Tag Archives: Companies Act 2013

Differential Voting Rights: Helping Tech Companies to an easy climb up the mountain of entrepreneurship

There is a common and a convenient rule of one vote – one share practised by most of the companies. This rule is generally referred to as voting rights on ordinary shares. However, when there is a requirement to deviate from this rule, the concept of differential voting rights comes into play. This differential voting rights are known as DVRs in India and dual-class shares or DCS in the international perspective. These DVRs are rights which are disproportionate to their economic ownership. When a promoter or shareholder wants to retain decision making powers and rights, they can do so by retaining shares with superior voting rights or by issuing of shares with lower or fractional voting rights to other investors.

The concept of DVR has been captured in the Companies Act, 2013 under Section 43 (a)(ii) which says, that a company limited by shares may have equity share capital with differential rights on voting, or dividends, or otherwise. Rule 4 of the Companies (Share Capital and Debentures) Rules, 2014, provides certain conditions which are required to be complied with, for issuance of shares with differential rights. SEBI (Listing Obligations and Disclosure Requirement) Regulations, 2015, (“SEBI (LODR) Regulations, 2015”) also dealt with DVRs, but, it prohibited the listed companies from issuing shares with superior voting rights.

The need for DVR

In the current era, India is going through vast developments and advancement in many sectors especially the technology and information technology sector. These developments and advancements require huge capital. For raising capital, the companies seek investments, but these frequent and vast investments may lead to dilution of founder/ promoter stake. In order to cope with this, issuance of DVRs are helpful.

The journey of the framework

Earlier in 2000, the concept of DVR came to India through the Companies Act, 1956, whereby Indian companies were allowed to issue DVRs. However, in 2009, the Securities and Exchange Board of India (SEBI) had disallowed the issue of shares with superior rights to voting or dividend by listed companies, but they were permitted to issue shares with fractional voting rights. In order to bring the new framework, SEBI had invited comments from public on a Consultation Paper named ‘Issuance of shares with Differential Voting Rights (DVRs)’ (Consultation Paper[1]). It dealt with both the shares with superior rights (Superior Rights Shares or SR Shares) and inferior rights (Fractional Rights Shares or FR Shares). The framework got approved by SEBI in its board meeting on June 27, 2019 , permitting issuance of SR share by listed company and disallowing issuance of FR shares.

A walk through in to the new framework

Eligibility conditions: 

A company to be eligible to issue DVRs in form of SR shares, shall adhere to the following conditions:

  1. The company issuing SR share shall be technology company. SEBI defines a technology company as one that is “intensive in the use of technology, information technology, intellectual property, data analytics, bio-technology or nano-technology to provide products, services or business platforms with substantial value addition”.
  2. The SR shareholder should be a part of a promoter group and whose collective net worth does not exceed INR 500 crore. The investment made by SR shareholders in the shares of the issuer company will not be considered while determining the collective net worth.
  3. The SR shall be issued only to promoters/founders who hold an executive position in the company.
  4. The issuance of the SR shares should be authorized by passing a special resolution in the general meeting.
  5. SR shares have been held for at least 6 months prior to filing the Red Herring Prospectus (RHP).
  6. SR shares should have voting rights in the ratio of minimum 2:1 and maximum 10:1 compared to ordinary shares.

Listing and lock-in period: Post the IPO, the issuer company can list the SR shares on Stock Exchanges. However, SR shares are subject to lock-in after the IPO, until they are converted into ordinary shares. Transferring, pledging or lien of SR shares among promoters is prohibited under the framework.

Rights of SR shares: Except for voting on resolutions, the SR shares will be treated at par with ordinary shares in all other aspects. The total voting rights of SR shareholders (including ordinary shares), post listing should not exceed 74%.

Additional rules for companies with SR shareholders pertaining to enhanced corporate governance: The listed  companies issuing SR shares shall comply with the following rules for “enhanced corporate governance” such as:

  1. i) As prescribed under the SEBI (LODR) Regulations, 2015, Independent directors should comprise at least 1/2 of the board and 2/3 of committees (excluding the audit committee) and
  2. ii) The audit committee should only have Independent Directors.

Coat-tail provisions: After the IPO, the SR shares will be given same treatments as ordinary equity shares in terms of voting rights with respect to the following matters:

  1. Appointment or removal of Independent Directors and/or Auditors
  2. Cases where promoter is willingly transferring control to another entity
  3. Related Party Transactions involving SR Shareholder as per SEBI (LODR) Regulations, 2015
  4. Voluntary winding up of the Company
  5. Alteration of the Articles of Association or Memorandum of Association, except any such changes affecting the SR shares
  6. Voluntary Resolution Plan initiated under Insolvency & Bankruptcy Code, 2016
  7. Funds utilized for purposes other than business
  8. Substantial value transaction based on materiality threshold as prescribed under SEBI (LODR) Regulations, 2015
  9. Passing of special resolution for buy-back or delisting of shares
  10. Any other provisions as notified by SEBI from time to time

Sunset clauses: SR shares can be converted under two circumstances:

  1. Time based: After 5 years of listing, the SR Shares shall be converted to Ordinary Shares. By passing a resolution, the validity can be extended only once by 5 years. However, the SR shareholders shall not be allowed to vote on such resolution.
  2. Event based: In the event of demise, resignation of SR shareholders, merger or acquisition where the control would be no longer with SR shareholder, etc., the SR shares shall be compulsorily get converted into Ordinary Shares.

Changes to be incorporated in various laws pursuant to DVR framework:

The Companies Act, 2013: As stated earlier, under Section 43(a)(ii) of the Companies Act, 2013, and Rule 4 of the Companies (Share Capital & Debentures) Rules, 2014 framed under the Companies Act, 2013 prescribes that shares with DVRs in a company, shall not exceed 26% of the total post-issue capital. However, the new framework extends the limit to 74%. Therefore, corresponding changes are required to be brought in the Companies Act, 2013.  Another limiting factor in the Companies Act, 2013 is that “the company must have a consistent track record of distributable profits for the last 3 years”, but criteria for 3 years is silent on IPOs.  Such a criteria may not be helpful and rather impossible for all start-ups. Therefore, this matter should also be taken into consideration.

Securities Contracts (Regulation) Rules, 1957 (‘SCRR’): A company with multiple classes of equity shares at the time of undertaking an IPO, is required to make an offer of each such class of equity shares to the public in an IPO. Further, Rule 19(2)(b) of SCRR provides that minimum dilution and minimum subscription requirements as prescribed have to be complied with, separately for each class of the equity shares. It is a mandatory requirement under the rule that all kinds of shares shall be listed. There is no provision for listing one kind of share and not listing another. As the new framework demands for listing of SR shares without offering to public, it leads to a doubt for a company with different classes of shares whether it should proceed with listing all kinds of share or keep few of such equity shares unlisted. Therefore, a clarification is required in this regard.

SEBI (LODR) Regulations, 2015: Under regulation 41(3) of SEBI (LODR) Regulations, 2015, it has been stated that listed entity shall not issue shares which may confer to a person SR right on equity shares which are already listed. Therefore, an amendment is required which permits the grant of SR shares to equity shareholders.

SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (“SEBI Takeover Code”): Regulation 3 and 4 of SEBI Takeover Code provides that when an acquirer is holding 25% or more of the shares or voting rights in a target company, it has an obligation to make a public announcement of an open offer. Based on the stated Regulation of SEBI Takeover Code and the new DVRs framework, Regulation 10 is required to be amended in such a manner that Regulation 3 would not get triggered for making an open offer if the stated threshold is crossed by reason of SR shares getting lapse or converted into ordinary equity shares, provided that there is no attendant change in control in favor of the person crossing such threshold.

Further, Regulation 29 of SEBI Takeover Code requires disclosure for acquisition of additional voting right by holder of ordinary equity share. Since the change in voting rights brought after the conversation of SR shares to ordinary shares, which is an involuntary act on behalf of holder of ordinary equity share, there is a requirement of bringing change in format of disclosure under Regulation 30 of SEBI Takeover Code.

The pros and cons of DVRs:

Advantages from the perspective of issuer:

  • It solves the biggest issue of raising fund without diluting the voting right or the control of the founders/promoters over the company.
  • when there is ordinary equity shares issued to outside investors, there is a possibility that such shareholders acquire majority of the shares of the company and gain control over the management of the company, where as in the case of SR shares, this possibility is minimised.

Disadvantages from the perspective of issuer:

  • It is a challenge for the issuer to find such investors who are not interested in control and management of the company even after investing huge amount of money.
  • Issuing of SR shares is not considered a good corporate governance.

Advantages from the perspective of investor:

  • It is beneficial for those investors who are getting a higher rate of dividend over the ordinary shareholders.
  • The DVRs with FR shares are generally offered at a discount for equal number of shares.

Disadvantages from the perspective of investor:

  • DVRs with SR shares with the founders or large proportion of DVRs with FR shares with public investors, make management excessively powerful and can raise issues of corporate governance.
  • As a result of separating voting right from economic interests, there might be possibilities externalities like management entrenchment, excessive compensation of management, reduced dividend pay-out etc.

Conclusion

When we know that India is still considered to be a developing country and it has a lot of              competition with various other developed and developing states. India should have such corporate and commercial laws which are at par with the corporate and commercial laws of other countries. While India is giving majority of its space for incorporation and functioning of technology companies, it should have DVRs related laws like in US, Canada, Hong Kong etc. Such laws will help in raising the capital of tech companies. The applicability of DVRs law in India will not just help in growth and development of the tech companies in India, but it will also lead Indian tech companies to be good competitors for the tech companies incorporated in other nations.  It would help the promoters/founders of the company to grow their business fast. The only thing to be kept in mind by the companies while adopting such laws  is that, they shall also maintain a good corporate governance in their company.

Authors: Srisha Choudhary and Alivia Das

References:

[1] https://www.sebi.gov.in/web/?file=https://www.sebi.gov.in/sebi_data/attachdocs/apr-2019/1554115093453.pdf#page=1&zoom=auto,-16,800

New BEN-2 Form for declaration of Beneficial Owners

Ministry of Corporate Affairs (“MCA”) vide Notification dated July 1, 2019, amended the Companies (Significant Beneficial Owners) Rules, 2018 by substitution of the existing Form BEN-2 for declaration of Beneficial Owners through the Companies (Significant Beneficial Owners) Second Amendment Rules, 2019.

The Companies (Significant Beneficial Owners) Rules, 2018 was framed under Section 90 of the Companies Act, 2013 to identify the owners of a company incorporated by way of multilayered intermediate entities.  Such owners hold shares of a company but will not have any beneficial interest in such shares. These owners having an interest in indirect holding of shares, but their names are not entered in the register of members, are termed as ‘Beneficial Owner’. While such beneficial owner is required to file a declaration in Form BEN-1, the company is required to file a return in Form BEN-2.  These rules were earlier amended on February 8, 2019, whereby the definition of a significant beneficial owner was amended, to one who had a right of at least 10% of shares/voting right or has the right to receive 10% or more of distributable dividend. Form BEN-2 is to be filed within 30 days from the date of receipt of declaration in Form BEN-1. No additional fees is payable if Form BEN-2 is filed within 30 days from the date of deployment on MCA-21.

Source: http://egazette.nic.in/WriteReadData/2019/206373.pdf

Advisors in Start-ups and Early Stage Companies

India is witnessing a high growth in the number of start-ups in the country and is also amongst the top start-up ecosystems in the world. The government has provided a few benefits to startups as well, through the Startup India Action Plan.

However, only a few of these start-ups actually succeed. It is a treacherous path with a lot of unknowns. An advisor or an advisory board in a start-up might help the early stage companies to atleast know some of those unknowns. Financial investors certainly add value, sometimes domain expertise even. The comfort of speaking with an advisor where they bring in the expert views, advice and sheer experience onto the table is very valuable. As the saying goes, ‘Experience is the best teacher’.

Who are these Advisors and what role do they play?

An advisor is a person who brings in his unique skill sets and expert opinion on the business of the company, operational or otherwise. They are the people ‘who have been there and done that’. They can play a major role, especially if the founders and the team are new to the industry and do not have much experience. There are celebrity advisors even, who by being called as an advisor adds value to the startup.

Advisors can play different roles, for example, advisors who bring in their expertise in a particular domain or area; help with their networks and can introduce potential clients, employees or investors; or scaling up teams; expansion to new geo. It is not just having the advisors but also heeding to their advice. Therefore, advisors need to be chosen very wisely, so that their advice can be relied and executed upon.

How to choose the right Advisor?

Hiring an advisor who does not add much value or provides incorrect advice to the company may turn out to be counter-productive or disastrous. The advisors bringing in complementary skills or “deeper” skills which the founding team has a gap would be great. Identify the areas where the founders lack expertise or sufficient industry knowledge, where they face difficulties or have faced difficulties in the past or any area where they would require expert advice. Once there is clarity on where and why advisors are required, do some research and talk to people who can introduce you to some advisors. Discussing the same with the existing investors (if any) might also be a good idea as they might be able to connect the founders with the relevant people. And since the investors have invested in the company, they would ensure that the advisor will be someone who can add value to the company.

Ensure that they are people with the relevant expertise and knowledge, proven track record, good communication skills, networking skills, etc. Advisors should be individuals who would invest their time for the growth of the company and who can provide support to the founders where there is lack of expertise or knowledge.

Engaging with the advisor

An advisor may be compensated in cash, equity etc. Many a time, the advisor is interested in just giving back to the eco-system. One should evaluate if the advisor has time to provide support to the startup, whether the advisor is associated with other companies which the startup may have conflict / competition.  Maintaining a good rapport, having regular discussions and candid conversations, updating the advisor on a regular basis about the business and other relevant aspects of the business can go a long way. The most important factor is to ensure that there is trust between the parties.

Some startups look for a small investment by the advisors into the company, as a test to ensure that the advisor believes in the idea, startup, founders etc.

Compensation for Advisors

Let us now evaluate some of the ways to compensate advisors for the value-add they bring to the company.

Start-ups, more often than not, compensate advisors by giving a percentage of equity in the company since they may not have the finances to give cash compensation (unless well-funded). New shares can be issued to the advisors or shares can be transferred from the founders. Such issuance or transfer should ideally happen at the face value of the shares since it is a compensation for the services rendered by the advisors and the advisors would not want to pay the full price of the shares. As the same is being issued/transferred at face value instead of the fair market value, tax implications need to be evaluated since any issuance/transfer of shares below the fair market value will fall under the ambit of the Income Tax Act, 1961. Also, the percentage holding of the founders needs to be taken into account so that their shareholding percentage does not get diluted to a large extent considering that there will be future investments, where the shareholding will get diluted further. Another aspect to be considered is that, an issuance of shares will dilute the shareholding of all shareholders (including investors if any) whereas the transfer of shares from founders will dilute only the founders’ shareholding.

Another way of compensating the advisors is by issuing shares to them by way of consideration other than cash under section 62 (1) (c) of the Companies Act, 2013 (“Act”) read with rule 13 of Companies (Shares Capital and Debenture) Rules, 2014. The private placement process under section 42 of the Act will have to be followed for this purpose. The advisors have to raise invoice for the services rendered which will be commensurate with the fair market value of the advisory shares. Company will be responsible for TDS which will be a cash out on the Company. Further, the entire amount shall be taxed in the hands of the Investor as income from other sources, at the applicable tax slab.

Yet another option could be granting phantom stock options (“PSOs”) to the advisors. These are options which are settled by way of cash settlement. It a performance-based incentive plan through which the advisors will be entitled to receive cash payments after a specific period of time or upon reaching a specific target. A separate agreement can be entered into for capturing the details. This is directly linked to the value of the company’s share price. For example, the advisors could have promise of ‘x’ number of shares at ‘y’ price at grant. At exercise, the appreciation in the value of the share price, is handed out as cash incentive. Tax will be applicable at the time of payout. However, unlike employee stock options, which is recognized under the Act, PSOs by private limited companies does not fall under the ambit of the Act and therefore, will be in the nature of contractual right. Please see our previous post on  Phantom Stock Options to know more about this.

It has to be noted that advisors are not eligible for employee stock options (ESOPs) as ESOPs can be given only to employees and directors subject to the restrictions under the Act and relevant Rules.

Advisory shares to Non-Residents:

It becomes a little more complex when the advisor is a non-resident since the shares issued/transferred to a non-resident needs to be in compliance with the pricing guidelines as provided in Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2017 (“FDI Regulations“). As per the pricing guidelines, capital instruments which are issued or transferred to a non-resident has to be priced as per any internationally accepted pricing methodology for valuation on an arm’s length basis duly certified by a chartered accountant or a SEBI registered merchant banker, in case of an unlisted company. Considering these rules, granting of advisory shares to a non-resident can be a very tricky situation. PSOs may be a better option in this case.

Formal Agreement with Advisors

The engagement with the advisors should be fruitful for the company and help in its growth. It is advisable to enter into a formal agreement with the advisors which captures all important terms regarding the engagement which will be beneficial for both the company and the advisors. This will help in keeping track of the contribution of the advisors and also if in future, any differences arise between the company/founders and the advisors, it will always help to have a formal agreement. The exact role of the advisor and deliverables, vesting schedule, time commitments, compensation, non-compete, confidentiality, exit related provisions, etc. should be captured in such agreements. Specific milestones may also be included in these agreements. Once the milestones are satisfactorily completed, compensation as agreed can be given.

Once the advisors become shareholders in the company, depending on the shareholders’ agreement (if any), the advisor might need to enter into a deed of adherence, so that the rights of the shares are captured.

Author: Paul Albert

 

Simplified process of Incorporation & Commercial registrations

Introduction

The Ministry of Corporate Affairs (MCA) had notified the Companies (Incorporation) Third Amendment Rules, 2019[1] on 29 March 2019 which introduced the e-form INC-35 [Application for Goods and services tax Identification number, employees state Insurance corporation registration pLus Employees provident fund organisation registration (AGILE)]. The said AGILE form aims at bringing a single window where applicants can make applications under the Goods and Services Tax (GST), Employees Provident Fund Organization (EPFO) and Employees State Insurance Corporation (ESIC).

At present, the application for incorporation of a Company is made in e-form INC-32 (SPICe) along with e-Memorandum of Association (e-MOA) in Form No. INC-33 and e-Articles of association (e-AOA) in Form no. INC-34. Through e-form INC-32, the applicants can apply for PAN and TAN and now with the deployment of e-form INC-35, applications can be made for GST, EPFO and ESIC while incorporation of the Company.

This is a welcoming change brought about by the MCA wherein the incorporation process has been made hassle-free and the applicants can apply for various registrations while incorporating the Company. Previously, even after obtaining the certificate of incorporation Companies had to apply for registrations under the GST, EPFO and ESIC and subsequent approval. This proved to be a setback for companies and they couldn’t actually commence operation. However, with the introduction of the AGILE form the Ease of doing Business in India initiative has now been further enhanced.

How does this work?

For incorporation of the Company, applicants have to upload the requisite incorporation related linked e-forms i.e., INC-32, INC-33, INC-34 and INC-35. Thereafter, on approval of the same by the MCA, the Certificate of Incorporation, PAN and TAN is issued. Subsequently, the requisite information for GST, EPFO and ESIC (whichever service is availed) that has been filed in e-form INC-35 is forwarded to the concerned departments for its approval.

Thus, there are no repetitive submissions of incorporation related documents for obtaining registrations under GST, EPFO and ESIC.

Practical issues faced

Though this new amendment has made the incorporation process stress-free, applicants still face practical issues in this respect. Some of the issues are as follows:

  1. Companies have to provide a registered office address compulsorily for the AGILE form: While incorporating a company, applicants have an option to provide a correspondence address instead of a registered office address. However, they do have to obtain a registered office address within 30 days from the date of incorporation of the Company. This helps applicants a sufficient time to set up a registered office in case they do not have one at the time of incorporation. However, for the purpose of filing the AGILE form it is mandatory to have a registered office address as the form will only accept the address provided in the SPICe i.e., INC-32, or the correspondence address has to be the same as the address of the registered office.
  2. Principal place of business should be the same as the Registered Office of the proposed Company: Applicants willing to apply for GSTIN/Establishment code as issued by EPFO/Employer Code as issued by ESIC at the time of incorporating company, have to make sure that the principal place of business is the same as the Registered Office Address of the proposed Company. Thus, Companies intending to have the principal place of business different from the Registered Office address cannot avail this facility. They have to follow the existing registration procedure under the GST, EPFO and ESIC.
  3. Mandatory filing of AGILE form: Applying for GSTIN/ Establishment code as issued by EPFO/Employer Code as issued by ESIC at the time of incorporating company is optional. However, applicants have to still file the e-form as it is a linked e-form which accompanies the SPICe form for incorporation. This can prove to be an unnecessary compliance requirement for applicants who do not want to apply for GST, EPFO and ESIC registrations at the time of incorporation. 
  4. Resubmission of GST Application through the GST portal: In case of any error in the GST Application and the same has been sent for resubmission, applicants have to resubmit the application through the GST portal only. Further, if the TRN expires, a fresh application for GST shall have to be made through the GST portal too.

Conclusion

The introduction of this form surely proves to be beneficial for stakeholders however it still does not cover all the general registration requirements for a newly incorporated company such as Professional Tax, Trade License, Shop and Establishments, etc. Additionally, the MCA also has to look into the practical issue that are being faced and incorporate the changes to provide a seamless service.

Authors: Alivia Das and Ashwin Bhat

Reference:

[1] http://www.mca.gov.in/Ministry/pdf/companiesINC3rdAmendmentRules_30032019.pdf

Changes in Eligibility Criteria for Class Action Application

The Ministry of Corporate Affairs (“MCA”) on 08 May 2019 amended the National Company law Tribunal Rules, 2016, (“Rules”) which will streamline the provisions of Rule 84 of the said Rules (i.e. Right to apply under the Companies Act in case of Oppression and Mismanagement) and Section 245 (Class Action) of the Companies Act, 2013 (the Act).

While reading Section 245(1) of the Act together with the amended Rules it can be derived that following classes of members or depositors can Class Action under Section 245 of the Act before the National Company law Tribunal for seeking its order:

Category Criteria
In case of a company having a share capital The application shall be made by at least:

(a) 5% of total members or 100 members, whichever is less; or

(b) In case of an unlisted company, members holding at least 5% of issued share capital; or

(c) In case of a listed company, members holding at least 2% of issued share capital.

In the case of a company not having a share capital The application shall be made by atleast one-fifth of the total number of its members.
In case applicants are Depositors The application shall be made by at least:

 

(a) 5% of the total number of depositors or 100 depositors, whichever is less; or

(b) Depositors to whom the company owes 5% of total deposits of the company.

 

Source: http://www.mca.gov.in/Ministry/pdf/AmendmentRules1_08052019.pdf

Notification of Companies (Acceptance of Deposits) Second Amendment Rules, 2019

The Ministry of Corporate Affairs (the MCA) vide its Notification dated 30 April 2019, has amended the Companies (Acceptance of Deposits) Rules, 2014. This amendment is in relation to its earlier notification dated 22 January 2019 which mandated the non-government companies to file Form DPT 3 providing particulars of transactions that have not been considered as deposit under the Companies Act 2013 or both as on 22 January 2019. With this amendment, the MCA has amended to mandate the Companies to provide aforesaid information as on 31 March 2019. Further, it has extended the due date for filing Form DPT 3 from 22 April 2019 to 30 June 2019.

Source: http://www.mca.gov.in/Ministry/pdf/CompaniesAcceptanceDepositsSecAmendRules_01052019.pdf

Extension of due date for filing ACTIVE form

On 21 February 2019, the Ministry of Corporate Affairs (the MCA) had mandated all companies incorporated prior to 31 December 2017, to file Active Company Tagging Identities and Verification (Form INC 22A Active) on or before 25 April 2019. However, after considering the representation received various stakeholders, the MCA vide its Notification dated 25 April 2019, has extended the due date for filing the Form INC 22A Active till 15 June 2019.

Source:http://www.mca.gov.in/Ministry/pdf/CompaniesIncorporationFourthAmendmentRules_25042019.pdf