The idea floated by high-profile entrepreneurs, seeking dual-class share structure along with differential voting rights for founder-promoters of startups, is flawed. The Government must look for better ways to help small businesses

An advocacy group, IndiaTech, representing some of the most high-profile entrepreneurs, has made a submission to the Ministry of Corporate Affairs (MCA) and the markets regulator, Securities Exchange Board of India (SEBI), seeking a dual-class share structure along with differential voting rights for founder-promoters of start-ups that can encourage the country’s most valuable companies to get listed on the domestic stock exchanges instead of overseas exchanges such as Nasdaq and New York Stock Exchange (NYSE). 

At present, the Companies Act 2013, permits firms having consistent track record of distributable profits for three years to issue shares with differential voting rights (DVR) subject to a cap of 26 per cent of the total share capital. The lobby group wants the MCA to dispense with this caveat. Alternatively, the Ministry may consider allowing companies, who meet certain revenue threshold, to issue shares with DVR without having to meet the profitability criteria.

IndiaTech has also asked for increasing the current cap on shares with differential rights from existing 26 per cent to at least 51 per cent of a company’s post-issue, paid-up equity share capital. It has also sought conversion of ordinary shares into equity shares carrying DVR and equity shares with DVR into ordinary shares.

Typically, startups work on an innovative idea that holds the potential for huge business opportunities. Seeing this, ‘strategic’ investors pump in equity capital,  which in turn leads to an increase in their shareholding and corresponding reduction in the stake of a promoter. Depending on the scale of investment, the former may even acquire majority stake, reducing the latter to minority. The intent behind issuing DVR is to nullify this outcome.

A share having differential right bestows its holder voting power that is greater than what is available to an ordinary shareholder. As a result, even with lower share in the total equity capital, the promoter will be able to hold on to the driver’s seat (major beneficiaries are expected to be the so-called ‘unicorns’ — an acronym for start-ups which have a market capitalisation of over $1 billion). The idea is flawed.

First, a fundamental tenet of corporate functioning is that the voting power of an investor has to be proportional to his investment or the shares held by him in the company. This applies to all investors, including the promoter. Yet, any attempt to give disproportionate voting rights to the promoter, which can only be at the cost of other investors, will be ‘unfair’ and ‘discriminatory’.

Second, when strategic and financial investors bring in funds, the promoter gains due to increase in business prospects and phenomenal growth in his personal wealth. Then, for him to also remain in the driver’s seat — in so far as the management and control goes — sounds like having the cake and eating it too.

Third, in some cases, the promoter either exits or sells a portion of his/her shares at huge premium raking in the moolah (for instance, in Flipkart, one of the co-promoters sold his stake making billions of dollars). In such a scenario, he has to necessarily get reconciled to reduced or no control over the company.

Fourth, what makes one presume that the promoter alone is best positioned to run the affairs of the company in a manner so as to achieve the stated objectives? In fact, for strategic investors having made substantial investment, the sheer need to protect and grow it will make them eligible to take charge.

To expect that only the promoter is best suited to run (merely because he set up the company) is an untenable argument.   

Even so, nothing prevents the strategic investors (albeit with majority stake) to vest the promoter with powers by passing necessary resolution in this regard. That indeed is the way forward instead of the founder-promoter wanting to ride piggyback on law-makers and regulators to indulge in muscle-flexing.

In their obsession to remain at the helm, come what may, the promoters of startups want the Government to even dispense with the profitability track record criteria. This is bizarre. It means that even when a promoter pushes the company into losses continuously and despite being reduced to a minority shareholder, he/she should have the eternal right to remain in command and control.

In the same vein, they want to have the flexibility of conversion of ordinary shares into equity shares carrying DVR and equity shares with DVR into ordinary shares. This is done with an aim to enable all existing promoters to get into the drivers’ seat wherever the majority shares have slipped into the hands of strategic investors.

Letting the promoters have shares up to 26 per cent with DVRs — already allowed under the Companies Act, 2013 — was bad enough. To raise the cap to 51 per cent as demanded by the advocacy group, would substantially aggravate the imbalance.

This could be counter-productive for none other than the start-ups themselves. This because faced with the denial of voting rights in sync with their share holding, strategic investors will be disinclined to pump in capital, thereby nipping the chances of their growth in the bud.

To sum up, the idea floated by high-profile entrepreneurs is flawed. The Government should dismiss it with the contempt it deserves. There are better ways of giving support to startups.

(The writer is a freelance journalist)