[By Shyam Gandhi]
The author is a student of National Law University, Jodhpur.
INTRODUCTION
The introduction of Differential voting rights (DVR) shares was initially facilitated by the Companies (Amendment) Act of 2000. In 2008, Tata Motors became the first business to issue DVR shares. Subsequently, in 2009, the Securities and Exchange Board of India (SEBI) implemented a prohibition on the issuance of ‘Superior Voting Right’ shares due to concerns of potential financial misappropriation by shareholders holding shares with differential voting rights (DVRs). The decision was motivated by the aim of safeguarding minority shareholders from potential tyranny and preventing the consolidation of managerial control within family-owned enterprises. In the year 2019, the Securities and Exchange Board of India (SEBI) implemented a policy reversal by disallowing the issuing of shares with inferior voting rights while simultaneously allowing listed businesses to issue shares with Superior Voting Rights (SVR).
Section 43(a)(ii) of the Companies Act permits companies to issue equity shares with differential rights in terms of dividend, voting, or other aspects. These shares are commonly referred to as DVR shares. DVR shares can be categorized into two types: ‘Superior Voting Right’ shares, which grant voting rights beyond the conventional ‘one share, one vote’ principle, and ‘Inferior/Fractional Voting Right’ shares.
REINTRODUCTION OF DVR MECHANISM
SEBI, the Securities and Exchange Board of India, published a consultation paper on March 20, 2019, on the issuing of DVR shares. The purpose of this document is to address the growing discussion surrounding the necessity of allowing the issuance and listing of shares with DVRs in India. The study underscored the advantages and necessity of DVRs in the context of India’s period of rapid economic expansion, which necessitates firms to secure funds in order to maintain this growth. Moreover, it is worth noting that certain companies that adopt asset light business models may exhibit a preference for equity capital as opposed to debt capital. In order to raise equity capital, these companies may consider the issuance of shares with superior voting rights (SRs) to founders as well as shares with lower or fractional voting rights (FRs) to private or public investors. This approach can be viewed as a feasible alternative for such companies. SEBI approved a framework for the issuance of DVRs, on 27th June 2019.
ADOPTING A FLEXIBLE APPROACH
On September 28, 2021, SEBI proposed the relaxation of restrictions pertaining to differential voting rights (DVRs) for company founders. This recommendation is intended to enhance the prospects of technology startups, wherein founders often possess minimal ownership stakes in later stages but wield disproportionate control over operational matters. During the meeting, SEBI made the decision to raise the minimum net worth requirement for entrepreneurs and their companies from Rs 500 crore to Rs 1,000 crore. This adjustment aims to grant these entrepreneurs enhanced voting rights within their own companies. Moreover, prior to the present time, corporations were required to observe a waiting period of six months before issuing these shares and submitting their documents for the purpose of being listed on the stock market. Based on the recorded minutes of the meeting, the duration has been reduced to a period of three months. The strategy is based on the model observed at prominent companies in Silicon Valley, such as Facebook and Alphabet’s Google. In this model, investors possess larger ownership stakes than the founders, yet the founders maintain control through the allocation of greater voting rights. Typically, this entails granting the founders 10-20 votes per share, while investors are granted one vote per share.
EXISTING CHALLENGES REGARDING CURRENT FRAMEWORK
Currently, DVRs mechanism faces several challenges. Firstly, there is a lack of awareness and knowledge regarding the DVR. One of the primary factors contributing to the low level of knowledge about DVR shares is the minimal marketing and educational initiatives that have been made. It is possible that many people who are interested in investing do not have a complete understanding of what DVR shares are and how they operate. People are less inclined to make financial commitments to something they do not fully comprehend if there are not sufficient marketing and education efforts.
Secondly, those who are in possession of shares that have superior voting rights may, in some situations and under certain conditions, exploit their influence for the purpose of seeking personal gain or moving themselves closer to their own goals. It is possible that, as a result of this, decisions will be taken that are not in the best interest of the company or the individuals who have a stake in it.
Third, companies that are organised in a DVR fashion could run into a number of obstacles when they are attempting to raise capital. If a company does not grant equal voting rights to all of its shareholders, there is a risk that some investors may be hesitant to join that company. Thus, as a consequence of this fact, the business can have a more challenging time generating capital.
Lastly, there is an unequal distribution of voting power, which prompts people to worry about the propriety of corporate governance. Shareholders who have greater voting rights than other shareholders may be more likely to make decisions that prioritise their own personal interests above the long-term prosperity of the company as a whole or the interests of other shareholders. This has the potential to result in conflicts of interest as well as assessments that are not in line with the development of long-term value.
FAILURE OF DIFFERENTIAL VOTING RIGHTS MECHANISM
Even after more than 23 years of operation in India, only a handful of listed businesses have issued DVR shares, despite the fact that DVR Shares were originally established there in 2000. Tata Motors, was the first to opt for the DVR Shares, but recently Tata Motors announced that it will convert the DVR Shares into ordinary shares. The aforementioned action is being undertaken with the intention of streamlining its capital structure. As per the company’s statement, the proprietors of ‘A’ shares, who currently receive superior dividends compared to regular shareholders but possess the right to cast one vote for every ten ‘A’ shares held, will henceforth be granted ordinary shares. Thus, one of the disadvantages of DVR is its complicated capital structure.
Another issue with DVR pertains to its adverse effects on minority shareholders. In general, larger institutional investors exhibit a propensity to maintain their shareholdings over extended periods of time. Therefore, these are the individuals who will receive double voting privileges. This will serve to reinforce the existing substantial barriers to entry. Conversely, minority owners often exhibit a shorter duration of shareholding. Given their limited influence in the decision-making processes of the organization, it is probable that their capital will be exploited and that they will be marginalized as a group. Moreover, investors may find it difficult to intervene if their rights are violated or if the business is underperforming, increasing the likelihood of oppression of minority shareholders and mismanagement by the promoters due to their limited shares.
Another significant concern associated with DVRs is their impact on stock liquidity. Stocks are traded based on the fundamental assumption of their liquidity and the perpetual presence of a readily accessible market, should investors choose to convert their stocks into cash. The implementation of these voting rights impedes this process. The allocation of voting rights may not be equitable for shareholders who have just acquired ownership. Consequently, they will exhibit hesitancy in making a purchase. Previous shareholders who have already acquired these shares would likewise possess a substantial incentive to refrain from selling their shares. The implementation of this approach would result in the establishment of an artificial limitation on the availability of stocks, impeding the unrestricted operation of the market. For a market to operate freely, transaction costs should, in theory, be zero. Price distortions and reduced liquidity are inevitable results of imposing heavy fees. Due to the aforementioned points, the DVR mechanism in India has turned out to be futile.
CONCLUSION
The introduction and evolution of DVRs in India have been marked by a series of regulatory changes and policy shifts aimed at striking a balance between promoting corporate growth and safeguarding the interests of minority shareholders. DVRs were initially envisioned as a means to provide companies with flexible capital-raising options and their founder with greater control. Their implementation has faced a range of challenges and limitations.
The journey of DVRs has been far from smooth. Despite regulatory efforts and policy adjustments, DVRs have encountered several hurdles that have impeded their effective adoption. The lack of awareness and education around DVR shares has hindered investor participation, and concerns about the potential misuse of voting rights have raised questions about corporate governance. One major setback has been the limited number of companies opting for DVRs, even after more than two decades of their existence.
In essence, while the idea of DVRs held promise to balance control and capital needs, the experience demonstrates that their implementation requires careful consideration of various factors. DVR can be attractive for startups and emerging businesses, as it enables them to raise capital without diluting the control. However, shareholders will be skeptical to invest, if their interest is not protected. Thus, Striking the right balance between empowering founders and protecting minorities remains the strongest challenge. As India’s corporate landscape continues to evolve, DVRs have a long way to go. Communication, enhanced education, and refined regulations are essential to navigate this intricate terrain and ensure that DVRs contribute positively to the growth and development of India’s business ecosystem.