First among equals: The issue of shares with DVRs to promoters is good for tech start-ups, but not public investors

In a bid to add more muscle to Indian start-up founders in their dealings with private equity investors, the Centre relaxed the Companies (Share capital and Debentures) Rules last week, making it easier for companies to issue shares with differential voting rights (DVRs) to their promoters. Apart from allowing DVR shares amounting to 74 per cent of paid-up capital from the present 26 per cent, the new rules also waive the requirement of a three-year profit record for a company to be able to issue such shares. This follows amendments by SEBI last month to its listing and disclosure regulations, which enabled companies with shares carrying superior voting rights to be listed on the bourses, subject to certain conditions. While these measures are quite welcome for India’s start-up ecosystem, they may turn out to be a mixed blessing for retail investors in public markets.

For start-up founders, shares with superior voting rights solve two immediate problems. One, they get to retain control over business decision-making even after significantly diluting their equity stakes. Of late, there have been instances, including Flipkart’s, of start-up founders being unceremoniously ousted from the companies they actively contributed to, by foreign investors with more financial clout. Anointing promoters with special decision-making powers when their financial interests don’t justify it may not go down well with PE/VC investors, but that’s a matter to be bilaterally negotiated. Two, superior voting rights may also help pre-empt situations where promoters reluctant to dilute equity take on excessive leverage. In fact, if the intent of this move was to boost India’s entrepreneurial ecosystem, one wonders why SEBI has extended this concession only to companies which are “intensive in their use of technology”. New ventures in any field may benefit from pursuing asset-light models that reduce debt funding.

Having said this, there is a flip side to allowing companies with unequal voting rights to list in the public markets. Indian promoters, even with minority stakes, often manage to exercise undue influence on key corporate decisions; superior voting rights may only aggravate such mis-governance. SEBI has tried to pre-empt this by restricting the issue of superior rights shares only to promoters who hold executive positions, with a group net worth of less than ₹500 crore. There’s a list of voting decisions where they won’t have extra rights and a stipulation for more independent directors on these companies’ Boards. There’s also a sunset clause, requiring companies to convert superior rights shares into ordinary ones within five years of their public offer. But irrespective of these safeguards, the experience with DVR shares suggests that shares with inferior voting rights can suffer from low awareness, institutional interest, poor liquidity and chronic mis-pricing. It is the retail investors who may need to tread with caution. The possibility of promoters wielding disproportionate clout for the first five years is an extra risk factor to check for while subscribing to IPOs.

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