Markets | Tech start-up founders get a superior voting rights carrot but the sticks are many

Sebi has opened the door open to technology companies with superior voting shares to list on the main board of Indian stock exchanges. This is in response to lobbying by tech entrepreneurs as a condition for listing their start-ups in India. The government has been keen that Indian tech start-ups list in India, putting India on the global start-up map, as in other markets such as the US, London or Singapore.

If it works, it could create an ecosystem where tech start-ups can thrive, with talent and capital available locally. It will also drive growth of the Indian capital market and allow domestic investors to buy into start-ups more easily. But there are risks too, of the misuse of such instruments and the effect it could have on corporate governance. These concerns are possibly why Sebi has put in several safeguards in place. The overall impact of these safeguards themselves may make founders question if it’s worth it and may lead to more lobbying to relax some of these checks. Sebi should stand firm.

What has been allowed?

A company that has issued Superior Voting Rights shares (SVRs) can go public by issuing ordinary shares as long it fulfils other requirements.

Only tech companies—as prescribed under the Innovators Growth Platform market—are allowed to issue SVRs. This is a bit puzzling. SVRs are a route to encourage entrepreneurs to list on an Indian exchange. Once you have crossed the legal and ethical hurdle of allowing SVRs, it should be thrown open to all. Why manufacturing companies—which are also vital for India and Make in India—are not being allowed this relaxation is puzzling. That’s the first crib.

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Related to this is the second problem, which is the definition of tech companies. It says: A tech company that is intensive in the use of technology, information technology, intellectual property, data analytics, bio-technology or nano-technology to provide products, services or business platforms with substantial value addition. This appears to be very subjective.

For example, will a start-up that makes electric vehicles or drones fit here? It should. But then, every product uses some technology to be made, so why would a company that uses innovative technology to make furniture, chemicals, medicines or metals not fit in this definition? Again, does the technology have to be in-house or can it be licensed and how is intensive use of technology defined?

This is likely to lead to subjective decisions that will be challenged in court or where companies will try to game the rules.

And, substantial value addition has not been defined, making it a grey area. A hotel aggregator markets an app where its partner hotels put up their inventory for booking. How will Sebi decide if this value addition is enough or not?

Who can own SVRs?

Only promoters and founders who hold an executive position on the company are allowed to own SVRs. This may be to ensure that only entrepreneurs (as opposed to co-founders whose main role may be funding) are allowed to hold SVRs. This could be restrictive. At times, when a company grows rapidly, founders tend to take a backseat, with professionals taking over the executive role.

Second, the founder should not be part of a promoter group with a net worth exceeding Rs500crore. So, a younger generation entrepreneur from a promoter group with a net worth in excess of Rs500crore setting up a technology company cannot get shares with SVRs. This could be to prevent misuse by large business houses. Also, such start-ups get easier access to funding within the group itself.

SVRs will have voting rights of a minimum 2 compared to every 1 ordinary share and a maximum of 10 for every one ordinary share. But this is circumscribed by another rule on the overall share. So, the total voting rights for SVRs cannot exceed 74percent.

That is, if total ordinary shares are 100, then say 20 SVRs are issued with voting rights of 10:1, meaning entitling the owner to voting rights of 200 ordinary shares. On a total base of 300 shares, it gives the 20 SVRs a two-thirds majority. This is permissible. But if say 30 SVRs are issued, leading to a 75percent voting right, that is not allowed and will be limited at 74percent. This level matters under company law as certain resolutions require a three-fourths majority.

Apart from voting rights, SVRs don’t enjoy any special benefits on matters such as dividends.

While SVRs will be listed, this appears symbolic. They will be locked in till they are converted to ordinary shares. Promoters cannot transfer shares among themselves. That is, one founder cannot sell SVRs to another. These shares cannot be pledged. That means a lender cannot invoke a pledge and then take over these superior voting rights.

Corporate governance safeguards

Companies that issue SVRs will be subject to a higher standard of corporate governance. At least half of the board will comprise independent directors, compared to the norm of one-third otherwise. It has also said that two-thirds of all committees should be staffed by independent directors and the all-important Audit Committee will have only independent directors. This is to ensure that there is a greater degree of external oversight on the company’s function, to balance the higher voting rights given to the founders. Whether this will actually make a difference to corporate governance is not clear, as scams have unfolded right under the nose of independent directors.

Coat-tail provisions

There are occasions when the superior rights temporarily fall off SVRs. These are: appointing of or removing an independent director or an auditor, when the promoters are selling shares, when approving related party transactions, during insolvency, on delisting or buyback of shares. Sebi has the power to expand this list.

When SVRs will turn into ordinary shares

After five years of listing, these shares will be converted into ordinary shares. The founders can seek an extension for another five years but only ordinary shareholders can vote on that resolution. That is a carrot for founders to keep ordinary shareholders happy if they want to continue holding SVRs. Another clause says that the demise, resignation or a merger/acquisition will also see superior rights being withdrawn. That is, the law wants to ensure that only the founders responsible for setting up the company enjoy this right and it is not transferable.

In Conclusion

As an experiment, shares with differential voting rights have been issued earlier, notably by companies such as Tata Motors. This is a different experiment, seeking to get tech companies to list here.

Companies list in a market for a few reasons. It allows them to raise capital, give an exit to existing investors through an IPO, issue Esops to employees, and sometimes raises their public profile. Sebi’s SVR regulations could help but only if that’s the main reason why owners of brands such as PayTm, Ola and Oyo are not listed in India. That is not certain.

In some cases, they may not really need the capital. Or, they may not want the public scrutiny that comes with being listed. But scrutiny is necessary. After all, it is the minority’s willingness to take the risk of investing in a company that gives it and the promoters’ equity-holding a public market valuation.

More than anything else, there’s a time in a company’s life when it makes sense to become listed on the main board, usually not the early years of a start-up’s life. When you see how some start-ups have imploded, one really wonders if retail investors have the stomach for such a blow-up.

Along with SVRs, perhaps Sebi should also ask retail investors who want to invest in tech start-ups that can issue SVRs, to take a test to assess if they truly understand the risks of investing in such companies. Even if that does not stop people from throwing darts in the hopes of finding the next Amazon, at least Sebi could say you knew what you were getting into.

Lastly, by creating two classes of shareholders, India’s corporate governance standards have moved down by a few notches. That Sebi has done this despite the reservations expressed by many, is an indication that it believes the benefits outweighs the risk, or reflects the pressure brought upon it by the government.

The first step in assessing its success will be to see if tech start-ups actually list, or make more excuses not to. For instance, they may say the rules are restrictive. Some of the other countries may still be attractive. For instance, US-listed Facebook and Snapchat have issued shares to their founders without a sunset clause. Then, there’s the matter of Indian tech start-ups being ready for the public market and the scrutiny it brings.

The second is to see whether the SVRs lead to a broad misuse of superior rights or founders are able to balance their desire to retain control with the need to ensure that minority shareholders don’t feel short-changed. As of now, Sebi has not said anything about existing companies being allowed to issue SVRs. If that happens, it will open a new can of worms.