What is Preferential Allotment? | Definition, Pros vs Cons

A method commonly used by companies nowadays to expand their shares in the market is a preferential allotment. It is known as a preferential allotment when shares are made available to a certain set of people and companies (selected through the proper procedure) at a pre-decided price.

It is an easy and quick way to raise cash and capital. The investors naturally become stakeholders in the company. They can do so at reasonable and moderate prices instead of buying larger shares from the share market. This is the incentive offered to them.

Key Takeaways

1. A preferential allotment is a way to raise capital for a company, wherein it issues shares to selected investors.
2. The shares issued in preferential allotment carry special rights and privileges, such as a higher voting power or preferential dividend payouts.
3. Preferential allotment must comply with the regulations and guidelines set by the Securities and Exchange Board of India (SEBI).

Difference between Preferential Allotment and Private Placement

The preferential allotment is similar to private placement, and the two can be confused. Both involve a specific set of investors chosen by the company and the offering of shares in private. There is, however, a very fine difference between the two terms. The differences are enumerated as follows.

1. In the case of the private placement, the company offers the shares to a select group of investors. Regarding preferential allotment, shares are freshly issued for this purpose.
2. The documents and laws governing the two are widely different, as preferential allotment does not require the articles of authorization and valuation reports necessary for private placement.

Different Aspects of Preferential Allotment

1. This can be done after a resolution is made and most of the company’s existing shareholders pass the motion.
2. Minimum pricing guidelines and other laws determine which people or companies may be eligible, how many shares should be issued, and at what price.
3. There is also a cap on the number of allotted investors that can be chosen at once, not more than fifty.
4. The securities listed are shares and equities, including fully or partly convertible debentures or any shares that may be turned into equities.

Advantages of Preferential Allotment

1. A recurrent problem of most economies is under-investment, and one prominent way to resolve the problem is through preferential allotment.
2. Shares can be bought by those not comfortable with prices at the stock market, and they benefit inevitably from any increase in the values of common shares.
3. It is an easy and risk-free way for companies to raise necessary capital without borrowing from banks and risking their assets.

Disadvantages of Preferential Allotment

1. Preferential shareholders do not enjoy the same rights (such as voting rights) as the existing equity shareholders; thus, they can never be on par.
2. Before the minimum pricing limit was set and other guidelines were in place, companies were known to price otherwise financially lucrative shares at exorbitantly high prices.
3. Promoters have been frequently known to make preferential allotments to themselves and reap the benefits of the same while depriving genuine and interested investors.
4. Preferential shareholders have a claim to the company’s assets, which becomes undesirable for the company.

References

1. https://journals.sagepub.com/doi/abs/10.1177/0256090915590332