Comprehensive Guide to Bonus Shares Issuance by Private Companies

Unlocking Shareholder Value: A Comprehensive Guide to Bonus Shares Issuance by Private Companies Under the Companies Act, 2013

The issuance of bonus shares is a strategic tool for private companies to capitalize profits and reward shareholders without cash outflow. Governed by Section 63 of the Companies Act, 2013, these shares are distributed free to existing shareholders in proportion to their current holdings. Companies can fund bonus shares from their free reserves, securities premium account, or capital redemption reserve account, but not from revaluation reserves. The process requires authorization in the company’s Articles of Association, a board recommendation, and an ordinary resolution from shareholders. Key requirements include ensuring no default on fixed deposits, debt, or employee dues, and ensuring any partly paid-up shares are made fully paid. The procedure involves multiple steps, from a board meeting and regulatory filings to shareholder communication and share allotment. While this action strengthens a company’s capital structure and can enhance shareholder loyalty, it does not generate cash and involves administrative complexity. Once announced by the board, the decision is irrevocable, highlighting the importance of careful planning and compliance with all legal provisions.

1. Introduction

In the dynamic landscape of corporate finance, bonus shares represent one of the most strategic tools available to companies for rewarding shareholders while strengthening their capital base. Under the Companies Act, 2013, the issuance of bonus shares has evolved into a well-regulated mechanism that allows private companies to capitalize their accumulated profits and reserves, thereby converting them into share capital without any cash outflow.

Bonus shares, also known as capitalization shares or scrip dividends, are additional fully paid-up shares distributed free of cost to existing shareholders in proportion to their current shareholding. This corporate action serves multiple purposes: it rewards loyal shareholders, improves the company’s debt-to-equity ratio, makes shares more affordable for small investors, and demonstrates management’s confidence in the company’s future prospects.

For private companies, the bonus share mechanism under Section 63 of the Companies Act, 2013, provides a structured framework that balances shareholder interests with regulatory compliance. Unlike public companies, private companies have certain procedural simplifications while maintaining the core principles of transparency and fairness in the distribution process.

The significance of bonus shares extends beyond mere financial engineering. They represent a company’s ability to generate sustained profits and its commitment to sharing growth with stakeholders. When a private company issues bonus shares, it essentially transforms paper profits into tangible ownership stakes, thereby increasing the total number of shares outstanding while maintaining each shareholder’s proportional ownership.

Flowchart showing the complete procedure for issuing bonus shares by private companies under the Companies Act 2013

2. Legal Framework and Regulatory Provisions

i. Section 63 of the Companies Act, 2013

Section 63 serves as the cornerstone legislation governing bonus share issuance in India. This provision replaced the earlier regulations under the Companies Act, 1956, and introduced more comprehensive guidelines for both private and public companies. The section is structured into three key subsections, each addressing specific aspects of bonus share issuance.

Subsection (1) establishes the permissible sources for bonus shares, explicitly stating that companies may issue fully paid-up bonus shares from their free reserves, securities premium account, or capital redemption reserve account. Importantly, it prohibits the use of reserves created through asset revaluation, ensuring that bonus shares are backed by genuine profits rather than notional gains.

Subsection (2) outlines the mandatory conditions that must be fulfilled before any bonus issue. These conditions ensure that the company maintains financial stability and regulatory compliance throughout the process. The requirement for board recommendation followed by shareholder approval through a general meeting establishes a robust governance framework.

Subsection (3) contains a crucial restriction, explicitly prohibiting companies from issuing bonus shares in lieu of dividend payments. This provision ensures that bonus shares remain a separate corporate action distinct from dividend distribution.

3. Supporting Rules and Regulations

The Companies (Share Capital and Debentures) Rules, 2014, particularly Rule 14, provide additional operational guidelines for bonus share issuance. These rules specify implementation timelines and procedural requirements that complement the primary legislation.

Rule 14 establishes that once a board of directors announces its decision to recommend a bonus issue, the company cannot subsequently withdraw this decision. This provision protects investor expectations and market integrity by preventing arbitrary reversals of announced corporate actions.

4. Sources for Bonus Share Issuance

i. Free Reserves

Free reserves constitute the primary source for bonus share issuance and represent accumulated profits that are available for distribution as dividends. Under Section 2(43) of the Companies Act, 2013, free reserves are defined as reserves available for dividend distribution, excluding unrealized gains, notional gains, or asset revaluation reserves.

Private companies typically accumulate free reserves through retained earnings from profitable operations over multiple financial years. These reserves demonstrate the company’s ability to generate consistent profits while maintaining adequate cash flows for operational requirements.

ii. Securities Premium Account

The securities premium account represents the excess amount collected when shares are issued at a premium over their face value. This account can be utilized for bonus share issuance, effectively converting the premium collected from earlier share issues into additional share capital for existing shareholders.

For private companies, the securities premium account often reflects the growth in company valuation since the original share issuance. Using this account for bonus shares allows companies to share this value appreciation with existing shareholders.

iii. Capital Redemption Reserve Account

The capital redemption reserve account is created when a company redeems its shares or preference shares. This account maintains the company’s capital base and can be utilized for issuing bonus shares. Private companies with a history of share buybacks or preference share redemptions can leverage this source for bonus issues.

5. Mandatory Conditions and Requirements

i. Authorization by Articles of Association

Private companies must ensure that their Articles of Association contain specific provisions authorizing the capitalization of profits and reserves for bonus share issuance. If such provisions are absent, companies must amend their articles through a special resolution before proceeding with the bonus issue.

This requirement ensures that the company’s constitutional documents explicitly permit such corporate actions, providing legal certainty and protecting shareholder rights.

ii. Board Recommendation and Shareholder Approval

The bonus share issuance process requires a two-tier approval mechanism. The board of directors must first recommend the bonus issue, determining the ratio and terms of issuance. Subsequently, shareholders must approve the proposal through an ordinary resolution passed in a general meeting.

This dual approval structure ensures that both management and shareholders align on the bonus share decision, maintaining corporate governance standards.

iii. Financial Compliance Requirements

Private companies must demonstrate clean financial records before issuing bonus shares. Specifically, they must not have defaulted on:

• • Fixed Deposits: Any outstanding interest or principal payments on fixed deposits accepted from the public
  • Debt Securities: Interest or principal payments on debentures or other debt instruments
  • Statutory Employee Dues: Contributions to provident fund, gratuity payments, and bonus obligations

These requirements ensure that companies prioritize their obligations to creditors and employees before rewarding shareholders through bonus issues.

iv. Share Capital Compliance

All partly paid-up shares must be made fully paid-up before the bonus share allotment date. This requirement ensures that all shareholders are treated equally and that the company’s share capital structure remains consistent.

Additionally, companies must verify that their authorized share capital is sufficient to accommodate the bonus shares. If inadequate, the authorized capital must be increased through appropriate amendments to the Memorandum of Association.

6. Detailed Procedure for Private Companies

Step 1: Pre-Issue Preparations

Before initiating the bonus share process, private companies must conduct a comprehensive review of their financial position and legal compliance. This includes verification of available reserves, assessment of authorized share capital adequacy, and confirmation that all statutory requirements are met.

Companies should also review their Articles of Association to ensure proper authorization exists. If amendments are required, these should be completed through the prescribed procedure before proceeding with the bonus issue.

Step 2: Board Meeting and Resolution

The process formally begins with a board meeting convened after providing at least seven days’ notice to all directors. During this meeting, the board must:

• • Recommend the bonus issue and determine the appropriate ratio based on available reserves
  • Fix the record date for determining eligible shareholders
  • Approve the draft notice for the Extra-Ordinary General Meeting
  • Authorize company officials to take necessary actions for implementation

The board resolution must be comprehensive, covering all aspects of the proposed bonus issue while remaining subject to shareholder approval.

Step 3: Regulatory Filings

Within 30 days of passing the board resolution, companies must file Form MGT-14 with the Registrar of Companies, attaching the certified copy of the board resolution and explanatory statement. This filing ensures regulatory transparency and creates a formal record of the board’s decision.

Step 4: Shareholder Communication

Private companies must issue notices to all shareholders at least 21 clear days before the Extra-Ordinary General Meeting. The notice must include detailed explanatory statements outlining the rationale for the bonus issue, the proposed ratio, and the sources of funding.

This communication phase is crucial for ensuring informed shareholder participation and maintaining transparency in the decision-making process.

Step 5: Extra-Ordinary General Meeting

The EGM serves as the forum for shareholders to approve or reject the bonus share proposal. An ordinary resolution is required for approval, meaning a simple majority of votes cast is sufficient. The meeting must be conducted in accordance with the provisions of the Companies Act, 2013, and relevant Secretarial Standards.

Step 6: Post-Approval Compliance

Following shareholder approval, companies must file another Form MGT-14 within 30 days, attaching the certified copy of the ordinary resolution passed at the EGM. This filing formally notifies the regulatory authorities of shareholder approval.

Step 7: Share Allotment Process

The board must convene another meeting to pass a resolution for the actual allotment of bonus shares to eligible shareholders. This resolution should specify the allotment details, including the number of shares allotted to each shareholder based on their holdings as of the record date.

Step 8: Return of Allotment

Within 30 days of allotment, companies must file Form PAS-3 (Return of Allotment) with the Registrar of Companies. This form must include the board resolution authorizing allotment and a complete list of allottees with their respective allotment details.

Step 9: Share Certificate Issuance

For shares held in physical form, companies must issue share certificates within two months of allotment. For shares held in dematerialized form, the company must ensure that the bonus shares are credited to shareholders’ demat accounts through the depository system.

7. Restrictions and Prohibitions

a. Prohibition on Revaluation Reserves

Companies cannot issue bonus shares by capitalizing reserves created through asset revaluation. This restriction ensures that bonus shares are backed by actual profits rather than paper gains from asset appreciation. The provision maintains the integrity of the bonus share concept by limiting sources to genuine earnings.

b. Prohibition as Dividend Substitute

Section 63(3) explicitly prohibits issuing bonus shares in lieu of dividend payments. This restriction maintains the distinct nature of bonus shares as a capital restructuring tool rather than a dividend distribution mechanism. Companies cannot use bonus shares to avoid cash dividend payments to shareholders.

c. Irrevocability of Board Decision

Once the board of directors announces its decision to recommend a bonus issue, the company cannot subsequently withdraw this decision. This rule protects investor expectations and market integrity, preventing companies from manipulating share prices through false announcements.

8. Practical Example:

To illustrate the bonus share process, consider ABC Private Limited, a private company with the following financial structure:

• Company Profile:
  • Authorized Share Capital: ₹50,00,000 (50,000 shares of ₹100 each)
  • Paid-up Share Capital: ₹20,00,000 (20,000 shares of ₹100 each)
  • Free Reserves: ₹15,00,000
  • Securities Premium: ₹8,00,000
  • Total Available for Bonus: ₹23,00,000
• Shareholding Pattern:
  • Anil Kumar: 8,000 shares (40%)
  • Priya Sharma: 6,000 shares (30%)
  • Rajesh Gupta: 4,000 shares (20%)
  • Sunita Singh: 2,000 shares (10%)
• Bonus Issue Decision:

The board decides to issue bonus shares in the ratio of 1:2 (one bonus share for every two shares held), utilizing ₹10,00,000 from available reserves.

• Calculation of Bonus Shares:

• Financial Impact:
  • Before Bonus Issue:
    • Paid-up Capital: ₹20,00,000
    • Free Reserves: ₹15,00,000
    • Total Shareholders’ Equity: ₹35,00,000
  • After Bonus Issue:
    • Paid-up Capital: ₹30,00,000 (increased by ₹10,00,000)
    • Free Reserves: ₹5,00,000 (reduced by ₹10,00,000)
    • Total Shareholders’ Equity: ₹35,00,000 (unchanged)

This example demonstrates how bonus shares increase the number of shares outstanding while maintaining the proportional ownership of each shareholder and the total value of shareholders’ equity.

• Share Price Impact:

If the original share value was ₹175 per share (₹35,00,000 ÷ 20,000 shares), the adjusted price after the bonus issue would be approximately ₹116.67 per share (₹35,00,000 ÷ 30,000 shares). Each shareholder’s total investment value remains unchanged despite owning more shares at a lower per-share value.

9. Benefits and Limitations

A. Benefits for Private Companies

• Capital Structure Optimization: Bonus shares help private companies achieve a better balance between paid-up capital and accumulated reserves, creating a more robust capital structure that can support future growth initiatives.
• Shareholder Retention: By rewarding existing shareholders with additional shares, companies can encourage long-term investment and reduce shareholder turnover. This is particularly valuable for private companies seeking stable ownership structures.
• Enhanced Market Perception: Bonus issues signal management’s confidence in the company’s future prospects and financial stability. This positive signaling can improve the company’s reputation among stakeholders, including potential investors, creditors, and business partners.
• Tax Efficiency: Unlike dividend distributions, bonus shares do not create immediate tax obligations for shareholders in most jurisdictions. This tax-efficient reward mechanism can be particularly attractive to high-net-worth individuals and institutional investors.

B. Limitations and Considerations

• No Cash Generation: Bonus share issuance does not bring any cash into the company, unlike rights issues or public offerings. Companies requiring immediate capital infusion cannot rely solely on bonus issues to meet their funding needs.
• Administrative Complexity: The process involves multiple regulatory filings, meetings, and compliance requirements, creating an administrative burden and associated costs. Private companies must allocate sufficient resources for proper execution.
• Dilution of Earnings Per Share: While the total number of shares increases, the earnings per share may decrease proportionally if profits do not increase correspondingly. This metric dilution might concern performance-focused stakeholders.
• Limited Flexibility: Once announced, companies cannot withdraw bonus share decisions, reducing management’s flexibility in capital allocation strategies. This irrevocability requires careful planning and analysis before announcement.

10. Summary of Procedures

A. Procedure

B. Conditions and Requirements

C. Restrictions

11. Conclusion

The issuance of bonus shares by private companies under the Companies Act, 2013, represents a sophisticated mechanism for capital restructuring that balances regulatory compliance with shareholder value creation. Section 63 provides a comprehensive framework that ensures transparency, fairness, and financial prudence in the bonus share process while maintaining the flexibility needed for effective corporate management.

For private companies, bonus shares offer a strategic tool to optimize capital structure, reward loyal shareholders, and demonstrate financial strength without depleting cash reserves. The detailed procedural requirements, while creating administrative responsibilities, also ensure that all stakeholders’ interests are protected through proper governance mechanisms and regulatory oversight.

The success of a bonus share issue depends on careful planning, thorough compliance with regulatory requirements, and effective communication with shareholders. Companies must evaluate their financial position, assess the availability of appropriate reserves, and ensure that all statutory conditions are met before initiating the process. The irrevocable nature of bonus share announcements underscores the importance of thorough preparation and strategic decision-making.

As the corporate landscape continues to evolve, bonus shares remain a valuable instrument for private companies seeking to strengthen their capital base while rewarding shareholders. The regulatory framework under the Companies Act, 2013, provides the necessary structure to execute these transactions safely and effectively, contributing to the overall development of India’s corporate sector.

Private companies considering bonus share issuance should engage qualified professionals, including company secretaries, chartered accountants, and legal advisors, to ensure full compliance with regulatory requirements and optimal execution of the process. With proper planning and execution, bonus shares can serve as an effective tool for enhancing shareholder value while maintaining regulatory compliance and corporate governance standards.

The continued evolution of regulations and market practices necessitates that companies stay updated with the latest developments in corporate law and securities regulations. By maintaining this awareness and adhering to best practices, private companies can effectively utilize bonus shares as part of their broader capital management and shareholder relations strategies.

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Disclaimer: The information provided is for educational purposes and should not be considered as professional advice. The author shall not be liable for any direct, indirect, special, or incidental damage resulting from, arising out of, or in connection with the use of the information.