When Deal Urgency Meets Demat Compliance: A Lesson For PE, VC And M&A Transactions

A modest regulatory penalty can sometimes carry a larger transaction lesson.

The recent adjudication order involving Fyle Technologies Private Limited is a good example. The Registrar of Companies, Bengaluru, penalised the company and four of its directors for approving share transfers in physical form even though the transferors had not first dematerialised their holdings.

The recent adjudication order involving Fyle Technologies Private Limited highlights that strong leadership and governance are essential for transaction readiness, especially when deal urgency risks overshadowing compliance.

That question is becoming harder to ignore as mandatory dematerialisation moves from a company secretarial requirement to a basic condition for completing investments, exits and acquisitions.

What happened in the Fyle Technologies matter?

Under Rule 9B of the Companies (Prospectus and Allotment of Securities) Rules, 2014, Fyle Technologies was required to dematerialise its securities by June 30, 2025, underscoring the legal obligation to comply.

The company obtained an ISIN for its equity shares on July 8, 2025. A little over two weeks later, on July 24, 2025, its board approved transfers by shareholders whose shares were still held in physical form.

That sequence is important because obtaining an ISIN created the infrastructure for dematerialised holding, but it did not automatically convert existing physical shares into demat form.

Rule 9B(4)(a) requires a holder proposing to transfer securities after the applicable compliance date to ensure that the securities are dematerialised before the transfer. The Registrar accordingly held that the company and its officers in default had contravened Section 29 of the Companies Act, 2013, read with Rule 9B(4)(a).

The company explained that it had approved the transfers in physical form because of the exigencies of the transaction. It also stated that there was no mala fide intention, undue advantage or loss to any person.

Those submissions did not alter the outcome.

In addition to imposing penalties, the Registrar directed the company to dematerialise the shares and submit evidence of rectification. The directors were required to pay their respective penalties from their personal sources.

Why this matters beyond the penalty 

It would be easy to read the order as a procedural lapse that led to a small penalty. That reading would miss the larger point.

Transactions rarely take place in ideal conditions. Funding rounds may be tied to a company’s cash runway. A secondary sale may be commercially linked to a primary investment. An acquisition may need to close before a financial reporting date. An investor may be working against the expiry of an internal approval. Founders may also be depending on a liquidity event that has already been negotiated.

In that kind of environment, it is not unusual for parties to assume that compliance formalities can be completed after the commercial deal is locked in.

The Fyle Technologies order reminds us that some requirements cannot be pushed to the other side of closing. If the law requires shares to be dematerialised before transfer, commercial urgency cannot make a physical transfer compliant.

This distinction matters because transaction teams are generally very good at identifying large legal risks. They focus on ownership disputes, regulatory approvals, tax exposures, foreign investment restrictions and material litigation. Smaller operational issues are often left for the closing checklist.

Ongoing governance should actively include dematerialisation processes, offering transaction teams a sense of control and assurance in transaction stability.

The PE and VC perspective

PE and VC investments often combine several moving parts. A new round may involve a primary subscription by the incoming investor, a secondary sale by founders or early investors, the transfer of ESOP shares and a pre-closing capital restructuring.

Each leg of the transaction may raise a different dematerialisation question.

In a primary investment, the company must be able to credit the newly allotted securities to the investor’s demat account. In a secondary transaction, the selling shareholder must have already dematerialised the shares being sold. Where there are several sellers, even one seller's failure to complete the process can disrupt the intended closing mechanics.

This is particularly relevant for companies with a long or fragmented cap table. Early-stage companies may have shareholders who invested many years ago, former employees who have moved overseas, family trusts, angel investors or persons whose names and identification details do not match the company’s records. Physical certificates may have been misplaced. Signatures may have changed. Historical transfers may not have been fully documented.

These problems do not disappear because the parties have agreed on valuation or signed the investment documents.

PE, VC, and M&A professionals should proactively raise dematerialisation questions at the start of diligence to ensure transaction readiness, including whether the company has an active ISIN and if shares are dematerialised.

• Does the company have an active ISIN for every relevant class of securities?
• Have the selling shareholders dematerialised the shares proposed to be transferred?
• Do the depository records reconcile with the register of members and the transaction cap table?
• Are any dematerialisation requests pending or rejected?
• Have physical transfers been registered after the company’s applicable compliance date?

If the answers are incomplete, the issue should be reflected in the transaction timetable. Depending on the circumstances, the parties may need a longer long-stop date, a split closing or a change in the secondary-sale mechanics.

The M&A perspective: a title issue in disguise

For an acquirer, dematerialisation is also connected with title.

A buyer needs to know not only that the seller appears in the register of members, but also that the seller can lawfully transfer the shares through the required settlement mechanism. If shares that should have been dematerialised remain in physical form, questions may arise about the proposed acquisition and historical transfers recorded by the company.

That is why a clean-looking cap table may not tell the whole story.

During M&A diligence, the transaction team should examine whether any physical transfers were approved after the Rule 9B deadline applicable to the target. If such transfers exist, the buyer may need to consider corrective action, regulatory filings or adjudication proceedings. The issue may also justify a specific indemnity, an escrow arrangement or a closing condition requiring rectification.

The commercial effect can be greater than the regulatory penalty. An unresolved dematerialisation issue may delay closing, qualify title or affect the buyer’s willingness to release the entire purchase price.

The same issue often appears at exit. A company may operate for years without its physical shareholding structure causing visible difficulty. The problem usually surfaces only when an institutional investor or strategic buyer begins diligence. By then, the cost is not just a filing fee or a penalty; it is lost time and reduced deal certainty.

The additional AIF dimension 

When the investor or acquirer is an Alternative Investment Fund, a second regulatory layer applies.

Under SEBI’s current framework, an investment made by an AIF on or after July 1, 2025 must be held in dematerialised form, whether made directly in the investee company or acquired from another person. Earlier investments are generally exempt, subject to important exceptions—including where the investee company is independently required to facilitate dematerialisation or where the AIF, alone or together with specified SEBI-regulated entities, exercises control. Certain prescribed exclusions also apply.

This means that, in many transactions, both sides of the investment are subject to a dematerialisation requirement.

The portfolio company and its shareholders must comply with the Companies Act framework. At the same time, the AIF must comply with SEBI’s requirement concerning the form in which it holds its investment.

An AIF acquiring shares after July 1, 2025 should therefore not accept physical certificates on the understanding that they will be dematerialised after closing. The transaction should be structured so that the shares are transferred and credited through the depository system.

The position is equally relevant to a primary issuance. The investee company should have an active ISIN, and the securities allotted to the AIF should be credited directly to the relevant scheme’s demat account as part of the closing process.

For an AIF manager, this is not only a portfolio-company compliance point. It is also part of the fund’s own regulatory record and may matter to its custodian, trustee or sponsor, as well as to internal compliance testing. A workaround accepted by the deal team can therefore become a regulatory issue for the fund itself.

The leadership lesson behind the order

The most useful lesson from the Fyle Technologies order may be about decision-making under pressure.

Every board eventually encounters a situation in which the commercially convenient course and the legally compliant course do not move at the same speed. That is when the quality of governance becomes visible.

It is relatively easy to insist on process when there is no deadline. Leadership is tested when the company is close to completing an important financing, a founder exit or a strategic transaction and someone says: “Let us approve it now and regularise the paperwork later.”

The problem with that approach is that it turns compliance into something to be fixed after the event. It also moves risk from the transaction documents to the company and its directors. In this case, the order specifically required the directors to pay the penalties from their personal sources.

Good leadership does not mean slowing every transaction. It means building the legal and operational infrastructure early enough so that compliance does not become the cause of delay.

For a growing private company, maintaining an active ISIN, dematerialising promoter and investor holdings, reconciling the register of members with depository records and keeping the capitalisation table current should be seen as part of institutional readiness. These are not activities to begin only when a term sheet arrives.

There is also a board-culture point. If management routinely describes compliance as paperwork, the organisation will naturally address it at the last possible moment. If the board treats compliance architecture as part of financing and exit preparedness, teams are more likely to identify gaps before they become transaction risks.

The tone must come from the top. Founders, CFOs and directors should periodically ask whether the company could complete an institutional investment or acquisition today—not merely whether it has an attractive business or an agreed valuation, but whether its securities can actually be issued and transferred through the legally required mechanism.

This is especially important for companies that have grown quickly. Their commercial sophistication may have advanced much faster than their share-administration systems. A company may have global customers, institutional investors and a complex ESOP programme while still relying on physical certificates and historical records maintained during its earliest years.

Good leadership means identifying that gap before an investor or buyer does.

From closing checklist to transaction readiness

The practical response is not to add one more broad representation stating that the company has complied with applicable law. Transaction teams should look for documentary evidence.

The company should be able to demonstrate that its ISIN is active, relevant shareholders have dematerialised their securities, depository records reconcile with statutory registers, and the investor’s demat account is ready to receive the securities.

Where an AIF is involved, the closing process should also confirm that the investment is eligible for dematerialisation and will be credited directly to the appropriate scheme account.

More fundamentally, dematerialisation should form part of the company’s ongoing governance calendar. Companies that wait for a transaction to begin the process are allowing an avoidable operational issue to become a negotiating issue.

Closing thoughts

The penalty in the Fyle Technologies matter was small. The message is not.

Commercial urgency may explain why a company took a particular decision, but it does not remove a statutory precondition. Once the applicable deadline has passed, physical transfers cannot be treated as a temporary bridge to later compliance.

For PE and VC investors, this is a diligence and closing issue. For strategic acquirers, it is linked to title and transaction certainty. For AIF managers, it is an independent regulatory obligation. For founders and boards, it tests whether the company’s governance infrastructure has kept pace with its growth.

The companies best prepared for investment or exit are not those that fix compliance problems quickly after signing. They are those that treat dematerialisation as part of transaction readiness from the start.

This article is intended for general informational purposes and does not constitute legal advice.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.