Abstract
The shares of a company form the share capital of the company. They are divided into two types, equity shares and preference shares. Equity shares are further divided on the basis of voting rights as those with or without voting rights. The equity shares carrying voting rights may now carry differential voting rights. Differential voting rights mean that certain equity shares would carry more voting rights and certain equity shares would carry less voting rights. The standard principle is that each share would carry one vote, however one share carrying more than one vote or less than one vote would be known as shares with differential voting rights.
In this paper we have discussed the effect of the DVR framework introduced by SEBI on Start ups as well as that on Corporate Governance. This framework has turned out to be beneficial to the Start ups, allowing the founders to retain controlling interest while simultaneously raising capital, however, it may be at odds with the corporate governance. DVRs are against corporate governance fundamentals since they provide for insufficient voting rights, which may obstruct corporate dominance beliefs.
In this paper we have also analyzed the feasibility of differential voting rights in detail. It discusses the increase in Initial Public Offers in India and the impact of differential voting rights on those to come. This paper also discusses whether allowing public issue of shares with differential voting rights at this point of time in India could be considered as a failure or not. Dual class shares have their benefits but their risks outweigh the benefits.
Page Contents
Introduction
Due to technological advancement, numerous new businesses have been formed by entrepreneurs. As they become profitable, they put themselves up to public investors via listing on stock markets. To sustain their companies after encountering obstacles like fluctuating stocks, economic pressure, a creative solution has been introduced which is a Dual-class share system. This enables the companies to raise funds without diluting control.
Dual-class shares with Differential Voting Rights (DVRs) are being adopted by the companies to enable their promoters to keep managerial control even if they do not possess a majority of the shares. Innumerable companies are opting for this strategy.
Globally, the concept of DVR shares is recognized in countries like the United States, Hong Kong, Canada and Singapore. However, they are subjected to certain requirements. In India, DVR structure shares were allowed to all the companies until 2009 when SEBI imposed a prohibition on listing companies. But during its Board Meeting on 27th June, 2019, SEBI authorized the framework for issuance of DVRs shares.
What are Differential Voting Rights?
One of the basis of democracy is voting in which each citizen has a freedom to vote and as a result, has fairly distributed rights and duties. The power of voting plays a crucial role in the corporate world as well as the new firms are important for day-to-day operation of the economy. Usually, the voting power of the shareholders is relative to their shareholdings and this concept is “one share, one vote.” This norm is well-established in the legal field of corporate and its interpretation is that each share should have one vote. It is beneficial as it allows the large stockholders to supervise and maintain performance of management and allows minority stockholders to vote for directors and give approval for certain transactions.
Even though the principle of “one share, one vote” is practiced as a standard rule in business almost everywhere, it is not the only rule. Shares with differential voting rights(DVRs), as referred in India are the shares that allow promotor of the corporations to raise funds without relinquishing control, either by preserving shares with “superior voting rights” or by issuing shares with lower or “fractional voting rights” to shareholders. These are also referred to as dual-class shares, globally.
This concept goes against the “one share, one vote” rule. Shares with DVRs have either fewer than or more than one voting right per share. However, the potential of generating a greater dividend rate pays for the loss of voting rights, and likewise.
According to the Companies Act 2013, there are two categories of share capital which are equity share capital and preference share capital. Furthermore, it states that the corporation’s equity share capital can have differential rights with respect to dividend and voting. DVRs were first introduced in 2000 by the amendment of the Companies Act. Recently in 2019, SEBI allowed the framework where shares with DVRs can be issued.
There are two divisions of DVRs which are the Fractional Rights and Superior Rights. Superior voting rights are given to insiders and inferior voting rights are given to public stockholders (disproportionate to their economic ownership).
A company can only offer shares with DVRs in India if it gives less voting rights than simple shares of that same company. Certain arguments are associated with the concept of DVR. Some say that limiting the control to few members can lead to exploitation while others support DVRs as it helps the company to raise funds without losing control.
Differential Voting Rights & Startups
When promoters or founders of a startup reduce their holdings in order to raise numerous rounds of funding, they frequently lose controlling interest in the company. This difficulty can be remedied by issuing shares with differential voting rights (DVRs). They allow the promoters to keep control of the business. The DVRs equity shares give public investors superior, lesser, or fractional voting rights, allowing promoters to keep control over the company even if new investors enter the management. They’re similar to normal equity shares, but they are not subject to the standard principle of one vote per share.
On September 28, 2021, India’s markets regulator recommended to relax restrictions governing differential voting rights (DVRs) for company founders, a decision aimed at boosting technology startups wherein founders retain little holdings in later stages but have disproportionate power over operations. In the meeting, the Securities and Exchange Board of India decided to increase the amount of net worth an entrepreneur holds in the company from Rs 500 crore to Rs 1,000 so that they can have superior voting rights in their companies. Furthermore, before now, corporations had to wait for a period of six months between issuing such shares and filing their documentation for listing on the stock market. According to the minutes of the meeting, it has been decreased to 3 months. The strategy is modeled after Silicon Valley behemoths like Facebook Alphabet’s Google, wherein investors hold greater shares than those who founded them, but founding members retain control due to greater voting rights which is often 10-20 votes per share as compared to the one vote per share principle for the investors. With this verdict, several founders and investors noted that India is now on level with rulings in several other outside countries, particularly the United States, which had been a long-standing demand from the startup community. Many stakeholders in the startup ecosystem, however, have stated that while this is a significant boost for IT businesses looking to list in India, it remains to be seen whether this would decrease the number of firms looking to list elsewhere.
Yet as even more internet startups go public in India—after over a decade of eager anticipation—and founders make millions of dollars through perks and shares once their firms go public—the new reforms are critical. DVRs were first introduced by SEBI in 2019, however many corporations have been unable to use them due to the Rs 500 crore cap. Entrepreneurs have strengthened their legal entitlements in a variety of ways in recent years, ensuring that investors cannot dethrone them, particularly amid the ongoing startup funding boom.
Differential Voting Rights & Corporate Governance
Differential Voting Rights, as introduced by SEBI under Section 43 of the Companies Act of 2013, are shares that do not have voting rights, not like equity shares. DVRs are employed when a firm wants to increase its capital without compromising its voting rights. The voting rights and dividends differ in this case, and the investor can choose between a bigger dividend and fewer voting rights, or a lower dividend and more voting rights. Investors are looking for dividends and financial gain, not business control.
When issuing equity share capital with DVRs, the corporation must follow Rule 4 of the Share Capital and Debentures Rules 2014. The question is whether DVRs are in violation of corporate governance because they compensate for insufficient voting rights, which could obstruct corporate dominance. One of the arguments against DVRs was that if they were allowed, it would be a win / win scenario for promoters because superior rights would enable them to keep the shares regardless if they were traded. According to SEBI, there would be a two-tier structure with enhanced voting rights for unlisted businesses, with the share having greater voting power than any ordinary share. In comparison to ordinary shares, listed businesses would have an average voting right.
The voting power of DVR shares cannot now exceed 74 percent of total voting power, which was formerly 26 percent of the entire post-issue paid-up equity share capital, according to the changed rules. The rationale for this change was due to the absurdity of the percentages calculated on different bases. Other criticisms included: issuing DVRs with higher rights could harm marginal investors, marginalization of short-term shareholders, inability to achieve long-term growth, promoter dominance and abuse of DVRs could erode shareholder trust. Also, according to SEBI (ICDR) 2018, there needs to be a steady history of earnings for the last three years, with net tangible assets equaling Rs. 3 crores. However, for a tech business, this condition would be tough to meet because they have fewer physical assets.
The viability of DVRs is debatable. This action, on the other hand, was meant to render the Indian market more receptive to advanced countries. Minority investors could be issued Compulsorily Convertible Preference Shares (CCPS), which could be convertible into ordinary equity shares after 5 years.
Assessing the feasibility of the differential voting rights
Given the number of initial public offerings (IPOs) in the past two years, the Indian business ecosystem expects a turnaround; However, that number alone is not an indication of fertile ground for startups. Assetlight startup entrepreneurs are in an IPO due to the dilemma between capital investment and dilution of control in management. Additionally, capital dilution takes the company out of its long-term vision, which severely affects its performance. Issuing dual-class structures (DCS) that may have higher voting rights or economic benefits in the form of dividends. In the US, publicly traded companies are not allowed to issue DCS; However, in Hong Kong, certain companies may issue. , and the beneficiary must play an active role and make a material contribution to the business. The concept of Differential Voting Rights (DVR) or dual class structures as it is known in other countries is not alien to the Indian business environment. The Stock Corporation Act of 2013 allows a stock corporation to issue shares with differentiated rights. And in 2008, Tata Motors was the first to release DVRs.In 2009, however, the Securities and Exchange Board of India (SEBI) prohibited publicly traded companies from issuing SRs in holding stocks in relation to different voting rights and paying higher dividends. [1] This measure was carried out with the aim of avoiding the repression of minority shareholders and the anchoring of the administration in the hands of family businesses. Even so, India has the largest number of family businesses and developers who own about 45% of the total share capital. to move away from its previous measures to bring the Indian economic area closer to those of the US and China’s systems of encouraging foreign direct investment. Also, it should make it easier for knowledge-based technology startups that are lightweight and need DVR to get a larger amount of investment through going public. At the same time, it ensures that the founders do not lose control of the company even after several rounds of private equity financing. Assessing the Impact of Recent Changes SEBI recently published a Consultation Document on the Issuance of DVR Shares, which will significantly change the structure of transactions in the Indian market. It deviates from the principle of “one share, one vo”. According to Regulation 6 of the SEBI Regulations (Equity Issuance and Disclosure Requirements) 2018 (ICDR), only companies that have a consistent history of distributable profits for the past 3 years, net tangible assets of INR 3 billion, average income of at least DVRs can issue INR 15 billion and net worth of INR 1 billion. However, since technology-based startups have fewer tangible assets than property, plant and equipment and concentrate more on expanding their business in the first few years, the earnings and other requirements listed below are not met.The consultation paper highlighted this issue and proposed an amendment to the ICDR. The new framework has instilled confidence and optimism among the promoters have increased especially after the hostile takeover of Mindtree by Larsen and Turbo after the promoters of the former. they could not withdraw from the takeover offer. It is argued that risks related to financial security are i. A significant loss of control can be avoided by financing venture capital financing. They live on intangible assets and are quite low in assets. The issue of lower voting rights will discourage private equity investors from investing as they want to have a say in company decisions. In addition, institutional investors have concerns about the market valuation of such stocks and fear that companies are violating corporate governance principles. The issue of the DVR creates 2 classes of shareholders; one with more voting rights than the other and the SR shareholders can control the decisions in the boardroom.If the framework were adopted, two problems would be apparent that would affect the reputation of the business community: Foreclosure to short-term investors, as stocks with the lowest voting rights trade at a lower value than common stocks. Entrepreneurs will not be able to achieve long-term growth. Due to increased brokerage costs as a result of the separation of share ownership and voting rights, the framework will put off the investor in the long term.
Before the issue of DVR framework by SEBI, these shares were not being traded much as compared to ordinary shares long after they were introduced. The reasons included low dividends offered by the company, less voting rights and investors’ disinterest in participation. After Tata Motors introduced their DVR shares in the listed category in 2008, three other companies- Gujarat NRE Coke, Pantaloon Retail (Future Enterprises) and Jain Irrigation issued these shares. Due to the reasons stated above, these shares were not successful.
The case of DVRs and Dual-class shares have been a subject of debate. Assessing the global situation of dual class shares, a conclusion of DVRs in India can be derived. In the U.S., the promoters and investors for control of public firms have different claims regarding these stocks. The founders, who have the power to pick investors and the capital system, are in favor of dual-class structure while people in favor of investors are against it. This difference of opinion is because the founders need ownership of their firms after they go public because it gives them the opportunity to execute their plan, which they feel will increase corporate value and provide long-term profits, without worrying about their actions being contested by stockholders. Whereas the investors feel that the dual class share structure violates core corporate governance principles such as democracy of the stockholder.
According to a study published by the Investor Responsibility Research Centre and Institutional Shareholders Services, companies that have dual class shares have worse long-term financial outcomes than companies with a one-share-one-vote system. The dual class shares may be advantageous but the risks surpass the benefits.
India has allowed DVR shares but needs to be careful of the risks as corporate governance holds a vital role in the country’s rapidly growing economy. SEBI has issued the DVR framework for issuing these shares but has certain limitations. Firstly, in terms of eligibility conditions, it should be noted that authority to use such frameworks must be extended outside tech-based businesses. Secondly, only unlisted firms are allowed to issue DVR shares. This is unjust to the already listed companies. Further, the DVR framework’s inclusion of a time-based sunset clause creates certain issues.
Therefore, the DVR framework in India should look out for stockholders who may suffer financial harm due to bad management decisions made by executives, as well as promote clarity and responsibility in the decision-making process.
Conclusion
The belief of Indian buyers is evolving faster and the regulatory framework has to adapt at an equal pace. Capital marketplace, as this includes sizable modifications in diverse SEBI rules including ICDR, LODR, SAST, PIT etc. If the present framework for SEBI SAST have been redesigned with a rule-primarily based totally and precept manipulate test, as mentioned withinside the dialogue paper on the “ Brightline Test ”, We are probably interested by those questions as we delve deeper into the SEBI tests. At the middle of the talk approximately DCS systems withinside the global context and DVR systems withinside the Indian context is the essential anxiety or compromise among the liberty of a founder to pursue his vision. Value introduction and the want for buyers to shield themselves from corporation charges. Eighty two The preceding chapters must highlight the diverse coverage concerns, debates and practices throughout jurisdictions to spotlight the truth that the variety of concerns to be taken into consideration in assessing the effectiveness or adequacy of capital systems with disproportionate vote casting rights is pretty broad. In addition, the provisions state that given the variety among founders and groups in phrases of vision, implementation, enterprise and competition, this isn’t always a one-size-fits-all exercise. Eighty three to examine such systems, questions have to be asked including: (i) whether or not the Term helps the founder’s vision; (ii) whilst the time period offers a method of influencing control with the aid of using buyers; and (iii) whilst the runtime is essential to keep away from brokerage charges; and (iv) if there are much less restrictive method of fending off corporation charges, overview for yourself the declare that the problem is significantly complicated and that your evaluation have to consider the diverse dangers and charges related to such The discourse on DCS systems has and maintains to show the complexities and demanding situations concerned with adopting such systems.It is crucial to spotlight that withinside the U., CII’s monitoring of the IPO marketplace in 2017shows that extra than 4 in 5 groups went public with the only percentage one vote structure: of the one hundred and twenty 4 IPOs, 80 9 percentage created from groups with unmarried magnificence systems, which demonstrates the rare employment of DCS systems. 84The evaluation on this paper suggests that the ability advantages of DCS systems have a tendency to say no and the potential costs have a tendency to increase, over time. In addition, time-primarily based totally sundown clauses pose sizable troubles and aren’t designed to clear up the anxiety among a founder’s preference to be blanketed from interference or dismissal and the want for shareholders to shield themselves from locating corporation expenses because of horrific decisions. Measures with DVR, particularly withinside the context of India, aren’t simplest unsustainable, however additionally unjustified, because the governance dangers and corporation charges that end result from the capital systems with DVR, coupled with inadequate ideal rules Outweigh the benefits that the performance of such systems must deliver on the time of the IPO. In the occasion that DVRs are allowed, it’s miles claimed that theThe provisions set out withinside the preceding bankruptcy may be taken into consideration and brought into consideration in shaping the governance framework for the published and list of DVRs in India.
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