are not allotted within 60 days?
If the company does not allot shares within 60 days of receiving the money, it must refund the application money within 15 days. Failure to refund on time attracts interest at 12% per annum from the expiry of the 60th day.
