Dematerialization of shares of a private limited company in India

This article was co-created by the Carta team and global technology law firm Inventus Law.

As a part of the Government of India’s policies aimed at strengthening Indian financial markets and digitizing corporate compliance, the Ministry of Corporate Affairs of India (MCA) has taken steps over the last decade to require that all companies incorporated in India, except for small companies, issue all shares exclusively in dematerialized form.  Small companies are defined as companies whose paid-up capital does not exceed INR 4 Crores (roughly $476,000 USD at the time of this article’s publication) and turnover does not exceed INR 40 Crores ($4.76 million USD).

All private companies were required to mandatorily comply with the process of dematerialization by June 30, 2025.

This article will explain what dematerialization is, how the new rules were enacted, the consequences of non-compliance for private companies, and the impacts of dematerialization.

What is dematerialization?

Dematerialization is the process by which physical certificates of an investor are converted to an equivalent number of securities in electronic form and credited into the account of the owner of the securities. The mandatory dematerialization of securities to be undertaken by private companies is three-fold:

1. The company must issue securities in dematerialized form only.

2. The company must facilitate the dematerialization of its securities.

3. The company must only make any offer for the issue of any securities, buyback of securities, issue of bonus shares, etc. after the company has dematerialized the entire holding of its promoters, directors, and key managerial personnel.

What is the process?

The process of dematerialization is carried out by the company-appointed Securities and Exchange Board of India (SEBI)-registered Depository Participant (DP).

The process of dematerialization for a private company is as follows:

1. Amendment of the Articles of Association to authorize shareholders to hold shares in dematerialized form.

2. Appointment of SEBI-registered independent Registrar and Transfer Agent to act as an intermediary between the company and the securities depositories (NSDL/CDSL).

3. Acquisition of an International Securities Identification Number (ISIN) for each type of security issued.

4. Opening of a Demat Account with a SEBI-registered DP.

5. Dematerialization of existing securities through the DP by submitting the physical share certificates.

6. Notifying the MCA of half-yearly returns through the prescribed Form PAS-6.

How were the new dematerialization rules enacted?

The new policies regarding dematerialization came in a series of regulatory actions from 2014 to 2024 undertaken by the MCA through various additions to the Companies (Prospectus and Allotment) Rules.

• On March 31, 2014, the MCA introduced a requirement to Rule 9 that the promoters of all public companies making an offer of its securities to the public can hold shares only in dematerialized form.

• On September 10, 2018, the MCA inserted Rule 9A, which imposes a mandatory obligation on all unlisted public companies to issue all securities only in dematerialized form and to facilitate the dematerialization of all existing securities.

• On October 27, 2023, the MCA inserted Rule 9B, which requires every private company (except small companies), to issue securities only in dematerialized form and facilitate the dematerialization of all its existing securities.

• On January 12, 2024, the SEBI issued a circular mandating Alternative Investment Funds to hold their investments in a private limited company in dematerialized form irrespective of whether the investment  is made directly in the investee company or is acquired from another entity.

Consequences of non-compliance

While the rules do not explicitly mention an exact penalty for the defaults under Rule 9B, Section 450 of the Companies Act, 2013 provides the penalties and/or punishments for instances when no specific penalty or punishment is provided.

Pursuant to Section 450, “the company and every officer of the company who is in default or such other person shall be punishable with fine which may extend to ten thousand rupees, and where the contravention is continuing one, with a further fine which may extend to one thousand rupees for every day after the first during which the contravention continues.” 

Impact of dematerialization

Dematerialization of securities brings fundamental advantages over physical share certificates, including the total elimination of any risk of loss, theft, damage, or fraudulent activities like forgery. Additionally, it entails widespread benefits that permeate through critical parts of the broader corporate ecosystem.

Transparency

Transparency acts as a cornerstone of a healthy corporate system by fostering efficiency, integrity, and trust. It also makes the market more attractive to investors. The dematerialization of shares promotes a more transparent approach to transactions related to securities as all dealings can be electronically monitored. It makes it easier to track ownership and transfer of shares. This makes record-keeping clear and accessible, and ultimately curtails frauds.

Cost

Dematerialization significantly reduces the costs borne by companies for printing, storing, and handling physical share certificates. It also eliminates costs such as stamp duties and transfer fees. Furthermore, by cutting down these ancillary tasks, it also cuts down costs related to the labor required to carry out these tasks.

Ease of transfer process

The process of transfer of shares is significantly more streamlined and less cumbersome than the undertaking of physical share transfers. This reduces delays that often occur in share transfers and reduces administrative strains.

Improved corporate governance

The accurate and up-to-date shareholder records provide an easy way for companies to reconcile their records with that of the authorities in order to maintain regulatory compliance. This creates an all-round better environment of corporate governance.

 As of March 2024, India had 1,691,495 active companies and the regulatory regime is focused towards the creation of an environment rooted in the pillars of trust, efficiency, and transparency with a view to improve ease of business in the country. The 2023 amendment, and the widespread consequences the same, marks an inflection point for corporate compliance given that private companies constitute the greatest portion of all active companies, thus greatly widening the regulatory net and augmenting the government’s broader digitization drive.

Our thanks to Inventus Law for the expertise and insight they brought to the creation of this article. Carta  is here to assist you with navigating these changes and ensuring compliance with the new dematerialization regulations. Email us at partnerships-apac@carta.com if you have any questions.