The Securities Exchange Board of India (SEBI) has recently circulated a consultation paper on Differential Voting Rights (DVRs). Issuance of shares with differential voting or dividend rights is not a novel concept for India. It has been around since 2000 and a few listed companies, like Tata Motors and Pantaloons, have issued shares with differential voting / dividend rights.
However, ever since, SEBI amended the Listing Regulations in 2009, to state that listed companies are not permitted to issue shares with ‘superior rights’, there have hardly been any takers for this instrument. SEBI’s current proposal appears to be an attempt to breathe some life into such instruments by providing more flexibility in structuring the terms of such issuances, albeit with some checks and balances.
The Companies Act permits all companies to issue equity shares with differential rights as to dividend, voting or otherwise – provided they comply with the conditions prescribed by Rule 4 of the SEBI (Share Capital and Debentures) Rules, 2014. Key conditions for such issuance include: the company should have a consistent track record of distributable profits for the past three years and the shares with differential rights shall not exceed 26% of the total post-issue paid-up equity share capital. Moreover, a company is not permitted to convert its existing equity share capital into share capital with differential voting rights and vice versa.
Given the existing framework, SEBI’s consultation paper proposes a new regime governing issuance of shares with differential voting rights. The paper deals with two kinds of shares:
- SR Shares” –shares with superior voting rights as compared to ordinary equity shares.
- “FR Shares” – shares with fractional voting rights as compared to ordinary equity shares.
The key conditions relating to the issuance of SR shares are as follows:
- SR Shares can be issued only by companies whose equity shares are proposed to be listed. It is therefore not possible to issue further SR Shares once the ordinary shares of the company are listed. There exists some ambiguity as to whether it is possible to only list the ordinary shares (and retain the SR Shares in unlisted form). The SEBI proposal also states that, once listed, any subsequent rights or bonus issue, will not be by way of SR shares. It could therefore only be by way of ordinary shares or FR Shares.
- Only promoters of the company are entitled to subscribe to SR Shares. The term used is promoter, i.e. any person who has control over the company, as opposed to a founder of the company, which normally refers to entrepreneurial individuals who may have founded the company.
- The Companies Act cap will apply, meaning that, differential shares cannot exceed 26% of the total paid-up equity share capital. Additionally, the promoter voting rights (an aggregate of ordinary, FR and SR Shares) cannot exceed 75% of the total voting rights.
- The SR Shares will be illiquid shares and cannot be traded, even if they are listed. They are under perpetual lock-in after the IPO and the promoters are not permitted to encumber them in any manner whatsoever, including by way of a pledge or a non-disposal undertaking. Transfer of SR Shares inter-se promoters is also not permitted.
- SR shareholders are entitled to the same dividend rights as ordinary shareholders.
- The differential voting rights of SR shares shall be a maximum of 10:1 vis-à-vis ordinary shares.
- There are certain coat-tail provisions – wherein, for certain resolutions such as, amendment to charter documents, change in control etc., all shareholders including SR shareholders will have only one vote per share. This is prescribed by SEBI and not for the promoters to offer at the time of listing.
- The SR Shares will automatically get converted into ordinary shares at the end of five years (which is extendable for another five-year period with shareholder consent) or on the occurrence of certain events such as a merger or acquisition, demise of promoter, etc. This may require amendment to the Rules under the Companies Act, which currently do not permit conversion of differential shares into ordinary shares.
Key conditions relating to the issuance of FR shares are as follows:
- FR Shares can be issued by a company whose equity shares are already listed and traded on a recognised stock exchange for at least one year. They could be by way of a fresh issue, bonus issue or rights issue.
- A preferential issue, a Qualified Institutional Placement or issuance of depository receipts is also possible after one year of the initial FR Share issuance.
- The voting rights on FR Shares shall not exceed a ratio of 1:10 vis-à-vis ordinary shares.
- The company may at its discretion pay additional dividends to FR Shareholders.
- The FR Shares can be converted into ordinary shares only through a scheme of arrangement.
Shares with DVRs or dual classes of shares, have been historically used by founders / promoters to retain control of the company whilst raising funds for the business’s growth. It has been particularly popular with new-age technology companies such as Google, Facebook and Alibaba.
In the past decade, India has witnessed a tremendous surge in entrepreneurial efforts, especially in the technology space; and one of the key issues faced by founders is to raise funds for growth without diluting control. SEBI’s attempt to address this concern, by improving access to the Indian capital markets through a regulated DVR regime, is timely. However, it will be successful, only if the Companies Act requirement of a three-year track record of distributable profits is relaxed for technology / start-up companies.
SEBI’s attempt to balance the concerns of the promoter with that of prudent corporate governance measures, by making the SR Shares non-transferable, providing for coat-tail provisions, sunset period etc., are appreciated, and highly necessary in the Indian scenario where adherence to corporate governance norms is generally lax. Having said that, SEBI could consider providing further flexibility in terms of monetising the SR Shares, permitting transfer of SR Shares inter-se promoters, permitting the shareholders to determine the sunset period etc. Such steps would make this instrument an attractive / viable option for founders. The FR Shares, on the other hand, may not find very many takers, as it is not fundamentally different from the existing regime relating to issuance of shares with inferior differential rights.