Mandatory Demat of Securities: A New Compliance Era for Startups

The regulatory landscape for private limited and public unlisted companies in India has undergone a seismic shift with the introduction of mandatory dematerialization. This transition, spearheaded by the Ministry of Corporate Affairs (MCA), aims to modernize the corporate framework by eliminating physical share certificates in favor of a secure, transparent, and digital ecosystem. For startups, this is not just a regulatory hurdle but a critical step toward institutionalizing their cap table and preparing for future scaling, funding rounds, or potential exits.

The mandate originates from Rule 9B of the Companies (Prospectus and Allotment of Securities) Rules, 2014 which was introduced in October 05, 2023. This rule requires all private companies, except for specific exempt categories, to issue securities exclusively in dematerialized form and to facilitate the conversion of all existing physical holdings. As the corporate environment moves toward 100% digitization, startups must align their internal processes with these requirements to ensure seamless operations and maintain investor trust.

Understanding Rule 9B and Its Impact on Private Limited Companies

Rule 9B signifies the end of the era of physical share certificates for most private entities. Previously, dematerialization was primarily a requirement for public companies, while private firms could choose to maintain physical registers. The new rule ensures that every transaction involving securities be it a fresh issue, a transfer, or a buyback is recorded electronically through authorized depositories like NSDL and CDSL.

For most Indian startups (i.e., private companies that are not classified as small companies), shares must be held in dematerialised (demat) form. Before issuing any new shares, conducting a rights issue, bonus issue, or buyback, the company must ensure that the shareholding of its promoters, directors, and key managerial personnel (KMP) is already dematerialised. This pre-offer demat compliance is mandatory and must be completed before undertaking such corporate actions.

Is Your Startup Exempt? The Small Company Threshold

Not every private company is immediately hit by this mandate. The MCA has provided a clear exemption for “Small Companies” as defined under Section 2(85) of the Companies Act, 2013. However, startups are often designed for rapid growth, and once they cross certain financial milestones, the exemption lapses, and the 18-month compliance clock begins.

Small vs. Non-Small: Thresholds at a Glance

Metric	Small Company Threshold (Exempt)	Non-Small Company (Mandatory Demat)
Paid-up Share Capital	Up to INR 10 Crore	Exceeding INR 10 Crore
Annual Turnover	Up to INR 100 Crore	Exceeding INR 100 Crore

In addition to the financial thresholds, certain entities such as Government companies and Nidhi companies are exempt from Rule 9B. However, holding companies and subsidiary companies are not treated as “small companies” under the Companies Act, 2013 and therefore cannot claim this exemption, regardless of their paid-up capital or turnover. Companies should review their audited financial statements each year to confirm their eligibility status. If a company ceases to qualify as a “small company” at the end of a financial year, it must comply with the mandatory dematerialisation requirements.

Critical Deadlines for Dematerialization

For companies that were already “non-small” as of March 31, 2023, the initial deadline for compliance was set for September 30, 2024. Subsequent extensions and specific rules for growing startups have clarified the timeline.

• Initial Compliance Date: September 30, 2024, for companies exceeding thresholds in FY 2022-23.
• Extended Deadline: Some regulatory updates pointed toward June 30, 2025, as a final grace period for certain entities to complete the transition.
• Rolling Deadline: For startups growing out of the “small” category today, the deadline is exactly 18 months from the end of the financial year in which the thresholds were breached.

Step-by-Step Compliance Guide for Startups

Navigating the dematerialization process requires coordination between the company, its legal advisors, and SEBI-registered intermediaries. Founders should follow this structured approach to ensure 100% compliance.

1. Amendment of Articles of Association (AoA)

The first legal step is to review the company’s AoA. Most older AoAs may only mention physical certificates. Startups must pass a special resolution to amend their AoA, authorizing the company to issue and hold securities in electronic form as per the Depositories Act, 1996.

2. Appointment of Registrar and Transfer Agent (RTA)

A startup must appoint a SEBI-registered RTA. The RTA acts as the vital bridge between the company and the depositories. They handle the technical aspects of share creation, transfers, and corporate actions. While larger companies always use RTAs, startups now find them essential for managing their digital cap tables.

3. Obtaining the International Securities Identification Number (ISIN)

The company must apply for a unique ISIN for each type of security issued (e.g., Equity Shares, Series A Preference Shares, CCPS). This identification number is required for the shares to be recognized and traded within the NSDL or CDSL systems.

4. Facilitating Shareholder Conversion

Once the ISIN is active, the company must notify its shareholders. Each shareholder must open a Demat account with a Depository Participant (DP) if they do not already have one. They then submit a Dematerialization Request Form (DRF) along with their physical certificates to the DP, who coordinates with the RTA to credit the electronic shares.

Mandatory Reporting: The Role of Form PAS-6

Compliance does not end with the conversion of shares. To ensure ongoing transparency, the MCA requires half-yearly reporting. This is done through Form PAS-6, which tracks the reconciliation of the company’s share capital.

PAS-6: Key Compliance Snapshot

Requirement	Details for Startup Compliance
Filing Frequency	Half-yearly (within 60 days of the end of each half-year)
Filing Deadlines	May 30 (for March ending) and November 29 (for Sept ending)
Key Information	Total shares held in NSDL, CDSL, and physical form
Certification	Must be certified by a practicing CA or CS
Purpose	To identify discrepancies between issued and demat capital

Strategic Benefits of Dematerialization for Founders

While seen as a compliance burden, dematerialization offers significant strategic advantages for a growing startup. It professionalizes the company’s image in the eyes of institutional investors and venture capitalists.

• Elimination of Risks: Digital shares cannot be lost, stolen, or forged, which is a common issue with physical certificates during relocation or office shifts.
• Efficiency in Funding: During a fresh funding round, issuing new shares to investors is near-instantaneous once the ISIN is in place, reducing the closing time for deals.
• Easier Transfers: Founders and early employees can transfer shares (subject to lock-ins) with much less paperwork and zero stamp duty on transfers in demat mode (in certain jurisdictions/scenarios).
• Enhanced Transparency: A digital cap table managed by a depository provides a “single version of truth,” preventing disputes over shareholding percentages.

Consequences of Non-Compliance

Ignoring the mandate can lead to operational paralysis. Beyond the residual penalties under Section 450 of the Companies Act, which include fines for the company and its officers, the practical implications are more severe. Non-compliance with Rule 9B restricts a company from issuing new securities, undertaking rights or bonus issues, or carrying out buybacks. Shareholders holding shares in physical form are also prohibited from transferring their shares or subscribing to new securities until dematerialisation is completed. In addition, the company and its officers in default may be subject to monetary penalties, and such non-compliance can delay or block fundraising, exits, and other corporate transactions. A startup in default will find it impossible to raise new capital because it cannot legally issue new shares or process a rights issue. Furthermore, existing shareholders will be unable to transfer their stake to any third party until their holdings are dematerialized. For a founder looking for an exit or a secondary sale, this lack of compliance can become a deal-breaker. Ensuring your startup is “Demat-ready” is therefore not just about following the law; it is about protecting the liquidity and future growth of your venture.