Almost two years to the day, the Securities and Exchange Board of India (“SEBI”) introduced the concept of superior voting equity shares (“SR Shares”) in the SEBI ICDR Regulations of 2018 (ICDR – ‘Issue of Capital and Disclosure Requirements’) to ease initial public offers of tech-based start-up companies.

Founders of such companies are inclined to use SR Shares where their company (expectedly) has multiple rounds of fund raise requirements from various financial investors and ordinary voting right equity shares would dilute a founder’s control. SEBI is now reviewing whether the present ICDR regime needs further modifications to facilitate a company with SR Shares meaningfully achieve listing.

The whole issue has several features of interest. For example, which shareholders with SR Shares (“SR Shareholders”) should be considered?

Key models

A company can have founder equity shareholding control structured in a few key models: (a) direct equity holding by one or more individual founders; (b) founder may have relatives hold equity shares; or (c) founder holding is through trusts/holding companies (special purpose vehicle or SPV).

Notwithstanding variations to the structure, the crux would be in the individual founder exercising control. Thus, SEBI’s focus may well be on the founder’s direct or indirect holding of SR Shares, and such founder would be the relevant SR Shareholder for the purposes of the ICDR.

SEBI may even consider allowing SR Shares only for individual founders for a company going the IPO route, as they are the ones who would effectively need to exercise control rather than relatives with passive shareholding. If required, the maximum permissible voting ratio of 10:1 could be increased to 12:1 or 15:1. Another point of interest is whether SR Shares be allowed for a SPV? The key challenges to allowing SR Shares for a SPV have always been opacity and the fact that there could be dilution of founder’s control in the SPV itself. If SR Shares are allowed in SPVs, it would indeed be complex to monitor and require disclosures from the founder and the SPV.

In this regard, few requirements to consider would be: (a) positive shareholding control over the SPV by the individual founder, which may not be diluted below 50.1 per cent till the sunset of the SR Shares. Disclosures regarding the founder’s direct and beneficial holding in the SPV would be required periodically as well as on transaction triggers. The voting ratio for SR Shares would also be tested against the vehicle in that case.

If founder-holding is a combination of direct and through a SPV, the voting ratio and other conditions under the ICDR would have to be satisfied by both.

Net worth considerations

Then, there is the question of what the net worth considerations should be. At presently, it is ₹500 crore collective net worth limit for promoter groups. Changing this to net worth of individual founders may be more useful. While already present in the ICDR, a clearer clarification that such net worth would exclude the individual’s (direct or indirect) equity-linked investment in the company would be helpful.

As the conditionalities are for main board listing and considering how PE/VC led company and founder growth would typically mature before an IPO, a threshold of ₹750 crore for a single founder and, where there are two or more founders, an aggregate of ₹1,500 crore for all individual founders combined may be considered. Given that the investments into the company would not be considered, if there is a SPV, its investment into the company might not matter.

Furthermore, what should be the minimum period of holding SR Shares? At present, the ICDR mandates that the SR Shares should be held for a minimum period of six months prior to filing of the red herring prospectus. While six months is not unreasonable, a shorter period could also be considered to allow founders greater flexibility to prepare a company for an IPO. Also, if there is a SPV, the minimum holding period should apply on it as well. As a corollary, if the founder holding of SR Shares in the company is a combination of direct holding and SPV holding, the minimum holding period should apply to both. Any time-period beyond minimum holding need not be identical for both. Also, given that the voting ratio could be tested through holding of direct SR Shares (either for individual founder or vehicles) and the net worth test could be limited to individual founders minus investment in the company; during the six-month period inter se transfer between individual founder and his SPV could also be permitted.

In sum, to aid founders and tech-based start-ups to best use SR shares en route to a main board IPO, a shift in focus from promoter/promoter group to individual founders and their controlled investment vehicles may provide the right balance.

(The author is a Mumbai-based Corporate Partner with HSA Advocates, and additionally heads the practice for the Firm’s Kolkata Office. Views expressed herein are personal and not to be construed as legal advice.)

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