India has for long held the common perception of one-share one-vote, which assumes that all shares represent an equal percentage of a corporation and that all shareholders have equal rights and obligations. This common perception is likely to witness some churn in the times to come. Capital markets regulator, Securities and Exchange Board of India (“SEBI”) has issued a consultation paper on issuance of shares with differential voting rights (“DVRs”) and invited public comment on it till April 20, 2019.
Let’s try and unbox the concept of DVRs.
DVRs or dual-class shares (“DCS”) is a system in which a single company may issue different classes of shares with distinct voting rights and dividend payments. Typically, the shares issued to general public are distinct from the shares issued to the founder(s)-promoter(s) and investor(s) in that the latter class may have higher voting power or more control over the company. Jurisdictions like the United States have had DCS structures for a few decades now, while others like Singapore and Hong Kong have recently jumped on that bus. Still others like the United Kingdom and Australia are more circumspect about the disparity the DCS structure creates between shareholders' economic and voting rights, and have thus far, not permitted it.
The American affinity to the DCS structure is, among other reasons, why certain companies like Manchester United (UK) and Alibaba (China) chose to list their IPOs on the New York Stock Exchange even though football and Alibaba aren’t as popular in the US. Others like Facebook and Google, which had huge listings in the US deployed versions of the DCS structure to great effect. On the other hand, SNAP Inc., the holding company of the massively popular social media app Snapchat by offering shares with no voting rights in its IPO, raised more than a few eyebrows.
Voting is important as it provides the shareholders control over the company’s affairs. Under the Companies Act, 2013, shareholders have the right to vote in matters relating to the company’s merger, appointment of director, amendments to the constitutional documents of the company, etc. In a single-class structure of shares, A with 10 votes will exercise the same degree of control over the company as B, with 10 votes. In a DCS structure, if A holds 10 shares with higher voting power, she will exercise a higher degree of control over the company than B, who may hold 10 ordinary shares.
Interestingly, SEBI had prohibited companies from issuing shares with “superior” rights with regard to voting and dividends in 2009. This had acted as a barrier to Indian companies issuing shares with DVRs, prompting several companies to list outside India in order to incorporate a DCS structure in relation to their shares. This new step by SEBI is seen by some as an attempt to make India a more friendly jurisdiction for Indian as well as foreign companies to incorporate and list.
SEBI's consultation paper proposes two routes for issuing DVRs:
Further, it discusses the concepts of “superior” and “inferior” rights as to shares, i.e. when shareholders receive voting rights in excess of one vote per share, there would be share with superior voting rights (SR share) and conversely, with inferior or fractional voting rights (FR share).
SR shares may only be issued by unlisted companies and that too only to promoters. The idea is to ensure that promoters maintain more control via their voting rights in addition to their economic rights before the company opts to list its shares. Once the company is listed, it can no longer issue SR shares. There are a few other conditions related to SR shares:
The addition of the sunset clause highlights that DVRs are mostly required at the initial stages of a company’s lifecycle. During and immediately post incorporation, DVRs play an important role in enabling the promoters to assume business risks without ceding control. Subsequently, once the business is more established, shares with DVRs lose their purpose and are converted into regular shares. The sunset clause also has a corporate governance play, effectively preventing promoters from exercising control over a company by holding on to a small number of shares for a large period of time.
On the other hand, the paper proposes that FR shares may only be issued by companies whose shares have been listed on the stock exchange for at least a year. FR shares are usually issued to outsiders and investors who want control in the company. Voting rights on FR shares cannot exceed a ratio of 1:10, i.e. one vote for every 10 shares. Companies may pay a higher dividend on FR shares as an incentive for investors to opt for them, in lieu of lower control rights.
The paper also recommends amendments to the Companies Act, 2013 and various other SEBI Regulations such as those relating to capital issuances, continuous listing requirements, buyback and takeovers, which reflect the impact of DVRs on these legislative and regulatory provisions.
(We are now on your favourite messaging app – WhatsApp. We highly recommend you SUBSCRIBE to start receiving your Fresh, Homegrown and Handpicked News Feed.)