Dematerialisation of Shares by Private Companies - MCA’s Rule 9B

In October of 2023, the Ministry of Corporate Affairs (MCA) amended the Companies (Prospectus and Allotment of Securities) Rules 2014 (PAS Rules) via the Companies (Prospectus and Allotment of Securities) Second Amendment Rules 2023 (PAS Amendment Rules) by adding rule 9B.

This new rule mandates dematerialisation for all private companies excluding small companies and government companies.

What is Dematerialisation?

Dematerialisation of securities is the process of converting physical share certificates and other investment documents into an electronic format. These electronic holdings are then stored in a demat account, managed by a depository.

In India, there are two depositories registered with SEBI:

• NSDL (National Securities Depository Ltd.)
• CDSL (Central Depository Services (India) Ltd.)

NSDL and CDSL are both safe custodians for your dematerialised securities in India. Depending on who your Depository Participant (DP) i:e bank or broker, is registered with, your demat account will be held with either NSDL or CDSL.

MCA’s 9B Rule Explained

Prior to the Ministry of Corporate Affairs (MCAs) Rule 9B, dematerialisation of shares was optional for private companies. It was mandated only for publicly traded companies and some large private companies.

This meant most private companies in India relied on physical share certificates — a system vulnerable to loss, theft, and forgery. All private companies are now required to convert their existing physical certificate to electronic certificates by Sept 30th, 2024, and only issue shares electronically going forward.

Rule 9B discusses the issue of securities in dematerialised form by private companies and states that:

1. Every private company, other than a small company, shall

a. Issue the securities only in dematerialised form and

b. Facilitate dematerialisation of all its securities

per provisions of the Depositories Act, 1996 (22 of 1996) and regulations made thereunder. A small private company is referred to as a company with a paid-up capital of less than ₹4 crore and a turnover of less than ₹40 crore. 

2. If a private company isn't considered small based on its financial records at the end of a financial year ending after March 31, 2023, it must follow these rules within 18 months after the end of that financial year.

3. Any private company as specified above, when making offers for issuing securities, buying back securities, issuing bonus shares, or offering rights after it needs to follow this rule, must ensure that all securities held by its promoters, directors, and key managerial personnel have been dematerialised as per the rules of the Depositories Act, 1996 (22 of 1996), and related regulations before making such offers.

4. Every holder of securities of the private company referred to in sub-rule (2),- 

a. Planning to transfer these securities should dematerialise them before the transfer.

b. Similarly, anyone subscribing to securities of the private company through private placement, bonus shares, or rights offered after this rule applies to the company must make sure their securities are dematerialised before subscribing.

5. The rules from (4) to (10) of rule 9A will apply accordingly to the dematerialisation of securities under this rule.

6. The provisions of this rule shall not apply in the case of a government company.

Dematerialising the shares of private companies is expected to streamline share management and enhance security for both, companies and investors. It could also potentially improve liquidity within the private securities market.

Read the MCA rule 9B circular.

Step-by-Step Process for Dematerialisation of Shares by Private Companies

Now that you understand the rule for dematerialisation, let us take you through the detailed process of complying with it.

Step 1: Amendment of Articles of Association (AoA)

Your company's AoA needs to be updated to authorize shareholders to hold shares in dematerialised form. This may involve legal assistance.

Step 2: Appointment of Registrar and Transfer Agent (RTA)

You need to appoint a SEBI (Securities and Exchange Board of India) registered independent Registrar and Transfer Agent (RTA). They will act as intermediaries between the company and the depositories (CDSL or NSDL).

Step 3: Obtaining International Securities Identification Number (ISIN)

Apply for an ISIN number for each type of share your company has issued (e.g., common stock, preferred stock). This unique code identifies your company's securities globally.

‍Step 4: Opening Demat Account

The company needs to open a Demat account with a Depository Participant (DP). DPs are usually banks or brokerage firms authorized to facilitate dematerialisation.

Step 5: Dematerialisation of Existing Shares

Facilitate the conversion of existing physical share certificates held by shareholders into electronic form through the DP. This may involve shareholders submitting their physical certificates to the DP.

Step 6: Dematerialisation for Promoters, Directors & Key Managerial Personnel (KMP)

Ensure all promoters, directors, and KMPs hold their shares in dematerialised form before issuing any new securities. They need to link their Demat accounts with the company and have their shareholdings electronically credited to them.

Step 7: Regular Reporting (PAS 6): 

You are now required to submit half-yearly returns in the form of PAS 6, notifying the Ministry of Corporate Affairs of the dematerialisation details.

Depositories, Depository Participants and RTAs

In the entire dematerialisation process, you will come across three key players who work together to manage and track ownership of dematerialised shares - Depositories, Depository Participants and RTAs.

‍Who is a Depository?

A depository is either National Securities Depository Limited (NSDL) or Central Depository Services (India) Limited (CDSL) in India. They act as a central electronic repository for holding securities in digital format.

They maintain accounts for Depository Participants (DPs) and their clients (beneficial owners). They also electronically settle trades and transfer securities between DPs and ensure safekeeping and record-keeping of dematerialised securities

Who is a Depository Participant (DP)?

They act as an intermediary between the depository (NSDL or CDSL) and investors. It could include banks and brokerage firms. Depository participants open demat accounts for investors to hold their securities electronically. They allow the buying and selling of securities through the depository and provide account statements and other services to investors.

Who is the Registrar and Transfer Agent (RTA)?

They are appointed by the issuing company (whose shares are being held) to manage the company's shareholder records. They maintain records of shareholders and their holdings and process corporate actions like bonus issues, stock splits and dividend payments.

They act as a liaison between the company and the depository.

In short, the depository acts as the core infrastructure, holding the electronic records of securities. DPs act as access points for investors, allowing them to buy, sell, and hold their securities electronically. RTAs are responsible for maintaining accurate shareholder records and working with the depository to ensure smooth processing of corporate actions.

‍Important Considerations When Dematerialising

1. Fees

Opening and maintaining demat accounts involve fees.

2. KYC and PAN

You'll need KYC (Know Your Customer) documents and a PAN card (tax identification number) for the company and its shareholders for the dematerialisation process.

‍3. Share Transfer Restrictions

The Companies Act requires companies to alter Articles of Association (AoA) for any issue of shares. The risk here is that DP is not restricted by these rules, and may directly act upon the executed Delivery Instruction Slips (“DIS”) submitted by the transferor and process the demat share transfer requests, without confirming AoA amendments.

Hence- it is recommended that the private companies put in place adequate checks and filters at the depository’s level (for example, freezing of ISIN) and/or they should inform the DPs, as practically as possible, about the legal restrictions in the charter documents and that, the DPs is bound to act strictly as per those AoA restrictions/procedures prior to processing any share transfer requests.  

‍4. System Capacity

With a total of 24,61,937 registered companies in India, depositories could face challenges in managing the high volume of applications they receive for dematerialisation. Expect potential delays in processing, so it's advisable to initiate the process as early as possible to avoid any inconvenience.

What Are the Consequences and Penalties for Non-Compliance of Dematerialisation?

While there are no specific penalties for non-compliance with Section 29 of the Companies Act, which addresses the dematerialisation mandate along with Rule 9B of the PAS Rules, it's important to note that the general penalties outlined in Section 450 of the Companies Act could potentially be applicable in this scenario:

• The company can't issue or allot any securities including bonus shares in any form and Buyback of shares/securities. 
• Any shareholder who has not dematerialised their holdings will be unable to sell their shares or subscribe to additional shares.
• The company faces monetary penalties of INR 10,000 plus INR 1,000 for each day the violation continues, with a maximum of INR 200,000.
• Every officer of the company in default also faces the same penalties, with a maximum of INR 50,000.

Dematerialisation Is Easy With EquityList

EquityList is a cap table management solution that allows start-ups to issue and track their shares, grant equity compensation and avail compliance and advisory services.

We work with 300+ startups including companies like Cars24, Slice, Shiprocket, Blackbuck and smallcase.

Since the Ministry of Corporate Affairs (MCA) required private companies to dematerialise their shares, we've been striving to make the process quicker and easier for our clients. The only thing you have to do is make sure all your equity and shareholders data is available on the EquityList platform.

How Does EquityList Streamline Dematerialisation for Private Companies?

If you are not a user already, you need to sign up on our platform and add all information related to your cap table and shareholders. That’s it! Your job ends here, and ours starts.

What we then do is:

1. Become Your One-stop Solution

Partner with a reputed RTA to carry the process on behalf of our clients and make them compliant with the new rules in 2-3 weeks.

This includes all the following services:

• Draft all documents
• Coordination with shareholders 
• Streamlining dematerialisation documentation creation
• Liaising with our partner RTA
• Coordinating with CDSL/NSDL to ensure a smooth transition
• Adding dematerialisation data on EquityList for your access
• Offer Effortless Amendments

For amending the Articles of Association (AoA), board resolutions and shareholder resolutions for dematerialisation -  e- signature is integrated into our product. So all the early requirements from the Depository Participant can be executed quickly.

2. Simplify Compliance

• All information required for Form PAS 6 filing every six months can be directly exported from EquityList. Form PAS 6 format.‍
• EquityList provides a digital Register of Members, simplifying compliance requirements via Form SH 1.

FAQs

‍1. What is the meaning of dematerialisation?

Dematerialisation refers to converting physical share certificates into electronic form and holding them in a demat account.

‍2. What is an example of dematerialisation?

Up until now, private companies would give physical share certificates to their shareholders. However, after MCA’s amendment to the PAS Rules 2014, they are now mandated to convert these physical certificates into digital form through dematerialisation. It allows the conversion of physical share certificates into electronic form and stores it in your demat account. This is very similar to holding money digitally in a bank account.

‍3. What is the process of dematerialisation of shares of a private company?

Dematerialising private company shares requires updating legal documents, appointing an RTA, obtaining unique security codes, and opening Demat accounts for the company and individual shareholders. Existing physical certificates are converted to electronic holdings, with mandatory dematerialisation for key personnel. Finally, regular reports are submitted to the government. This multi-step process ensures secure and efficient share management.

To understand the detailed process, read our blog above.

‍4. Is dematerialisation compulsory for private companies?

Yes. In October of 2023, the MCA updated PAS Rules 2014 and added a new provision that mandates all private companies except for small companies to dematerialise their shares by Sept 30th, 2024. Going forward these companies will only issue share certificates in dematerialised form.

‍5. What is the dematerialisation of private limited company shares?

Dematerialisation of private limited company shares refers to the process of converting physical share certificates into an electronic format. This means that instead of holding paper documents as proof of ownership, shares are stored in a demat account.

‍6. What is the rule 9B of dematerialisation?

Rule 9B, introduced in the Companies (Prospectus and Allotment of Securities) Second Amendment Rules, 2023, governs the mandatory dematerialisation of shares in private companies. It aims to achieve complete dematerialisation of shares in non-small private companies, enhancing security, efficiency, and transparency in shareholding management.

‍7. What is the 9B issue of securities in dematerialised form by private companies?

Rule 9B mandates most private companies in India to convert physical share certificates to electronic form. This means existing paper shares must be dematerialised and future issuances will be electronic only. The deadline for existing companies was September 30th, 2024.

‍8. Is the dematerialisation of shares mandatory?

Yes, the dematerialisation of shares is mandatory for most private companies in India. 

Rule 9B dictates that companies must convert their existing physical shares to electronic form and future issuances must be electronic only. This applies to all private companies except those classified as "small" based on a specific financial threshold. The deadline for completing this process is September 30th, 2024. This shift aims to improve security, efficiency, and transparency in shareholding management.

9. How to dematerialise physical shares of private limited companies?

Dematerialising physical shares in a private limited company requires a coordinated effort. The company first appoints a SEBI-registered Depository Participant (DP). Shareholders are then informed about the process and deadlines. They submit their physical certificates along with a dematerialisation request form to either the company or the chosen DP. After verifying the details and authenticity of the certificates, the DP electronically credits the corresponding shares into the shareholder's demat account. 

‍10. What is the difference between depository and dematerialisation?

A depository acts like a bank for your securities. It holds your shares and other financial instruments electronically safely and securely. Whereas, dematerialisation is the process of converting your physical share certificates into electronic form. 

‍11. What is dematerialisation and rematerialisation?

Dematerialisation turns physical shares into digital holdings, like depositing cash in a bank. Rematerialisation does the opposite, it converts electronic shares back to paper certificates, similar to withdrawing cash.

12. What is the time limit for the dematerialisation of shares?

The deadline for dematerialisation is Sept 30, 2024, for existing non-small companies. However, companies exceeding the "small company" criteria after March 31, 2023, are provided an 18-month window from their financial year-end to comply. 

‍13. What is the deadline for dematerialisation?

All private companies are mandated to comply with the rules of dematerialisation by Sept 30, 2024.

14. Do you still need a cap table management software after dematerialising your securities?

Absolutely! Dematerialisation merely converts physical securities (shares) to a digital holding and directly stores the securities into the shareholder’s demat accounts. Post dematerialisation, you’ll still need to manage your cap table to track ownership, issue equity grants as part of your ESOP/SAR/RSU pools, store investment documents, model fundraising simulations, and provide dashboards to your shareholders. 

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