Introduction:

Can a private limited company raise funds with the ability to control majority voting power with a relatively small percentage of total equity? This has become an important question in the modern startup world, where it is believed that there can be genius founders or wizards who should be able to control the future of a company even when their shareholding is greatly diluted to raise money for growth.

The solution of this problem is differential voting rights share. As the name suggest the equity shares with differential voting rights are shares with distinct voting rights and dividend payment. Shares with differential voting rights can either have superior voting rights (i.e. multiple votes on one share) or inferior voting rights (i.e. a fraction of voting right on one equity share) or differential rights as to dividend. Well known companies like Alibaba, Facebook and Google have structured their shareholding in dual category, including, Class A and Class B shares, differentiated in terms of voting rights and dividend payments which provides the founder to have control over the company

No doubt differential voting rights is gaining popularity in India too. Tata Motors, were the first company in India to issue differential voting rights in 2008.  Since then, Pantaloons retails and Gujarat NRE Coke Limited in the year 2009, Jain irrigation systems limited in the year 2011 has came up with differential voting rights. Recently, the start ups like ZOMZTO, OYO etc has issues shares with differential voting rights to retain control even as they raise equity capital from global investors


Shares with Differential Rights under the Companies Act, 2013

Section 43(2) of the Companies Act, 2013 (“2013 Act”) deal with shares with differential voting rights and Rule 3 and 4 of the Companies (Share Capital and Debentures) Rules 2014, deals with the applicability and eligibility to issue shares with differential voting rights

Applicability:

The provision applies to:

A)      All unlisted public Companies

B)      All private companies

C)      Listed companies

Eligibility

The company issuing shares with differential rights as to dividend, voting, or otherwise, has to comply with the following conditions:

  • 1.      The Articles of Association of the Company shall authorizes to issue share with differential voting rights
  • 2.      The company shall  obtained its shareholders approval by passing ordinary resolution at its general meeting; In case of a listed public company, it has obtained approval through postal ballot;
  • 3.      The shares with differential voting rights shall not exceed the 74% of the total post issue paid up equity capital including shares with differential voting rights
  • 4.      The company has not defaulted in filing its financial statements and annual returns for the three (3) preceding financial years prior to the year in which shares with differential rights are to be issued;
  • 5.      The company has not defaulted in payments of its dues on due dates, repayment of term loan, deposits or interest on deposits, or failed to redeem its debentures or pay dividend thereon.
  • 6.      Provision has made for the Company who has made default that they may issues shares with differential voting rights after the expiry of 5 years from the end of financial year in which default has been made.
  • 7.      The company has not been convicted of any offence during last three years under Securities and Exchange Board of India Act, 1992, Securities Contracts (Regulations) Act, 1956, and the Foreign Exchange Management Act, 1999;Reserver Bank of India Act 1956.

Shares with Differential Rights under the Securities Exchange Board of India

A company may issue differential voting rights  having superior voting rights shares (SR shares) has  permitted to do an initial public offering (IPO) of only ordinary shares to be listed on the Main Board, subject to fulfillment of eligibility requirements of the SEBI(Issue of Capital and Disclosure Requirements) Regulations, 2018 and the following conditions:

1.      The Issuer Company is a tech company (as defined under the Innovators Growth Platform) i.e. 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.

2.      The SR shareholder is not part of the promoter group whose collective net worth is more than Rs 500 Crores. While determining the collective net worth, the investment of SR shareholders in the shares of the issuer company shall not be considered.

3.      The shares with superior voting rights should have been issued only to the promoters/founders holding executive position in the issuer company.

4.      The issue of shares with superior voting rights must have been authorized by a special resolution passed at a general meeting of the shareholders.

5.      The shares with superior voting rights must have been held for a period of at least 6 months prior to the filing of the Red Herring Prospectus.

6.      The shares with superior voting rights should have voting rights in the ratio of minimum 2:1 to maximum 10:1 compared to the ordinary shares.

7.      The shares with superior voting rights have the same face value as ordinary shares.

8.       The company has only one class of shares with superior voting rights.

Listing and Lock-in: The shares with superior voting rights shall also be listed on Stock Exchanges after the issuer company makes a public issue. However, shares with superior voting rights shares shall be under lock-in after the IPO until their conversion to ordinary shares. Transfer of shares with superior voting rights shares among promoters shall not be permitted. No pledge/ lien shall be allowed on shares with superior voting rights.

Rights of shares with superior voting rights: The shares with superior voting rights shall be treated at par with the ordinary equity shares in every respect, including dividends, except in the case of voting on resolutions. The total voting rights of SR shareholders (including ordinary shares), post listing, shall not exceed 74%.

Corporate Governance: The companies having shares with superior voting rights shareholders shall be subject to enhanced corporate governance as follows:

i.                 2/3 rd of the Board and Committees (excluding Audit Committee) as prescribed under SEBI(LODR) Regulations, 2015 shall comprise of Independent Directors

ii.                ii. Audit Committee shall comprise of only Independent Directors.

Coat-tail Provisions: Post-IPO, the share with Superior voting rights Equity Shares shall be treated as ordinary equity shares in terms of voting rights (i.e. one share with Superior voting rights share shall have only one vote) in the following circumstances:

i.            Appointment or removal of independent directors and/or auditor;

ii.           In case where promoter is willingly transferring control to another entity

iii.         Related Party Transactions in terms of SEBI(LODR) Regulations involving SR shareholder

iv.         Voluntary winding up of the company;

v.           Changes in the company’s Article of Association or Memorandum – except any changes affecting the share with Superior voting rights

vi.         Initiation of a voluntary resolution plan under IBC;

vii.        Utilization of funds for purposes other than business

viii.      Substantial value transaction based on materiality threshold as prescribed under LODR;

ix.         passing of special resolution in respect of delisting or buy-back of shares; and

x.            Any other provisions notified by SEBI in this regard from time to time.

 

Sunset Clauses: share with Superior voting rights shall be converted into ordinary shares in following circumstances/ events:

i) Time Based: The share with Superior voting rights shall be converted to Ordinary Shares on the 5th anniversary of listing. The validity can be extended once by 5 years through a resolution. Share with Superior voting rights shareholder would not be permitted to vote on such resolutions.

ii) Event Based: share with Superior voting rights shares shall compulsorily get converted into ordinary shares on occurrence of certain events such as demise, resignation of SR shareholders, merger or acquisition where the control would be no longer with SR shareholder, etc.

Fractional Rights Shares: Henceforth, issue of fractional rights shares by existing listed companies shall not be allowed

Post-Allotment Compliances

i.        Filing of PAS- 3: After allotment of differential voting rights shares, the company shall, within 30 days thereafter, file with the Registrar a return of allotment in e-Form PAS-3, along with the fee as specified in the Companies (Registration of Offices and Fees) Rules, 2014.

ii.      Issue of share Certificate: The company shall issue share certificates within 2 months from the date of allotment. After allotment of differential voting rights shares, the company secretary of the company or any other authorised person by the Board of Directors shall make necessary entries in the register of members within 7 days from the date of allotment.

iii.     Maintenance of Register of Members— where the company issues equity shares with DIFFERENTIAL voting rights, the register of members maintained that shall contain all the relevant particulars of the shares so issued along with details of the shareholders.

 

Conclusion

 

From Promoters point of view:

 

The issue of differential voting rights shares is a welcome move especially for new technology companies having asset light models with no profitability and in continuous need of equity or debt funding for growth. The past decade has shown that repeated equity funding substantially dilutes promoter's stake and therefore control over business and decision making in the company. Retaining founder's interest and control in the business is not only of great value to the shareholders but also important for the growth of the business. Hopefully, the new regulations would aid Indian growth start-ups and their promoters to continue retaining greater control over their companies. However, the right to issue shares with superior voting rights has come with many checks and balances including restrictions and increased compliances and it is yet to be seen if the promoters would be ready to undertake these additional compliances to retain control.

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