Markets regulator SEBI on Thursday issued a new framework for certain technology companies to issue differential voting rights (DVR) shares from July 1, making it easier for the promoters of tech start-ups to go in for initial public offerings. It proposed allowing technology companies that issue Differential Voting Rights (DVR) shares to undertake an initial public offering (IPO) of their ordinary shares, subject to several conditions, which are summarised below. DVR shares, as their name suggests, carry disproportionate voting rights as compared to their economic ownership and thus go against the principle of one share, one vote. They can carry superior voting rights (more than one vote per share) or fractional voting rights (less than one vote per share), or simply have differential rights as to the dividend. They are popular with founders and promoters of start-ups as they help them retain control over the company’s decisions while also raising funds from the market. Start-up entrepreneurs, who have been calling for differential voting rights shares for some time to fend off hostile takeovers and pressure from powerful investors, have welcomed the decision.

SEBI’s new framework

Here is a summary of SEBI’s new framework for issuing DVR shares (the full document is at the bottom of this post):

Eligibility conditions: A technology company with superior voting rights shares (SR shares) will be permitted to do an IPO of only ordinary shares if it meets the conditions below. SEBI defines a tech 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”.

  1. The superior rights (SR) shareholder should be a part of a promoter group whose collective net worth does not exceed Rs 500 crore. The investment of SR shareholders in the shares of the issuer company will not be considered while determining the collective net worth.
  2. The SR shares have been issued only to promoters/founders who hold an executive position in the company.
  3. The issue of these SR shares has been authorised by a special resolution at a general meeting of the shareholders.
  4. SR shares have been held for at least 6 months prior to filing the Red Herring Prospectus (RHP).
  5. SR shares have voting rights in the ratio of at least 2:1 and at most 10:1 compared to ordinary shares.

Five-year lock-in period: SR shares will be subject to a five-year lock-in after the IPO, until they are converted into ordinary shares. Transfer, pledging or lien of SR shares among promoters is also not permitted.

Rights of SR shares: SR shares will be treated at par with ordinary shares in every respect, including dividends, except for voting on resolutions. The total voting rights of SR shareholders (including ordinary shares), should not exceed 74%.

Additional rules for companies with SR shareholders: Such companies will also be subject to the following rules for “enhanced corporate governance”: i) Independent directors should comprise at least half of the board and two-thirds of committees (excluding the audit committee); ii) The audit committee should only have Independent Directors.

Coat-tail provisions: Post-IPO, SR shares will be treated as ordinary equity shares in terms of voting rights on all key matters, including the appointment or removal of independent directors and auditors, or voluntarily winding up the company.

Sunset clauses: SR shares can be converted into ordinary shares five years after listing. This period can be extended only once, by another five years, through a resolution, but SR shareholders will not be able to vote on such resolutions. SR shares will be compulsorily converted into ordinary shares in certain circumstances, such as the death or resignation of SR shareholders, or a merger or acquisition following which the SR shareholder no longer holds control, etc.

Fractional rights shares: Existing listed companies cannot issue fractional rights shares. However, this may be reviewed after gaining enough experience in the use of SR shares.