SEBI's recent framework for issuance of shares having superior Differential Voting Rights ("DVRs") has fuelled the historical debate on differential voting rights and created ripples Dalal Street and the promoter community.
Shares having DVRs, operate against the traditional "one-share, one-vote" norm, thereby, providing shareholders with voting rights that are disproportionate to their economic ownership. While prevalent in developed capital markets such as the U.S.A., Hong Kong and Singapore, "dual-class capital structures" have had a limited presence in India. Prior to the recent amendments notified by SEBI, the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015 included enabling provisions for listed companies to issue DVRs, albeit with inferior voting rights. However, DVR structures with inferior voting rights have hitherto met with a tepid response by India Inc., with only handful of listed companies such as Tata Motors, having issued DVR shares to the public.
Proponents have hailed DVR structures as a tool for promoter-controlled companies to raise capital without compromising control, to avoid hostile takeovers, and to incentivise startups to undertake an IPO on domestic bourses. On the other hand, naysayers have voiced concerns that DVR structures could catalyse potential entrenchment of the management, erosion of corporate governance standards and minority shareholders' oppression. However, the superior voting rights appended to the DVR shares should not be viewed as a double edged sword, in light of the checks and balances proposed by SEBI.
Per the new framework, a "tech company" as (defined in the Innovators Growth Platform) having superior voting shares ("SR Shares"), is permitted to undertake an IPO. It is widely believed that innovative companies are more dependent on the vision of their founders at the seed stage. However, with a view to target a wider net of companies engaged in other sectors, there may be merit in extending the eligibility to larger groups which may be determined on the basis of economic relevance. With the aim to liberalise the framework for startups, recent amendments to the Companies (Share Capital and Debentures) Amendment Rules, 2019 have done away with the requirement for unlisted companies to have a consistent track record of profitability for the last 3 years.
In terms of eligibility, in the absence of enabling provisions for existing listed companies to issue SR Shares to its promoters, SEBI does not seem to level the playing field for all listed companies (i.e. newly listed or already listed companies).
The recent amendments do not permit SR Shares to have differential dividend. Accordingly, unlisted companies having SR Shares with differential dividend would be required to ensure prior compliance with this condition prior to undertaking an IPO. SR Shares should have been issued to "promoters / founders" holding executive positions in the company ("SR Shareholders"). Keeping in mind the unique nature of India Inc. comprised of a majority of promoter-owned companies, SEBI has proposed various safeguards to prevent misuse. Corporate governance safeguards inter alia include: (i) capping the ratio of voting rights to 10:1; (ii) capping the total voting rights of SR Shareholders and ordinary shareholders to 74%; (iii) requiring the board and committees (other than audit) to comprise at least ½ and 2/3rd independent directors respectively etc. Further, "coat-tail" provisions have been introduced which require SR Shares to be treated as ordinary equity shares in terms of voting rights on matters pertaining to appointment or removal of independent directors and/or auditor; related party transactions involving the SR Shareholder etc.
Time and event based "sunset" clauses have also been notified by SEBI, which trigger mandatory conversion of SR Shares to ordinary equity shares. Time based sun-set clauses require the SR Shares to be converted to ordinary shares on the 5th anniversary of listing, subject to a one time extension of up to 5 years pursuant to shareholders' approval. Given the constant disruption in the technology sector, a dynamic strategy should be adopted for setting the outer limit of the tenure of SR Shares, as opposed to a "one-size-fits-all" approach.
Further, event based sunset clauses require compulsory conversion of SR Shares into ordinary shares on the demise or resignation of the SR Shareholder, SR Shareholder ceasing to exercise control etc. Given that new framework rests on the premise that promoters are instrumental in long-term value creation, when promoters holding SR Shares act in a mala fide manner by causing the company to contravene provisions of applicable law, or become disqualified for appointment as a director under the Companies Act, 2013, such instances could be considered as additional triggers for event based sunset clauses.
Overall, the new framework has been a long-awaited measure for tilting the balance between economic ownership and control in favour of promoters of early-stage companies. The eventual success of this framework could pave the way for DVR structures as a flexible tool open to strategic investors in mature listed companies. With the objective of India becoming a $5 trillion dollar economy in the next 5 years, keeping in the mind the tectonic shifts in the Indian corporate governance regime, the relevance and strength of DVR structures will be tested in times to come.
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