The Securities and Exchange Board of India (Sebi) recently issued a consultation paper on shares with differential voting rights (DVRs), inviting comments on the proposals in a report of the DVR Group formed by Sebi’s Primary Market Advisory Committee. With this, Sebi has enlivened the debate on the introduction of dual class shares in India.

DVR shares are a class of corporate shares with fractional, or superior voting rights, than ordinary equity shares. They are apt for companies whose owners do not want to dilute their control over their businesses by issuing ordinary equity shares. By issuing DVR shares with fractional voting rights, they can raise capital without the risk of a hostile takeover. Similarly, by issuing themselves DVR shares with superior voting rights, promoters can retain control even as the regular equity base expands.

Currently, as per Section 43(a)(ii) of the Companies Act, 2013, a limited-liability company may have equity share capital with differential rights on voting, or dividends, or otherwise. Further, Rule 4 of the Companies (Share Capital and Debentures) Rules, 2014, prescribes certain conditions, which need to be fulfilled to issue shares with differential rights. Further, Sebi’s listing obligations and disclosure requirement regulations, 2015, prohibit companies from issuing shares with superior voting rights. DVR shares have not been an attractive method of raising capital in India. Only a few companies, such as Pantaloons and Tata Motors, have issued DVR shares so far. The consultation paper, however, recommends that both fractional rights (FRs) and superior rights (SRs) be allowed.

The key recommendations of the DVR Group on FR shares are as follows:

1. On the first-time issue of FR shares, the companies whose shares have been listed and traded for one year shall be permitted to issue FR shares by way of: A rights issue, a bonus issue pro rata to all equity shareholders, and a follow-on public offer (FPO).

2. On the subsequent issue of FR shares, a company that has already listed FR shares shall be eligible to make a rights or bonus issue of FR shares of the same class.

3.On Qualified Institutional Placement (QIP), or a preferential issue, a company whose FR shares have been listed for at least one year shall be eligible to do a preferential issue or QIP of FR shares of the same class.

4. The face value of FR shares shall be the same as ordinary equity shares.

5. The FR shares shall not exceed a voting ratio of 1:10. The company can have only one class of FR shares with ratio ranging from 1:2 to 1:10.

6. Additional dividends can be paid per FR share compared to dividends on ordinary equity shares.

7. FR shares can be extinguished only through a buy-back or reduction of capital.

The key recommendations on SR shares by companies whose equity shares are proposed to be listed are as follows:

1. Such shares can be issued only to promoters of an unlisted company. An unlisted company where promoters hold SR shares shall be permitted to hold an Initial Public Offer (IPO) of only ordinary equity shares provided the SR shares are held by the promoters for more than one year prior to the filing of a draft order document with Sebi.

2. Once the ordinary equity shares are listed, the company will not be allowed to issue SR shares to any person.

3. All SR shares shall remain under a perpetual lock-in after the IPO.

4. The face value of SR shares shall be same as that of ordinary equity shares.

5. No third-party interest, such as lien, etc., will be allowed to be created over SR shares.

6. The company will be allowed to issue only one class of SR shares with the voting ratio ranging from 2:1 to 10:1.

7. Post IPO, SR shares shall be eligible for the same dividend and other rights as ordinary equity shares, except for superior voting rights.

8. Post listing, the voting rights with the promoters through the SR shares and ordinary equity shares shall not exceed 75% of the total voting rights.

9. Post IPO, SR shares will be treated as ordinary equity shares in terms of voting rights in the specified circumstances.

10. SR shares shall get converted into ordinary equity shares on the fifth anniversary of the listing of the firm’s ordinary shares. The validity is, however, extendable by another 5 years with the approval of shareholders by way of a special resolution in a general meeting.

Apart from the above, the paper lists amendments to be made in various laws, such as the Companies Act, Takeover Code, and Sebi (Issue of Capital and Disclosure Requirements) Regulations, in order to bring DVR shares into effect.

With India becoming a hub of tech startups, we could adopt the norms that prevail overseas, especially in the US, where Facebook, Google etc. have introduced shares of different classes to raise capital. It would give Indian promoters of fast-growth businesses an option to raise capital without diluting control over their enterprises. Hence, Sebi’s effort is worthy of appreciation.

However, with numerous amendments required in law, it appears that there is still a long way to go before the above discussed model is actually available to companies in India. It will be interesting to watch Sebi push through these amendments with various regulators.

L. Badri Narayanan & Pooja Vijayvargiya are, respectively, partner and principal associate at Lakshmikumaran and Sridharan, a law firm

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