There is a common and a convenient rule of one vote - one share practised by most of the companies. This rule is generally referred to as voting rights on ordinary shares. However, when there is a requirement to deviate from this rule, the concept of differential voting rights comes into play. This differential voting rights are known as DVRs in India and dual-class shares or DCS in the international perspective. These DVRs are rights which are disproportionate to their economic ownership. When a promoter or shareholder wants to retain decision making powers and rights, they can do so by retaining shares with superior voting rights or by issuing of shares with lower or fractional voting rights to other investors.
The concept of DVR has been captured in the Companies Act, 2013 under Section 43 (a)(ii) which says, that a company limited by shares may have equity share capital with differential rights on voting, or dividends, or otherwise. Rule 4 of the Companies (Share Capital and Debentures) Rules, 2014, provides certain conditions which are required to be complied with, for issuance of shares with differential rights. SEBI (Listing Obligations and Disclosure Requirement) Regulations, 2015, (“SEBI (LODR) Regulations, 2015”) also dealt with DVRs, but, it prohibited the listed companies from issuing shares with superior voting rights.
The need for DVR
In the current era, India is going through vast developments and advancement in many sectors especially the technology and information technology sector. These developments and advancements require huge capital. For raising capital, the companies seek investments, but these frequent and vast investments may lead to dilution of founder/ promoter stake. In order to cope with this, issuance of DVRs are helpful.
The journey of the framework
Earlier in 2000, the concept of DVR came to India through the Companies Act, 1956, whereby Indian companies were allowed to issue DVRs. However, in 2009, the Securities and Exchange Board of India (SEBI) had disallowed the issue of shares with superior rights to voting or dividend by listed companies, but they were permitted to issue shares with fractional voting rights. In order to bring the new framework, SEBI had invited comments from public on a Consultation Paper named ‘Issuance of shares with Differential Voting Rights (DVRs)’ (Consultation Paper). It dealt with both the shares with superior rights (Superior Rights Shares or SR Shares) and inferior rights (Fractional Rights Shares or FR Shares). The framework got approved by SEBI in its board meeting on June 27, 2019 , permitting issuance of SR share by listed company and disallowing issuance of FR shares.
A walk through in to the new framework
A company to be eligible to issue DVRs in form of SR shares, shall adhere to the following conditions:
The company issuing SR share shall be technology company. SEBI defines a technology company as one that is “intensive in the use of technology, information technology, intellectual property, data analytics, bio-technology or nano-technology to provide products, services or business platforms with substantial value addition”.
The SR shareholder should be a part of a promoter group and whose collective net worth does not exceed INR 500 crore. The investment made by SR shareholders in the shares of the issuer company will not be considered while determining the collective net worth.
The SR shall be issued only to promoters/founders who hold an executive position in the company.
The issuance of the SR shares should be authorized by passing a special resolution in the general meeting.
SR shares have been held for at least 6 months prior to filing the Red Herring Prospectus (RHP).
SR shares should have voting rights in the ratio of minimum 2:1 and maximum 10:1 compared to ordinary shares.
Listing and lock-in period: Post the IPO, the issuer company can list the SR shares on Stock Exchanges. However, SR shares are subject to lock-in after the IPO, until they are converted into ordinary shares. Transferring, pledging or lien of SR shares among promoters is prohibited under the framework.
Rights of SR shares: Except for voting on resolutions, the SR shares will be treated at par with ordinary shares in all other aspects. The total voting rights of SR shareholders (including ordinary shares), post listing should not exceed 74%.
Additional rules for companies with SR shareholders pertaining to enhanced corporate governance: The listed companies issuing SR shares shall comply with the following rules for “enhanced corporate governance” such as:
i) As prescribed under the SEBI (LODR) Regulations, 2015, Independent directors should comprise at least 1/2 of the board and 2/3 of committees (excluding the audit committee) and
ii) The audit committee should only have Independent Directors.
Coat-tail provisions: After the IPO, the SR shares will be given same treatments as ordinary equity shares in terms of voting rights with respect to the following matters:
Appointment or removal of Independent Directors and/or Auditors
Cases where promoter is willingly transferring control to another entity
Related Party Transactions involving SR Shareholder as per SEBI (LODR) Regulations, 2015
Voluntary winding up of the Company
Alteration of the Articles of Association or Memorandum of Association, except any such changes affecting the SR shares
Voluntary Resolution Plan initiated under Insolvency & Bankruptcy Code, 2016
Funds utilized for purposes other than business
Substantial value transaction based on materiality threshold as prescribed under SEBI (LODR) Regulations, 2015
Passing of special resolution for buy-back or delisting of shares
Any other provisions as notified by SEBI from time to time
Sunset clauses: SR shares can be converted under two circumstances:
Time based: After 5 years of listing, the SR Shares shall be converted to Ordinary Shares. By passing a resolution, the validity can be extended only once by 5 years. However, the SR shareholders shall not be allowed to vote on such resolution.
Event based: In the event of demise, resignation of SR shareholders, merger or acquisition where the control would be no longer with SR shareholder, etc., the SR shares shall be compulsorily get converted into Ordinary Shares.
Changes to be incorporated in various laws pursuant to DVR framework:
The Companies Act, 2013: As stated earlier, under Section 43(a)(ii) of the Companies Act, 2013, and Rule 4 of the Companies (Share Capital & Debentures) Rules, 2014 framed under the Companies Act, 2013 prescribes that shares with DVRs in a company, shall not exceed 26% of the total post-issue capital. However, the new framework extends the limit to 74%. Therefore, corresponding changes are required to be brought in the Companies Act, 2013. Another limiting factor in the Companies Act, 2013 is that “the company must have a consistent track record of distributable profits for the last 3 years”, but criteria for 3 years is silent on IPOs. Such a criteria may not be helpful and rather impossible for all start-ups. Therefore, this matter should also be taken into consideration.
Securities Contracts (Regulation) Rules, 1957 (‘SCRR’): A company with multiple classes of equity shares at the time of undertaking an IPO, is required to make an offer of each such class of equity shares to the public in an IPO. Further, Rule 19(2)(b) of SCRR provides that minimum dilution and minimum subscription requirements as prescribed have to be complied with, separately for each class of the equity shares. It is a mandatory requirement under the rule that all kinds of shares shall be listed. There is no provision for listing one kind of share and not listing another. As the new framework demands for listing of SR shares without offering to public, it leads to a doubt for a company with different classes of shares whether it should proceed with listing all kinds of share or keep few of such equity shares unlisted. Therefore, a clarification is required in this regard.
SEBI (LODR) Regulations, 2015: Under regulation 41(3) of SEBI (LODR) Regulations, 2015, it has been stated that listed entity shall not issue shares which may confer to a person SR right on equity shares which are already listed. Therefore, an amendment is required which permits the grant of SR shares to equity shareholders.
SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 ("SEBI Takeover Code"): Regulation 3 and 4 of SEBI Takeover Code provides that when an acquirer is holding 25% or more of the shares or voting rights in a target company, it has an obligation to make a public announcement of an open offer. Based on the stated Regulation of SEBI Takeover Code and the new DVRs framework, Regulation 10 is required to be amended in such a manner that Regulation 3 would not get triggered for making an open offer if the stated threshold is crossed by reason of SR shares getting lapse or converted into ordinary equity shares, provided that there is no attendant change in control in favor of the person crossing such threshold.
Further, Regulation 29 of SEBI Takeover Code requires disclosure for acquisition of additional voting right by holder of ordinary equity share. Since the change in voting rights brought after the conversation of SR shares to ordinary shares, which is an involuntary act on behalf of holder of ordinary equity share, there is a requirement of bringing change in format of disclosure under Regulation 30 of SEBI Takeover Code.
The pros and cons of DVRs:
Advantages from the perspective of issuer:
It solves the biggest issue of raising fund without diluting the voting right or the control of the founders/promoters over the company.
when there is ordinary equity shares issued to outside investors, there is a possibility that such shareholders acquire majority of the shares of the company and gain control over the management of the company, where as in the case of SR shares, this possibility is minimised.
Disadvantages from the perspective of issuer:
It is a challenge for the issuer to find such investors who are not interested in control and management of the company even after investing huge amount of money.
Issuing of SR shares is not considered a good corporate governance.
Advantages from the perspective of investor:
It is beneficial for those investors who are getting a higher rate of dividend over the ordinary shareholders.
The DVRs with FR shares are generally offered at a discount for equal number of shares.
Disadvantages from the perspective of investor:
DVRs with SR shares with the founders or large proportion of DVRs with FR shares with public investors, make management excessively powerful and can raise issues of corporate governance.
As a result of separating voting right from economic interests, there might be possibilities externalities like management entrenchment, excessive compensation of management, reduced dividend pay-out etc.
When we know that India is still considered to be a developing country and it has a lot of competition with various other developed and developing states. India should have such corporate and commercial laws which are at par with the corporate and commercial laws of other countries. While India is giving majority of its space for incorporation and functioning of technology companies, it should have DVRs related laws like in US, Canada, Hong Kong etc. Such laws will help in raising the capital of tech companies. The applicability of DVRs law in India will not just help in growth and development of the tech companies in India, but it will also lead Indian tech companies to be good competitors for the tech companies incorporated in other nations. It would help the promoters/founders of the company to grow their business fast. The only thing to be kept in mind by the companies while adopting such laws is that, they shall also maintain a good corporate governance in their company.
Authors: Srisha Choudhary and Alivia Das