A spate of new share sale filings by internet start-ups such as Zomato, Paytm and Policybazaar, has put the spotlight on the regulatory framework for superior voting right shares, or SR shares.
This concept, introduced two years ago, ensured that start-up founders get to keep skin in the game after initial public offerings, or IPOs. But promoters have complained that the rules are too onerous and on July 1, India’s market regulator sought public feedback on proposals to loosen the framework. Here’s a closer look at the issue:
What are SR shares?
Superior voting right shares, which offer a higher dividend than ordinary shares, do not subscribe to the dictum of one share-one vote. They enable founders to retain control of their companies even after new investors come in.
Why did Sebi introduce this framework?
“Promoters/founders of new age tech companies may have the necessary vision and skills to take the company forward; however, such individuals may lack the ability to infuse capital. Thus, promoters/ founders of new-age tech companies undergo significant shareholding dilution in order to raise capital at early stages,” Sebi said in the paper, explaining the background to the concept of SR shares.
“One of the reasons for introduction of SR shares was to encourage such promoters/founders who have an executive position in the company to retain a certain amount of control for a limited period of five years, extendable by another five years, with ‘checks and balances’,” the regulator added.
While SR shares are a relatively new concept in India, the sale of such shares is allowed in countries like the US, and closer home in Hong Kong and Singapore, subject to stricter corporate governance norms. Facebook founder and CEO Mark Zuckerberg, for instance, has managed to keep control of the social media network by issuing such shares, carrying 10 votes each, to himself and his associates compared to one vote to public shareholders when he took the company public.
Sebi had previously shunned the concept because of concern that it could lead to misuse of power by founders and go against the interests of small shareholders.
When did it give the go-ahead?
In 2019, the regulator gave the go-ahead to founders of tech-oriented start-ups (infotech, nanotech, biotech, data analytics, for instance) voting rights in the ratio of 2:1 (two votes for one share) to 10:1 (10 votes for one share) compared to public shareholders.
Under those rules, SR shares were to get converted to ordinary shares after five years of listing or the death or exit of the shareholder with superior rights.
What are the new proposals to revise the framework?
Net-worth requirement: Under current norms, if the SR shares cannot be issued to an entity that is part of a promoter group with a collective networth of more than Rs 500 crore.
Market participants have complained that this norm is too onerous and keeping prospective SR shareholders away from utilizing the SR shares framework,” the regulator said in its consultation paper. Moreover, the definition of promoter and promoter group is too broad. This has led to a situation where the networth of the relatives of founders is included. Further, promoter groups can be very large where there are multiple founders, said the regulator.
Therefore, SEBI has sought public feedback on whether the networth of the SR shareholder should be considered individually, or as part of the promoter group, and also a review of the Rs 500 crore threshold.
Shareholding entities: Under current rules, SR shares are issued only to promoters or founders who hold an executive capacity in the issuer company. Now SEBI has sought feedback on where SR shares can also be issued to holding companies, registered family trusts and partnerships where the founders or promoters of the issuer company are in control or the sole trustees.
The regulator has proposed this loosening since in many companies, the promoter shareholding is structured through holding companies or family trusts or limited liability partnerships for succession planning and tax planning and so on.
“Current Regulations would require unwinding of these structures to enable direct holding of SR shares by founders/ promoters. This may have various implications, including from a taxation perspective and may even impact the ability of the Issuer company to do an offer for sale...,” the regulator explained.
Timing of issuance of SR shares: Current norms require SR shares to have been held for at least six months prior to the filing of the initial share sale prospectus. SEBI has proposed to do away with this rule since market participants have complained that this leads to delays in issuing shares through an IPO.
How have tech companies reacted?
As expected, tech companies have cheered these proposals. IndiaTech, an industry association that represents start-up founders and investors, has suggested to SEBI that the networth requirement for start-up founders be determined individually and not as a group, the Economic Times reported on August 2 on its website, adding that the club of tech businesses wanted the threshold to be maintained at Rs.500 crore.
It also proposed that the sunset clause of five years for founders to hold control of their companies, extendable for 10, be prolonged.
“We recommend a sunset period of at least 15 years, which can be extended for another five years with shareholders’ approval,” Ramesh Kailasam, CEO of IndiaTech, was quoted as saying by ET.IndiaTech also called for SEBI to consider bringing the post-IPO capital requirement for promoters to 5 percent, or even mandating founders with less than a 20 percent holding, to lock in their shares for a year, the report said.