How to Issue Shares in a Startup in India?

Issuing shares in an Indian startup is the foundational act of building a company of co-owners. It formally transitions the startup from an idea to a legally-backed business entity. It’s a strategic process of distributing equity to investors, founders, and key employees. This aligns everyone’s financial interests with the company’s long-term success.

This move is essential not just for raising capital. It helps establish a solid legal and financial structure required by the Ministry of Corporate Affairs (MCA). This structure ensures compliance and supports future exponential growth.

The whole process is meticulously governed by the Companies Act, 2013, ensuring every new co-pilot is properly onboarded and everything is documented for a smooth flight. This includes issuing shares, recording them in statutory registers, and complying with regulatory requirements like filing with the RoC. 

Proper documentation of share issuance protects shareholder rights and ensures transparency. It also requires valuation by a SEBI-registered Category I Merchant Banker or an experienced Chartered Accountant.

What is the Right Issue of Shares​?

The Issue of Shares is the formal, legal process by which a company allocates new shares to external parties, especially in a startup. These external parties can include investors or employees. The allotment occurs in exchange for funding or services and is governed by the Companies Act, 2013. This process officially divides the company’s ownership into tradable units and transfers them, turning recipients into legal shareholders.

• Purpose: To raise equity capital (funding) for the business.
• Result: Converts recipients into legal shareholders with fractional ownership rights.
• Regulatory Body: Governed by the Companies Act, 2013, and requires reporting to the Registrar of Companies (ROC).
• Impact: Leads to the dilution of the ownership stake held by existing shareholders.

Types of Share Issuance in India for Startups

Startups in India issue shares to raise capital and manage ownership. These types of share issuance help startups raise capital, reward employees, and structure ownership efficiently, ensuring compliance with regulatory requirements.

• Private Placement: Shares offered directly to select investors, like angels or VCs.
• Rights Issue: New shares offered to existing shareholders in proportion to their holdings.
• Bonus Shares: Free shares issued from the company’s reserves to reward current shareholders.
• ESOPs (Employee Stock Ownership Plans): Shares offered to employees, often at a discount, to attract and retain talent.
• Preferential Allotment: Shares offered to specific investors, commonly used by startups to raise funds from venture capitalists or angel investors.

A company must have a clear plan before issuing shares. This involves choosing the right method, such as a private placement for specific investors, a rights issue for current shareholders, or a bonus issue.

After deciding, the Private Limited Company obtains a professional valuation to set a fair share price. The process then requires approvals through a Board Resolution and, if needed, a Shareholder Resolution. Finally, the company dispatches formal offers, collects funds, and completes all necessary filings with the Registrar of Companies (ROC) to ensure legal compliance.

Why is Issuing Shares Important?

Issuing shares is essential for a startup’s growth and survival. It allows a company to raise capital to fund its operations and expansion without taking on debt.

• Raising Capital: Issuing shares allows a company to secure funds from investors without taking on debt. The company can use this capital to finance operations, research and development, or expansion plans, providing a crucial lifeline for business growth.
• Attracting Investors: Issue of shares makes a company an attractive investment opportunity. Investors can become part-owners, sharing in the company’s future profits and growth, which is essential for attracting angel investors and venture capitalists.
• Acquiring Talent: Companies can use shares as a non-cash incentive to attract and retain top talent. Offering equity through ESOPs gives employees a sense of ownership, aligning their interests with the company’s long-term success.
• Building Credibility: Investors often see a company that has successfully issued shares and built a base of shareholders as more credible and stable. This can help in securing partnerships, loans, and other forms of financing.
• Facilitating Acquisitions: Companies can use shares as currency to acquire other companies. Instead of using cash, a company can offer its own shares in exchange for another company’s assets or equity, making the acquisition process more flexible.
• Improving Financial Position: Issuing shares strengthens a company’s balance sheet by increasing its equity. This reduces reliance on debt and can improve the company’s creditworthiness, making it easier to borrow money in the future if needed.

What is the Process to Issue Shares in a Startup?

The process involves a series of structured steps to ensure legal compliance and proper onboarding of new shareholders.

Step 1: Board Meeting & Valuation

The process begins with the company’s board of directors.

• The Board must conduct a meeting and pass a resolution formally approving the share issuance, specifying the type and number of shares to be issued.
• Companies must obtain a valuation report from a registered valuer to determine the Fair Market Value (FMV) if they issue shares at a price higher than their face value. This is crucial for compliance and to avoid tax issues. 

Step 2: Shareholder Approval

This step ensures all company owners are on board.

• The company must convene an Extraordinary General Meeting (EGM) of the shareholders to seek their approval for a private placement or a rights issue.
• At least 75% of the shareholders must pass a Special Resolution at the EGM, authorizing the board to proceed with the share issuance.

Step 3: Prepare the Offer Letter

The company must formally invite investors to subscribe to the shares.

• For a private placement, the company must prepare and dispatch a formal offer letter in Form PAS-4 to the identified investors within 30 days of the Special Resolution.
• The company provides all the key details in this offer letter, including the number of shares being offered, the price, and the subscription deadline.

Step 4: Allot Shares and Collect Funds

The company can now officially proceed with the issue of shares and receive the money.

• The company must receive the application money from the investors into a separate bank account specifically opened for this purpose.
• The board must hold a subsequent meeting to pass a resolution for the allotment of shares, officially issuing them to the investors within 60 days of receiving the funds.

Step 5: File with the ROC & Issue Certificates

The final step involves legal documentation and record-keeping.

• The company must file Form PAS-3 (Return of Allotment) with the Registrar of Companies (ROC) within 30 days of the share allotment.
• Additionally, you must file Form MGT-14 to report the special resolution to the ROC. 

Note: MGT-14 is needed only when a special resolution is passed. If the authorized share capital changes, filing Form SH-7 may also be required.

• Finally, after the issue of shares, issue share certificates to new shareholders within 60 days of allotment and update the statutory registers. If refunds aren’t made within 15 days after this period, interest at 12% per annum may apply (Section 42, Companies Act).

What is the Regulatory Framework for Issuing Shares in a Startup?

The Companies Act, 2013, strictly regulates share issuance in startups to safeguard stakeholder interests.

• Companies Act, 2013: This is the primary legal framework that governs all aspects of the issuance and transfer of shares in India. It provides detailed regulations and procedures that companies must follow, from the types of shares they can issue to the required filings and approvals.
• Private Placement Rules (Section 42): This section outlines the specific rules for issuing shares to a select group of investors, which is the most common method for startups. It includes a limit of 200 allottees per financial year and mandates the filing of Form PAS-3 to report the allotment.
• Rights Issue Procedures (Section 62): This section defines the process for offering new shares to a company’s existing shareholders. The procedure requires the company to give current owners a specific timeframe, not less than 15 days, to accept the offer.
• Prohibition on Discounted Shares (Section 53): The Act strictly prohibits a company from issuing shares at a price below their face value. Exceptions exist for specific cases like sweat equity shares issued to employees or directors for their expertise or intellectual property.
• Valuation Norms: For any share issuance at a premium, a valuation is mandatory. A registered valuer must determine the Fair Market Value (FMV) of the shares. This is crucial to avoid “angel tax” for investors and to comply with FEMA guidelines for foreign investment.
• Filing with ROC: The company must formally report every share allotment to the Registrar of Companies (ROC). The company must file Form PAS-3 within 30 days of the allotment to document the transaction and the details of the new shareholders.

Common Mistakes to Avoid

While issuing shares, startups often overlook key compliance requirements that can lead to penalties or legal issues.

• Incorrect Valuation: Issuing shares below FMV can lead to the company and its investors facing a heavy tax burden.
• Missing Deadlines: Failing to file forms like PAS-3 within 30 days of allotment can result in significant penalties.
• Skipping Approvals: Not getting the required Board and Shareholder Resolutions can invalidate the entire share issuance.
• Violation of Private Placement Rules: Issuing shares to more than 200 people or not following the proper offer letter procedure can lead to legal complications.

Note: Always consult an expert before issuing shares to ensure full compliance and avoid potential legal or financial issues.

Final Thoughts

In conclusion, issuing shares is a fundamental and transformative step for any startup. It’s the primary way to raise capital, allowing a company to fuel its growth, expand operations, and invest in innovation without taking on debt. By following the structured share issuance process, approvals, valuation, and ROC filings, a startup secures vital funding. At the same time, it builds a credible and legally compliant foundation for future growth.  

Share issuance is more than just a financial transaction; it’s an exercise in formalizing partnerships and aligning interests. The process of bringing new shareholders on board, whether they are investors or employees, creates a shared sense of ownership and commitment to the company’s vision.