The BLC Stance: Demat before the deal

When any company acquires a "small" company (as defined in Section 2[85] of the Companies Act, 2013), specifically, where the acquisition results in the acquirer gaining 51% or more of the outstanding shareholding of the target, the acquirer's advisers will often ask that the target's shares be dematerialised before closing.

In this BLC Stance, we explain the practical benefits of this position, along with its limitations, so that you can form your own independent stance while negotiating your next term sheet!

Practical benefits

Dematerialisation is more than a change of format. To move shares into demat form, every shareholder must come forward with original share certificates, open a demat account, and have the holding reconciled against the register of members by a registrar and transfer agent. Lost certificates, unstamped or unrecorded transfers, shares still standing in the names of deceased members and gaps in the register tend to surface at this stage.

For a target whose shares are spread across family members, early investors or other non-executive holders, the exercise is in effect a practical test of title, and it is better run before the price is paid than after. Demat shares are also simpler to transfer at closing, to pledge to a lender, and to deal with in later funding rounds.

Limitations

That said, dematerialisation before the acquisition is not something the law requires in the ordinary case. Rule 9B of the Companies (Prospectus and Allotment of Securities) Rules, 2014 requires private companies to issue and hold securities in demat form, but leaves out small companies: at present, those with paid-up capital of up to INR 10 crore and turnover of up to INR 100 crore.

A holding company or a subsidiary can never be a small company, whatever its size. The target therefore loses that status the moment it is acquired. The demat obligation, however, does not arise on that date. Status is tested on the last day of the financial year, on the audited financial statements, and the company then has eighteen months from the close of that year to comply.

To illustrate: a target acquired in November 2026 is not a small company on 31 March 2027, and has until 30 September 2028 to dematerialise. Until then, a transfer of physical shares remains valid, and the acquisition itself can close on share certificates and transfer forms.

Where the position differs

Three situations call for more care.

The first is where the acquirer is a public company, whether listed or unlisted. The target then becomes a deemed public company, and Rule 9A of the same Rules, which governs unlisted public companies, applies from the date of acquisition, without the eighteen-month window. Here, the manner of acquisition determines whether the shares must be dematerialised. The restriction operates on future issuances and transfers, and not on those already completed. A transfer made while the target is still a small private company, including the very transfer that makes it a subsidiary, does not itself attract the requirement. A deferred acquisition is different: where the first tranche makes the target a subsidiary, every later tranche is a transfer of shares of a deemed public company, and the shares must be dematerialised before that tranche can be completed. Since every later tranche then depends on the shares being in demat form, and the time the demat process takes is itself uncertain, it is advisable in a deferred acquisition to have all the shares dematerialised before the first tranche is acquired, so that the later tranches can proceed smoothly. The exception is a target that becomes a wholly owned subsidiary, which Rule 9A exempts.

The second is where the target was already outside the small company definition, in which case it may already be past its compliance date.

The third is one of timing: once the compliance date passes, the company cannot issue, buy back or allot bonus or rights shares unless its promoters, directors and key managerial personnel hold in demat, so a fund-raise planned soon after closing may bring the date forward in practice.

Deciding the Stance

The real question is not whether to dematerialise, but when, and who bears the timing risk. The process depends on depositories, the registrar and the cooperation of each shareholder, and can take several weeks. As a condition precedent, it places the closing date in the hands of third parties.

Where the shareholding is simple and title is clear, a post-closing covenant to dematerialise well within the statutory window will usually serve. Where the shareholding is fragmented, title is in any doubt, or the acquirer is a public company, there is a sound case for making it a condition precedent: on the strength of what the exercise reveals, and not because the statute demands it. This update is for general information only and is not legal advice.

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