Good news! Start-ups can raise capital from abroad without losing control of the company; here’s how

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Updated: August 17, 2019 11:56:55 AM

Start-up India: In less than a week, the Modi govt announced two major reliefs for start-ups on the issue of angel tax and by liberalising norms for issuing DVR shares and ESOPs.

Start Up India, DVRs, ESOPs, Differential Voting Right SharesStart Up India.

Start-up India: In a major relief to Start-ups that were trying to raise capital from abroad while retaining the control over the decision-making process of their companies, the Union government Friday made crucial changes in the law that will permit Indian companies to issue majority shares with differential voting rights (DVRs). The Government also removed the requirement of distributing profits in the last three years before Indian companies can issue this kind of shares. It will enable Indian promoters to retain control of their companies as they pursue growth and long-term value creation for shareholders while they raise equity capital from global investors, said the ministry of corporate affairs.

“It would strengthen the hands of Indian companies and their promoters who have lately been identified by deep pocketed investors worldwide for acquisition of controlling stake in Indian start-ups to gain access to the cutting edge technology development being undertaken by them,” said the government.

Fresh amendments made in the Companies (Share Capital & Debentures) Rules of the Companies Act of 2013 will permit Indian companies to issue up to 74 per cent shares of the total post issue paid-up share capital with differential voting rights.

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Unlike ordinary shares, differential voting rights shares (DVRs) are those shares where investors do not get voting rights commensurate to their investment. However, these investors get a proportionate share in the dividend paid by the company. Some foreign investors are more interested in investing through DVRs as they do not want to interfere with the decision-making process of an Indian start-up and are more concerned with the dividend paid by them. It also suits Indian start-ups as they can raise capital by diluting majority stake in the company but at the same time maintain control over the decision-making process.

Raising the limit for issuing DVRs from 26 per cent to 74 per cent will permit Indian start-ups to dilute majority stake without ceding control over the decision-making process.

It will allow Indian companies to issue shares to those foreign investors who may not be interested in taking the control of decision-making process of a company but are more interested in dividend payment.

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“As startups that have done several rounds of capital raise, the original founders are left with shareholding percentage in high single digits with equity investors having more shareholding than them which in some cases led to investors taking the lead in key decisions,” said Sachin Taparia, founder and chairman of LocalCircles.

“With the model of shares with differential voting rights, the founders/promoters will now be able to raise the necesary capital and still be able to retain control of the company and key decisions. We appreciate the Government supporting the startup industry’s recommendation and taking action”, Sachin Taparia told Financial Express Online.

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In addition to these two changes, the period for issuing Employee Stock Options (ESOPs) to promoters and directors of DPIIT recognised start-ups who hold more than 10% equity shares in a company has been enhanced from 5 to 10 years. Now, start-ups can issue ESOPs to their directors and promoters within 10 years from the date of incorporation against the earlier limit of 5 years.

Last week, the Modi government had extended relief from Angel tax to DPIIT recognised start-ups with retrospective effect.

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