Equity Funding under Companies Act, 2013

Last Updated : 08 Mar, 2024

What is Equity Funding under Companies Act, 2013?

Equity Funding under the Companies Act 2013 refers to the process through which a company raises its capital by issuing shares to investors in exchange for ownership in the company. Equity represents ownership in a company, and those who hold equity shares are known as shareholders or equity investors. Companies Act 2013 has made strict regulations concerning the concealment of funds. A company is not permitted to make any sort of investment through more than two layers of investment companies. It is observed that corporations use this as a common practice to divert funds via investing through several step-down subsidiaries. Placing such restrictions can help prevent the diversion of such funds.

Section 186 of the Companies Act 2013 applies to both public and private companies. The section deals with the provisions regarding ‘Loan and Investment’ by a company. In addition to Section 186, Rules 11, 12, and 13 also provide provisions governing the making of loans and investments, giving of guarantees, and providing of securities by a company.

Legal Requirements for Equity Funding

Geeky Takeaways:

The Companies Act 2013 has crucially handled the issue of concealment of funds by diverting them to several subsidiaries. A company is not permitted to make investments through more than two layers of investment companies.
Section 186 is restrictive, and its focus is on governing intercorporate loans and intercorporate advances.
Section 186 applies to both public and private companies.
By imposing limits, requiring board approvals, and mandating disclosure, the Companies Act promotes responsible financial management and also protects the interests of stakeholders.

Table of Content

Section 186 of Companies Act, 2013
Legal Requirements for Equity Funding
Non-applicability of Section 186
Penalty for Contravention of Section 186
Conclusion
Equity Funding under Companies Act, 2013- FAQs

Section 186 of Companies Act, 2013

Section 186 of the Companies Act 2013 establishes rules for regulating the loans and investments that can be made by a company registered under the act. The section also states that a company can make investments through more than two layers of investment companies by following certain restrictions that they have to adhere to. A company cannot directly or indirectly provide a loan, security, or guarantee to any person or a body corporate. Furthermore, the company cannot acquire the securities of any other body corporate through purchase, subscription, or any other means.

Section 186(2) of the Companies Act, 2013 also establishes that:

A company cannot directly or indirectly advance a loan to any person or body.
A company cannot directly or indirectly advance any security or provide a guarantee in connection with a loan to any other person or body corporate.
A company cannot directly or indirectly acquire, by way of purchase, subscription, or otherwise, the securities of any other body corporate.
A company cannot directly or indirectly acquire a company’s paid-up share capital exceeding 60% of paid-up share capital, 100% of the company’s free reserves, and the securities premium account, whichever is greater.

Legal Requirements for Equity Funding

Requirement 1: Approval of Board

1. In all cases irrespective of the amount of loan, investment, guarantee, or security, the approval of the Board is required.

2. The approval of the Board shall be obtained by a unanimous resolution passed at a Board meeting along with the consent of all the directors present and voting at the meeting.

3. Resolution by mere circulation or resolution of the committee of directors is not sufficient to approve any loan, investment, guarantee, or security.

Requirement 2: Approval of the Members by Passing a Special Resolution

1. A prior approval using a special resolution is necessary when the aggregate of the loan, investment, guarantee, or security already made together with the loan, investment, guarantee, or security proposed to be made exceeds the limit specified under Section 186(2) of the Companies Act 2013.

2. The limit provided under Section 186(2) is the number higher of:

60% of paid-up share capital + free reserves + securities premium or
100% of free reserves + securities premium.

3. The contents of the special resolution passed shall also contain the total amount up to which the Board is authorized to make loans, guarantees, investments, or security.

4. No approval by special resolution is required when:

The loan is given by a company to its wholly-owned subsidiary, a joint venture company, or
A guarantee is given or security is provided by a company to its wholly-owned subsidiary or joint venture company.
Where the holding company acquires the securities of its wholly owned subsidiary by way of subscription or otherwise.

Requirement 3: Approval of Public Financial Institutions

1. The company is required to obtain prior approval from a public financial institution from which it has taken a term loan.

2. The directors of the company shall pass a resolution at a Board meeting.

3. Approval of PFI will not be required if:

The aggregate amount of loans, guarantees, investments, or security already made together with the loan, investment, guarantee, or security proposed to be made does not exceed the limit provided under the mentioned section.
As per the terms and conditions of such a term loan, there is no default in repayment of loan installments or interest to a public financial institution.
The Board can pass a resolution at the Board of Directors meeting or through a resolution passed by circulation in the case of a Specified International Financial Services Centre (IFSC) public company or Specified IFSC private company.

Requirement 4: Rate of Interest

The Rate of Interest (RoI) chargeable should be higher than the rates prevailing on one, three, five, or ten years of government security closest to the tenure of the loan.

Requirement 5: No Subsisting Default with Respect to Deposits

1. A company that has made a default in repayment of any deposits accepted by it or a default in payment of interest on deposits shall not make any loan, guarantee, investment, or security until such a default exists.

2. In other words, when a company fails to repay the deposit amount or interest amount on the due date, it may make a loan, guarantee, investment, or security only after such default in repayment has been made good.

Requirement 6: Disclosures in Financial Statements

1. The company is required to disclose to the members in the financial statement:

The full particulars about the loans given, investments made, guarantee or security provided, and
The purpose for which such a loan, guarantee, or security is proposed to be utilized by the recipient of the loan, guarantee, or security.

Requirement 7: Company registered under SEBI

1. Any company that is registered under Section 12 of the Securities and Exchange Board of India (SEBI) Act 1992 shall not be engaged in taking inter-corporate loans or deposits exceeding the prescribed limit provided under the act.

2. The company is required to furnish the details of the loan or deposits in its financial statement.

Non-applicability of Section 186

1. For the Government Company

A company engaged in defense production owned by the government.
Governmental companies other than the listed companies may obtain approval from the Ministry of Corporate Affairs, which is in charge of those companies.

2. For the Acquisition of Shares

Any purchase of shares that is assigned as per the right shares.
Acquisition by any investment company whose primary business is itself the acquisition of securities.

3. For Loans, Guarantees, or Security

A banking company in the ordinary course of its business.
An insurance company in the ordinary course of business.
A housing finance company in the ordinary course of its business.
A company that provides infrastructure or finances to the companies.

Penalty for Contravention of Section 186

Section 186 of the Companies Act 2013 provides the following punishments which are imposed if a company violates this section.

For Company	Fine – Minimum Rs. 25000 and, Maximum Rs. 5,00,000
For an Officer in Default	Maximum Imprisonment – 2 years; and Fine – Minimum Rs. 25,000 and, Maximum Rs. 1,00,000

Conclusion

Section 186 of the Companies Act 2013 applies to both public and private companies. The section deals with the provisions regarding ‘Loan and Investment’ by a company. In addition to Section 186, Rules 11, 12, and 13 also provide provisions governing the making of loans and investments, giving of guarantees, and providing of securities by a company. The Companies Act has provided for seven major legal requirements that are to be followed under Section 186. The act has also specified penal provisions in case a company violates this section. The penalty shall be levied on both the company and the officer in default. The section has provided the cases in which this section shall not be applicable.