Preferential allotment: selling shares to select investors

When a company wants to raise money quickly from chosen investors, it can use a preferential allotment. This guide explains what preferential allotment is, how it works and the safeguards around it.

Quick answer

A preferential allotment is when a company issues new shares to a select group of investors, such as promoters or institutions, at a price fixed in advance. It lets a company raise money quickly from specific investors rather than the general public, but it follows SEBI rules to protect existing shareholders.

Key takeaways

• Preferential allotment issues shares to select investors.
• The price is fixed in advance under set rules.
• It helps a company raise money quickly.
• Buyers are often promoters or institutions.
• SEBI rules protect existing shareholders.

What is a preferential allotment?

A preferential allotment is a way for a company to raise money by issuing new shares to a chosen group of investors, rather than offering them to the general public or all existing shareholders.

The shares are sold at a price fixed in advance, worked out using a formula set by SEBI. This lets the company bring in specific investors, such as promoters, large institutions or strategic partners.

Why do companies use it?

The main appeal is speed and certainty. A preferential allotment can raise money faster than a public offer, because the company deals with a small number of known investors.

It can also bring in a strategic investor who adds value beyond money, or let promoters increase their stake. So it is often used for targeted fundraising.

How is the price decided?

To protect existing shareholders, SEBI sets rules on the minimum price for a preferential allotment, usually based on the recent market price of the share over a defined period.

This pricing rule stops shares from being sold too cheaply to insiders, which would unfairly dilute other shareholders.

What are the safeguards?

Because a preferential allotment favours a select group, it must follow safeguards. Shareholders usually approve it through a special resolution, and there are lock-in periods on the new shares.

These rules, set by SEBI, aim to keep the process fair and transparent, so existing shareholders are not harmed by shares going to a chosen few on easy terms.

How does it affect existing shareholders?

A preferential allotment increases the total number of shares, which can dilute the holding of existing shareholders. But if the money raised helps the company grow, it can still be positive over time.

Shareholders should look at who is buying, at what price and why. Any investment decision should be your own after proper research and reading all related documents.

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