Shares with differential voting rights (“DVRs”) are like ordinary equity shares, having either superior voting rights (i.e. more than one vote per share) or inferior voting rights (i.e. less than one vote per share). Equity shares may also be issued with differential rights as to dividend or otherwise.
In accordance with the Companies Act, 2013 and the Companies (Share Capital and Debenture) Rules, 2014, a private limited company may issue equity shares with (a) voting rights; or (b) differential rights (as to dividend, voting or otherwise).
According to the consultation paper issued by the Securities and Exchange Board of India on “Issuance of shares with Differential Voting Rights”, the issuance of shares with DVRs in companies led by promoters/founders, enable such promoters/founders to retain decision-making powers. Further, it also helps in fund-raising without dilution of control and serves as defense mechanism against any hostile bid for change in control.
While considering issue of shares with DVRs, the issuer company may consider certain pros and cons, including the following:
Dilution of control: By issuance of shares with DVRs, a company can raise money and founders of the company can continue to keep control over decision-making in the company. Hence, issuance of shares with DVRs may allow founders to raise capital while keeping control over the decision-making.
Takeover of management: By issuance of shares with DVRs, the possibility that a person/ institution may take over the management of a company by acquisition of majority shares, may be reduced, as compared to issuance of ordinary equity shares with usual voting rights.
Growth of business: In founder led companies with effective interest of founders, issuance of shares with DVRs helps in growth of business, as there is minimal voting power with the investors.
Funding large projects: In case a company is desirous of funding in money for large projects without giving management control, then, such funding may be done by way of issuance of shares with DVRs, since there is no risk of dilution of control of the founders.
Difficulty in finding investors: Usually investors are prohibited by their charters to invest in shares with DVRs. Strategic investors may want voting rights as they would like to play a role in the management of the company. Due to this, and prohibition in their charters to invest in such shares, it might get difficult for a company to find investors willing to invest against shares with DVRs.
Lack of awareness: Due to lack of investor awareness, investors might not be able to understand the DVR structures or risks associated with it to make an informed investment decision. The same may be true for the founders, as some may consider shares with DVRs as unique instruments.
High Dividend: In lieu of surrendering/ letting-go of voting rights, investors may require the issuer company to pay a higher dividend to them as compared to the dividend paid against usual equity shares. The makes investor’s involvement more “financial” in nature; and less “partnership-based” like the usual private equity/ venture capital investors.
Issuance of shares at discount: Investors may prefer the issuance of shares with DVRs to be issued to them at discount as compared to the usual equity shares since rights attached to such shares may seem to be inferior.
When a private limited company considers issuing shares with DVRs, following may be considered as its priliminary checklist:
1. The articles of association of the company should authorize issue of shares with DVRs;
2. The charter documents of the investor should allows for investing in such instruments;
3. The authorized share capital of the issuer company should be sufficient and adequate for issuing new shares with DVRs;
4. By issuance of shares with DVRs, the voting power in respect of shares with DVRs should not exceed the prescribed cap;
5. The issuer company should have filed its annual accounts and annual returns for the 3 (three) preceding financial years prior to the year in which shares with DVRs are to be issue;
6. The issuer company should not have failed to repay on due dates, deposits or interest on deposits, or failed to redeem its debentures or pay dividend thereon;
7. The company should not have failed in:
(i) payment of the dividend on preference shares; or
(ii) repayment of any term loan from a public financial institution or state level financial institution or scheduled bank or interest payable thereon; or
(iii) payment of any dues/ statutory payments relating to its employees to any authority; or
(iv) crediting the amount in Investor Education and Protection Fund to the Central Government.
8. The company should not have been convicted for any offence under the Securities and Exchange Board of India Act, 1992, Securities Contracts (Regulations) Act, 1956, and the Foreign Exchange Management Act, 1999.
Earlier, there was also a requirement by a company to have a consistent track record of distributable profits for the previous 3 (Three) years, prior to issuance of DVR shares. This has now been removed by way of an amendment.