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The proposed Paytm IPO has yet again raised the contentious issue of who should be classified as a promoter and why do people keenly shun this status. A recent report has said that certain top investors/management in do not desire to be termed as ‘promoters’.
To appreciate this, we need to understand this term and then consider how various laws define and treat promoters. Promoters, traditionally, are those enterprising persons who conceive a business idea, set up a company and seek investors to finance the business. They would run the business and later even hand it over to another management. The investors would participate in the ownership/profits/appreciation.
In western countries, promoters/management typically hold a small share in the capital. In India, traditionally, promoters are families who typically own substantial, usually 50 percent or more, of the equity. Their control would continue through succeeding generations. The challenge for the regulator is more of balancing the interests of these family promoters with those of the public/minority shareholders.
Thus, a multitude of provisions under the Companies Act, 2013 and various SEBI regulations focused on identifying these promoters and placing various responsibilities and liabilities on them.
To begin with, the term is defined very widely. Persons who are in ‘control’ of the company are deemed to be promoters. The term ‘control’ is widely framed and while majority shareholding is enough, even certain special rights under agreements are deemed to be control. Once such promoters were identified, specified relatives and connected entities are also deemed by law to be part of the promoter group. The list of such persons is usually quite long.
They are required to have a minimum percentage of capital after an IPO is issued. Their shareholding was subject to lock in for one to three years. Extensive disclosures are required about the history and background of each of the promoters. They have to make regular disclosures of their shareholding and changes or charges made thereon. They are also the fulcrum around which independence of directors is tested. Any person who is connected to them in any of the specified ways is deemed not to be independent. If anything goes wrong in the company, they could be seen as the primary suspects of blame and punishment.
While there are many other provisions targeted at the promoters, the one that causes special bother relates to when and how they can exit as promoters. Declassification of a person from promoter to non-promoter is a lengthy, difficult and complicated affair. It is almost as if being a promoter is a one-way street, i.e., till death does you apart. It is not as if a promoter is trying to escape responsibility. There may be members of family who have no connection with the company. There may even be separations in the family. The promoter themselves could have so low a shareholding that they have literally no say, whether as a director or a shareholder. Yet they continue to be a promoter and remain subject to multiple restrictions, obligations and liabilities.
Of course, there are provisions for companies with ‘no identifiable promoters’. However, to qualify for this, one would have to escape the wide net cast by the very broad definition of ‘promoter’ and ‘promoter group’.
SEBI has been making attempts to partially right this. Indeed, two consultation papers have been recently issued to discuss how to simplify the reclassification and how to narrow down the definition. These, however, at best, scratch the surface. So the only way out is to squarely avoid becoming a promoter. The best way is to do this at the time of IPO. Hence, if the investors/management are indeed attempting this, they cannot be blamed.
But even this is not easy. The very wide definition even persons having a significant say in management, whether by way of shareholding or by agreements or otherwise, could be classified as promoters. Litigation on this issue (e.g., decision of SAT in Subhkam Ventures case, dated January 15, 2010, read with ruling of Supreme Court on appeal) has been inconclusive. In any case, the definition remains fairly wide.
The problem is further complicated because multiple laws have placed requirements on promoters. These include the Companies Act, SEBI Insider Trading Regulations, SEBI Takeover Regulations, SEBI Listing Regulations, the SEBI ICDR Regulations, certain laws made by the RBI, etc. Thus, there are multiple regulators involved. All this makes a change difficult, and complex.
But change we must. As SEBI has rightly pointed out in its recent consultation paper dated May 11 on redefining the term ‘promoter’, the holding of promoters has decreased steadily from 58 percent in 2009 to 50 percent in 2018 in top 500 companies. More importantly, the holding of institutional investors has substantially increased from 25 percent in 2009 to 34 percent in 2018. Many companies capitalising on new technology are professionally managed companies with no identifiable promoters. Hence, now the responsibility and obligations is sought to be increasingly placed on the Board of a company rather than the promoters.
A robust corporate governance with active involvement of institutional investors would be a better long term objective than focusing on family-centred promoters. However, considering that these consultation papers propose small changes rather than a proper overhaul, the concerns remain. Hence, for now, even if not easy, prevention would be a better strategy for management/investors of new companies than the very difficult cure.