One share, one vote” is the bedrock of Indian law on voting rights of shares. This means shareholders have one vote for each share held in a company, giving them voting rights proportionate to their shareholding. This might undergo change now as the concept of dual class structures for Indian shares is introduced. The dual class shares are commonly called differential voting right (DVR) shares. The DVRs are not new in the Indian context. The Indian company law introduced them way back in 2000. However, because of the stringent rules governing them, they remain unattractive even today. Thanks to SEBI regulations, listed entities cannot issue shares with superior rights with respect to voting or dividend over the other equity shares issued by a listed company.
SEBI had recently released a consultation paper on DVRs. The paper described that DVRs can help founders/promoters retain control over the company they create and grow. The paper said that dual structures help in fundraising without the promoters having to dilute their control and DVRs can also serve as defence mechanism against any hostile bid for acquisition of a company. The importance of having DVRs for promoters was hotly discussed in a recent hostile bid where L&T wanted to take control of Mindtree. Whether or not Mindtree’s promoters could have used DVRs (if the law had permitted) to avert this hostile bid is a question of interest and debate. Globally, many jurisdictions, including the US, allow founders to have DVRs to ensure they can keep control over their companies. Google’s and Facebook’s founders hold such shares. SEBI has recommended the issue of superior rights-based DVRs only to promoters of unlisted companies and to no other person. This is contrary to the Companies Act, 2013, which allows DVRs to be issued to anyone including the promoters.
In addition to serving as a defence mechanism, DVRs are used in the structuring of mergers and acquisition transactions. For instance, they can be used in private equity deals where promoters can take DVRs for higher voting rights while private equity investors can take them to get higher financial returns in the form of dividends.
The rules that apply for DVRs depend upon the company—private company, publicly unlisted company or listed company. An unlisted company (whether private or public) is governed by Section 43 of the Companies Act, 2013, and the Companies (Share Capital and Debentures) Rules, 2014 (“Rules”). A private company, by its memorandum and articles of association, can exempt itself from these provisions. Therefore, it can avoid compliance with the difficult rules of DVRs and is free to have its own terms for its DVRs. A publicly unlisted company does not enjoy the same advantage. It needs to necessarily follow the rules, including the one requiring it to have a consistent track record of distributable profits for the last three years and also the rule which caps DVRs till only 26% of the company’s total capital. Therefore, start-ups or tech companies (where DVRs are quite popular) prefer setting up private companies. But sooner or later, they need to go for a public listing to ensure an exit for their investors. It is at that stage that DVR rules, applicable to a listed company, kick in.
The SEBI (LODR) Regulations, 2015, do not allow listed entities to issue shares in any manner which may give any superior rights with regards to voting or dividend over the rights on equity shares that are already listed. This means a DVR with superior rights is not allowed while an inferior rights share is permitted. The SEBI’s proposals in the consultation paper seem equally stringent (if not more) than the existing law on DVRs. These include issuance of DVRs to only promoters and that too only pre-IPO and not after the IPO; permanent lock-in on DVRs, with no rights to trade and transfer them (even amongst promoters), and coat-tail provisions (i.e, provisions where DVRs will be treated as normal voting right shares). It appears that SEBI wants to test waters before allowing DVRs in a big way. It remains doubtful that DVRs will become more attractive than before.