How to Issue Shares to Investors in India: Legal & Compliance Guide

Issuing shares is a critical step for Indian startups raising capital. However, the process involves numerous legal and compliance requirements that vary based on the type of securities offered, amount raised, and type of investors.

This guide walks through the key steps and regulations involved in issuing shares to investors in India. By understanding and carefully following this process, you can raise capital legally while avoiding costly penalties.

Step 1: Determine the Type of Securities to Issue

The first decision is what type of security to issue to investors. The most common types are:

Equity Shares: Equity represents an ownership stake in the company, usually with voting rights. Equity shares are most common for long-term investors looking for capital appreciation. Issuing equity typically requires a valuation to set the price per share.

Preference Shares: Preference shares provide certain rights and privileges over equity shares, such as priority claims on dividends and assets. They can be participating (sharing in dividends with equity) or non-participating, and cumulative (accumulating unpaid dividends) or non-cumulative.

Convertible Notes: A convertible note is a debt instrument that converts into equity shares at a later date, typically at a discount to the next equity round's valuation. Notes delay the need for a valuation and provide quicker, simpler fundraising.

The right security type depends on the stage of your startup, fundraising goals, and investor preferences. Consult with your legal and financial advisors to determine the optimal structure.

Step 2: Conduct Due Diligence on Investors

Before accepting investment, conduct proper due diligence on potential investors. Key steps include:

• KYC (Know Your Customer): Collect identity and address proof documents from investors to fulfill KYC norms under the Prevention of Money Laundering Act (PMLA).

• Accreditation Checks: Confirm if the investor is accredited or sophisticated based on income and net worth criteria. Accredited investors have fewer disclosure protection requirements.

• Source of Funds: Verify the legitimate source of investment funds as per PMLA requirements.

• FDI Compliance: If accepting foreign investment, ensure compliance with FDI (Foreign Direct Investment) sectoral caps and approval routes.

  
  

Thorough due diligence protects your startup from legal and reputational risks down the line. Maintain records of all investor documentation.

Step 3: Get Board and Shareholder Approval

Issuing shares requires formal Board and Shareholder approval. The key steps are:

• Board Resolution: The Board must pass a resolution approving the share allotment and authorizing the issuance of a private placement offer letter to identified investors. The resolution must specify the number and type of shares issued.

• Shareholder Approval: A special resolution (75% majority) of existing shareholders is required to approve the proposed allotment if it is a preferential allotment.

• Update Authorized Share Capital: If the proposed allotment exceeds the current authorized share capital, shareholders must approve increasing the authorized limit.

  
  

Once the Board and Shareholders approve the allotment, document their resolutions in formal meeting minutes.

Step 4: Execute Definitive Investment Agreements

The formal investment agreements between the company and investors govern the terms of financing. Key agreements include:

• Share Subscription Agreement (SSA): The SSA sets forth the terms of the share purchase, including number and type of shares, price per share, payment terms, conditions precedent to closing, and representations and warranties by the company and investors.

• Shareholders' Agreement (SHA): The SHA governs the rights and obligations of the shareholders, including voting rights, preemptive rights, transfer restrictions, exit provisions, and management and governance matters.

• Amended Articles of Association (AOA): The updated AOA reflects the terms of the preference shares, if applicable, and any special rights granted to investors under the SSA and SHA.

  
  

Negotiate and finalize these agreements in consultation with experienced legal counsel to ensure all key terms are captured and risks mitigated. Once executed, file the updated AOA with the Registrar of Companies (ROC).

Step 5: File Share Allotment Forms

After executing the definitive agreements and receiving funds from investors, the company must complete the share allotment and regulatory filings within prescribed timelines:

• PAS-3: File Form PAS-3 (Return of Allotment) with ROC within 30 days of allotment

• PAS-4: File Form PAS-4 (Private Placement Offer Letter) with ROC before making any private placement offer

• PAS-5: File Form PAS-5 (Share Allotment Record) with ROC within 30 days of allotment

• MGT-14: File Form MGT-14 for special resolutions passed by shareholders within 30 days

  
  

Late filings can lead to monetary penalties for the company and officers in default. Ensure all forms are accurately filled and filed within the prescribed timelines.

Step 6: Update Statutory Registers and Issue Share Certificates

After completing the regulatory filings, update the company's statutory registers and issue share certificates to investors:

• Update Statutory Registers: Update the Register of Members (ROM) and Register of Share Transfers with details of the new allotment. If issuing preference shares, also update the Register of Preference Shareholders.

• Issue Share Certificates: Issue share certificates to the investors within 2 months of allotment. The certificates must bear unique identification numbers and be stamped with the company seal.

• Credit Demat Accounts: If the shares are in dematerialized form, credit the allotted shares to the investors' demat accounts.

  
  

Maintaining updated statutory registers and share certificates is mandatory under the Companies Act. Keep copies of all filings and certificates for your records.

How Fiscal Flow Can Help

Navigating the legal and regulatory landscape for share issuance in India can be complex and time-consuming, especially for first-time founders. At Fiscal Flow, we specialize in helping Indian startups raise capital while staying compliant.

Our team can assist with:

• Structuring the optimal type of security to meet your funding needs

• Conducting investor due diligence and KYC checks

• Drafting and negotiating the SSA, SHA, and AOA

• Ensuring timely filing of all ROC forms and resolutions

• Updating statutory registers and issuing share certificates

  
  

With our expertise, you can close your funding round quickly and confidently, knowing you've met all legal and compliance requirements. To learn more about how we can help your startup issue shares compliantly, contact us at info@fiscalflow.com.