Ease Equity Financing by empowering minority shareholders

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Harsh Maggon and Mahima Priyani

We are living in uncertain times. While the government doles out relief packages to save the economy, it must rethink certain regulatory frameworks to aid companies in fighting the unpredictable ill-effects of Black Swan 2020.

With diminishing cash flows and growth forecasts, one form of capital companies are likely to seek increasingly is equity financing. Listed companies especially find themselves caught in a regulatory quagmire of ‘minority protective’ rules which threaten to derail any possible ‘turnaround’ equity capital they may be eyeing.

Ironically, some of the minority protection rules such as pricing floors and open offer obligations have been operating against the interests of minority shareholders for a while now and it is time the rules were eased out for their benefit.

In the Indian public M&A (merger and acquisition) sphere, two significant minority protection requirements are seen to be the nemesis for companies in distress -- one requires acquirers to pay a minimum price for preferential issue of shares (a route often used to provide the much-needed equity capital to companies), and the second requires acquirers to make a mandatory tender offer (MTO) to public shareholders on acquisition of a significant threshold of shares or control in the listed company.

The price an acquirer pays for a preferential issue is required to be determined on the basis of the market price for the relevant stock (higher of the 26-week and 2-week VWAP, that is volume-weighted average price). This is the average traded price of a security throughout the day, based on both volume and price.

It is well known that stock prices are not always representative of the underlying value of the company – in fact, we find ourselves in the midst of a stock market meltdown, where a 26-week VWAP does not even realistically offer a value any acquirer will pay. Not to mention, a company in distress is seldom in a position to bargain for higher valuations.

Add to that, the requirement to make an MTO, and the combination makes it near impossible to raise any investment. Most distressed companies and acquirers would rather seek infusion of capital into the company in distress than make a payout to minority shareholders in an MTO – after all, such an infusion will only improve the long-term equity value for all shareholders.

The minimum pricing rules and MTO obligations have also failed to keep up with the growing involvement of minority shareholders in decision-making within listed companies. The Securities and Exchange Board of India (SEBI) has, over the past decade, mandated listed companies to obtain the prior approval of minority shareholders for several decisions – these have mostly been limited to matters where there is a perceived conflict of interest involving the management or the promoter group. Why is not SEBI permitting minority shareholders to approve or disapprove a transaction that deviates from these ‘minority protective’ rules, especially when their company is in the midst of a distress?

If a company in distress is looking to raise funds at prices lower than the mandatory floor price or is seeking an exemption from making an MTO, the listed company should be permitted to approach its minority shareholders for permitting such a deviation. If, after being duly informed of the reasons for such deviation, minority shareholders approve a deal, the listed company should be free to transact such a deal. This would incentivise bailout transactions by making them cost-efficient for acquirers. Interestingly, the laws of many developed countries such as the United States, the United Kingdom and Singapore contain similar whitewash exemptions for deviations from pricing norms and/or from MTOs.

With the likely dismal cash flows of most listed companies for the next two quarters and crash in stock markets, SEBI would do well to fix these rules which limit the ability of listed companies to raise ‘turnaround’ equity capital. The flexibility would, after all, only uphold shareholder democracy and empower minority shareholders to charter a future for their companies at a time when they could use this support.

Harsh Maggon is a Partner, and Mahima Priyani is an Associate at Trilegal. Views are personal.