Tag Archives: listing criteria

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

BSE Startup Platform and Revised Listing norms at National Stock Exchange

Many initiatives have been undertaken in the recent years for facilitating direct listing and consequent public trading of startup securities in India. In January 2010, Prime Minister’s Task Force recommended to set up a dedicated stock exchange for small and medium enterprises[2], which eventually led to the genesis of the SME Exchanges, NSE EMERGE and BSE SME platform. In our earlier Handbook on Initial Public Offering: SMEs, we have provided an overview of various SME platforms, benefits of SME listing and SME IPOs, list of documentation and comparatives of fees.

The rationale behind boosting SME listing could be manifold, from the perspective of all stakeholders in the ecosystem, i.e. the investors, growth stage companies, and the exchanges. The biggest impetus would be the greater access to sophisticated investors and wider portfolio base and investment opportunities for investors of both ‘Main Board’ and SME Exchange Platforms. This is also attractive from the perspective of providing exit opportunities to eligible existing investor base. As mentioned by the Managing Director of NSE, Mr. Vikram Limaye, “… a lot of money has been invested in start-ups and some investors in these companies may want to exit in the next 12-14 months…it is only appropriate for them to list in India and give an opportunity for the domestic investors to participate in their growth,”[3]

However, for various reasons, the SME platforms have not taken off or seen the traction that was envisaged during their formation. The eligibility criteria of companies with less than INR 25 crore in equity capital and those which have raised less than USD 4 million in external funding have been often cited to be the most crucial one of them. Many of the Startups[4] would have already raised large amounts of external funding from the now extensive venture capital and private equity fund base. Minimum promoter holding requirement is another set back as more often than not, a post Series B or Series C entity would have a diversified capital table where the initial subscribers’ holding could be much lesser than the required norms, with investors collectively or individually holding largest single block stakes in these companies. However, these companies might still not be matured enough to have met the eligibility criteria of the traditional IPO routes for accessing capital markets.

It is in this background that discussions around revising the listing criteria for Startups started at various levels. On 27 November and 28 November 2018, BSE and NSE, respectively, released the revised norms. We have provided the details of these below.

BSE Notice No. 20181127-23 dated 27 November 2018 on Introduction of BSE “StartUp Segment”.

The applicability seems to be for “Start-up Companies” in the identified sectors of “IT, ITES, Bio-technology and Life Science, 3D Printing, Space technology, E-Commerce, Hi- Tech Defense, Drones, Nano Technologies, Artificial Intelligence, Big data, Enhance/Virtual Reality, E-gaming, Exoskeleton, Robotics, Holographic Technology, Genetic Engineering, Variable Computers Inside body computer technology and other Hi-tech based companies”.

The criteria as notified by BSE are as follows:

  • Company should be registered as start-up with Ministry of Small and Medium Enterprises / Department of Industrial Policy and Promotion (MSME/DIPP). If not registered as Start-up with MSME/DIPP then the company’s paid-up capital should be minimum Rs. 1 crore.
  • Company should be in existence for a minimum period of 2 years on the date of filing the draft prospectus.
  • Preferably there should be an investment for a minimum of 2 years (at the time of filing draft prospectus) in the Company by:
    • Qualified Institutional Buyer or QIB[5]; or
    • Angel Investors/ Accredited Investors[6]
  • Company should have a positive net-worth.
  • Company should not have been referred to National Company Law Tribunal (NCLT) under Insolvency and Bankruptcy Code, 2016.
  • No winding-up petition must have been accepted against the Company by the NCLT.
  • None of the promoters/directors of the Company must have been debarred by any regulatory agency/agencies.

However, in addition to the above, compliance with LODR requirements and Chapter IX of the Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2018 [SEBI (ICDR) Regulation] is also mandated, with respect to conditions applicable for listing of SME Companies, viz. minimum application size, number of allottees etc.

NSE Circular No. 2/2018 dated 28 November 2018 on Listing Criteria for the Technology Startups on the SME Platform.

As mentioned in the Circular, “In order to facilitate technology startups with potential growth business model, to raise equity and list on Stock Exchange, NSE has formulated a criteria for listing such technology startups. These listed companies shall be operating within the regulatory framework as specified under Chapter IX of SEBI ICDR Regulations, 2018 and LODR requirements as applicable to SME Exchange.”

The major criteria as listed in the Circular are as follows:

  • As conditions precedent adherence must have been made to the provisions of Securities Contract (Regulation) Act, 1956; Companies Act, 2013; SEBI Act, 1992 and regulations prescribed therein.
  • Company must be incorporated in India under the Companies Act.
  • The post issue paid up capital of the company (at face value) shall not be more than Rs. 25 crores.
  • There must be a 3 years of track record of either:
    • applicant seeking listing; or
    • promoters/promoting company, incorporated in or outside India with at least 3 years of experience in the same line of business and shall be holding at least 20% of the post issue equity share capital individually or severally; or
    • Proprietary / Partnership firm and subsequently converted into a Company
  • Annual revenue of at least Rs. 10 crores and the issuer must have shown growth of at least 20% in the past one year. (Annual growth may be exhibited in the form of number of users/revenue growth/customer base)
  • Net-worth of issuer must be positive.
  • Must meet one of the following criteria:
    • At least 10% of pre-issue capital to be held by QIBs as on the date of filing of draft offer document; or
    • At least 10% of its pre-issue capital should be held by a member of the angel investor network[7] or private equity firms and such angel investor network or Private Equity Firm should have had an investment in the start-up ecosystem in 25 or more start-ups their aggregate investment is more than 50 crores as on the date of filing of draft offer document.

The criteria of minimum QIB, angel network or private equity holding is interesting as this now could give a clear pathway to the Startups from very early stages on who to raise funds from. A diligence on the investors would also become necessary in such scenarios.

  • The Company must not have been referred to the erstwhile Board for Industrial and Financial Reconstruction (BIFR).
  • No petition for winding up must have been admitted by a court against the Company.
  • No material regulatory or disciplinary action by a stock exchange or regulatory authority in the past three years must have been brought against the Company.
  • Further the following disclosures will be required to be made:
    • Any material regulatory or disciplinary action by a stock exchange or regulatory authority in the past one year in respect of promoters/promoting company(ies), group companies, companies promoted by the promoters/promoting company(ies) of the applicant company.
    • Defaults in respect of payment of interest and/or principal to the debenture/bond/fixed deposit holders, banks, financial institutions by the applicant, promoters/promoting company(ies), group companies, companies promoted by the promoters/promoting company(ies) during the past three years. In this regard, an auditor’s certificate shall also have to be provided.
    • Litigation record, the nature of litigation, and status of litigation pending against the applicant company, promoters/promoting company(ies), group companies, or companies promoted by the promoters/promoting company(ies).
    • Status of criminal cases filed or nature of the investigation being undertaken with regard to alleged commission of any offence by any of the Company’s directors and its effect on the business of the company, where all or any of the directors of issuer have or has been charge-sheeted with serious crimes like murder, rape, forgery, economic offences etc.

As may be noted, both the BSE and NSE Notice and Circular refer to the applicability of the SEBI (ICDR) Regulations.

Under Chapter IX of the SEBI (ICDR) Regulations, 2018 certain common criteria, irrespective of the SME Exchange sought to be listed in must be met. These are:

  • the amount for general corporate purposes, as mentioned in objects of the issue in the draft offer document and the offer document should not exceed 25% of the amount being raised in the issue;
  • promoters must hold at least 20% of the post-issue capital of the Company. However, if the post-issue shareholding of promoter is less than 20% then alternative investment funds, foreign venture capital investors, banks, or public financial institutions may contribute to meet the shortfall in the minimum contribution. In any case, the promoter cannot hold less than 10% of the post-issue capital;

This brings back the concerns related to minimum promoter holding as discussed above.

  • the minimum promoters’ contribution as mentioned above shall be locked-in for 3 years; any promoter shareholding in excess of the above shall be locked in for 1 year;

This could be a major concern for QIBs given their internal constraints, for instance, fund exit requirements.

  • apart from promoters’ pre-issue capital, the entire pre-issue capital held by persons other than promoters shall be locked in for 1 year, however this lock in period will not apply to share allotted to employees, shares held in an ESOP trust, and equity shares held by a venture capital fund or alternative investment fund (categories I and II) or foreign venture capital investor, provided that such equity shares must be locked in for a period of at least 1 year from the date of purchase by such investor.
  • entering into an agreement with a depository for dematerialisation of its specifies securities already issued and proposed to be issued;
  • all existing equity share capital must be fully paid up or forfeited;
  • all securities held be promoters must be in dematerialised form;

SEBI’s intent to relax listing norms for Startups seems to be in the pipeline[8] and it remains to be seen whether the realities of the Startup ecosystem are considered and reflected in the revised norms.

Authors: Ms. Sohini Mandal and Mr. Avaneesh Satyang

[1]BSE Circular dated November 27, 2018: Available at https://www.bseindia.com/markets/MarketInfo/DispNewNoticesCirculars.aspx?page=20181127-23

NSE Circular dated November 28, 2018: Available at http://nseindia.com/content/circulars/SME39509.zip

[2] As defined and categorized under the Micro, Small & Medium Enterprises Development (MSMED) Act, 2006

[3] Yuvraj Malik, “NSE in talks with Sebi to tweak start-up listing norms”, as reported in https://www.livemint.com/Companies/giHdsfq86vtiPzngwlQSqL/NSE-in-talks-with-Sebi-to-tweak-startup-listing-norms.html on 2 March 2018

[4] As registered with DIPP under the Startup India Action Plan

[5] As defined in Regulation 2(ss) of the Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2018: includes venture capital fund, alternative investment fund, scheduled commercial bank, foreign portfolio investor, et al.

[6] The concept of accredited investor is found in US securities law, which is similar to angel investors in India, only persons meeting the minimum net-worth criteria, professional experience and expertise requirements are recognised as accredited investors.

[7] By angel investor networks, the notice makes reference to angel funds, which are a sub-category of category-I alternative investment funds registered with SEBI, and angel investors are persons who propose to invest in angel funds and meet the net-worth, expertise, and experience criteria as specified under the SEBI (AIF) Regulations, 2012.

[8] PTI News, “SEBI To Relax Listing Norms For Startups, Rename it ‘Innovators Growth Platform’”, as reported in https://www.bloombergquint.com/markets/sebi-to-relax-listing-norms-for-start-ups-rename-it-innovators-growth-platform#gs.U99GjHQ on 9 December 2018