Companies sometimes need additional money to expand their business, repay loans, or fund new projects. One way they can do this is through a preferential issue of shares, where they offer new shares to selected investors instead of the general public.
This allows a company to raise money from specific investors, such as promoters or institutions. But what does this mean for people who already own its shares? Let’s understand how a preferential issue works and how it can affect existing shareholders.
What Is a Preferential Issue of Shares?
A preferential issue, also called preferential allotment, is when a company issues new shares to selected investors instead of offering them to everyone.
These investors can be promoters, big institutions, private investors, or strategic partners. A promoter is a person or group that controls or helped set up the company.
This is the basic meaning of a preferential issue. The company decides who gets the shares, within the rules.
Why Do Companies Choose Preferential Allotment?
- Targeted fundraising: The company can raise money from selected investors rather than approaching the general public.
- Strategic investors: It can bring in an investor who may offer business connections, expertise, or other support.
- Promoter participation: Promoters can increase their stake by subscribing to additional shares.
- Business requirements: The funds can be used for expansion, debt repayment, or working capital.
How Does a Preferential Issue Work?
For a listed company in India, the steps are roughly these:
- The board of directors approves the proposal.
- The company calls a shareholders’ meeting. The notice must give details such as who the allottees are and why money is being raised.
- Shareholders pass a special resolution, which needs at least 75% of the votes cast in favour.
- The company obtains in-principle approval from the stock exchanges before completing the allotment.
- The company allots the shares and receives the money.
- The shares start trading after the exchanges give trading approval.
Under SEBI’s rules for listed companies, anyone who sold shares of the company in the 90 trading days before the “relevant date” (explained below) generally cannot be an allottee. There are some exceptions.
A valuation report from an independent registered valuer is also required in certain cases. This includes preferential issues that may change control of the company, or that allot more than 5% of its post-issue fully diluted share capital to one allottee or a group of investors acting together.
At What Price Are Preferential Shares Issued?
The issue price is the price at which the company offers the new shares. SEBI sets a minimum price so that shares are not handed out too cheaply.
For a listed company with frequently traded shares, SEBI sets a minimum issue price. It is as following:
- The 90-trading-day volume-weighted average price (VWAP).
- The 10-trading-day volume-weighted average price (VWAP).
VWAP is simply the average price, weighted by how many shares traded at each price. Both averages are counted from the relevant date, which is 30 days before the shareholders’ meeting. If the company’s articles of association prescribe a method that results in a higher floor price, the company must use that higher price.
Example: The 90-day average is ₹48, and the 10-day average is ₹50. The minimum issue price is ₹50.
SEBI also has a definition for frequently traded shares. A company’s shares must have recorded a traded turnover of at least 10% of the total shares of that class during the 240 trading days before the relevant date. Shares that do not meet this condition follow a separate valuation-based pricing method.
Lock-in period
A lock-in period is a time during which allotted shares cannot be sold.
- Promoters and promoter group: Shares are generally locked in for 18 months from the date of trading approval. However, the part that exceeds 20% of the post-issue capital is locked in for 6 months.
- Other investors: Shares are generally locked in for 6 months from the date of trading approval.
The allottee’s existing shares in the company are also locked in. This generally applies from the relevant date until 90 trading days after the stock exchanges grant trading approval.
These lock-in periods apply to shares that are allotted and listed. Convertible securities such as warrants follow separate provisions.
Does a Preferential Issue Dilute Existing Shareholders?
Usually, yes. Dilution means the number of shares goes up, so each existing share represents a smaller slice of the company. Your percentage falls unless you also get new shares.
Example: A company has 10 lakh shares. Ramesh owns 1 lakh, which is 10%.
- The company issues 2 lakh new shares at ₹50 to selected investors.
- It receives 2 lakh × ₹50 = ₹1 crore.
- Total shares become 12 lakh.
- Ramesh still has 1 lakh shares, but 1 ÷ 12 = 8.33%.
Ramesh still owns the same 1 lakh shares, but his percentage ownership falls from 10% to 8.33%. The effect on the value of his investment depends on the issue price and how the company uses the money it raises.
Preferential Issue vs Rights Issue vs IPO vs Private Placement
| Preferential issue | Rights issue | IPO | Private placement | |
| Who can buy? | Selected investors | Existing shareholders | General public | Limited, chosen investors |
| Company status | Listed (SEBI rules) or unlisted | Mostly listed | Unlisted, going public | Listed or unlisted |
| Existing holders get priority? | No | Yes | No | No |
| Dilution | Yes, for those who don’t take part | Can be avoided or reduced if existing shareholders take up their entitlement | Yes | Yes |
A preferential allotment is itself a type of private placement under company law. For listed companies, SEBI adds extra rules on price, lock-in, and approvals. Unlisted companies follow the Companies Act rules instead, which are different.
What Should Investors Check Before Considering a Preferential Issue?
A preferential issue is not automatically good or bad news. Look at these points:
- Who is getting the shares? A strong long-term investor means something different from an unknown one.
- Are promoters participating? Promoters putting in their own money can be a positive sign. It is not a guarantee.
- What is the issue price? Compare it with the current market price.
- How will the money be used? Look for a clear purpose, such as growth or reducing debt.
- How much dilution will happen? Do the simple percentage calculation shown above.
- What is the lock-in? A longer lock-in suggests the allottees are in for the long term.
- Does the reason make sense? Check the company’s finances and record.
You can find these details in the company’s filings on the BSE and NSE websites.
FAQs
What is a preferential issue in simple words?
It is when a company sells new shares to a few selected investors instead of the public.
Is a preferential issue good or bad for shareholders?
It can be either. It depends on the price, the purpose, the investors, and the company's finances.
Who can get shares in a preferential allotment?
Promoters, institutions, and other chosen investors can, as long as they meet the rules. Generally, anyone who sold the company's shares in the previous 90 trading days cannot.
Do shareholders need to approve it?
Yes. A listed company needs a special resolution, which requires at least 75% of the votes cast.
How is the preferential issue price decided?
For frequently traded shares, it is the higher of the 90-day and 10-day VWAP. If the company's own rules result in a higher floor price, that price applies.
ARN Disclosure: Investik Future is an AMFI-registered Mutual Fund Distributor. ARN-341107 — Verify on AMFI ↗. Komal Thakur is the content author and digital marketer; the ARN registration belongs to Investik Future, not to the author personally.
