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  • Afrah Abdul

Re-evaluating Dual Class Regulation: Empowering India’s Startups Without Undermining Shareholders

[Afrah is a student at National University of Advanced Legal Studies]


Dual class shares involve public companies issuing two types of common shares under the company law. One class, usually held by founders and insiders, has more voting rights than the other class sold to public investors for financial support. This structure helps companies retain control while obtaining external funding. However, it sparks controversy due to the potential for insider control and negative impacts on corporate governance.


On the other hand, dual class share structures with differentiated voting rights have faced increasing adoption globally, with almost 30% of recent US Tech IPOs leveraging such models allowing the ‘Big 4’ founders such as Mark Zuckerberg to retain decisive control in their companies, despite dispersed ownership. However, Indian regulations traditionally mandate uniform voting rights or "one share one vote” which aims to safeguard minority investors - as emphasized by . Section 106 in the Companies Act 2013.


As India aspires to match the thriving innovation ecosystems of Silicon Valley, calls grow to relax this stringent prohibition on dual class structures balanced by appropriate shareholder safeguards. Evaluating merits of controlled models preserving strategic autonomy for visionary entrepreneurs while preventing excessive entrenchment remains vital as we shape optimal governance for the 21st century Indian economy.


Protecting Minority Investors: Genesis of One Share One Vote in India


The Securities and Exchange Board of India (SEBI) issued a consultation paper on issuance of differential voting rights (DVR) shares that aimed to provide a framework for the voting discourse. However, the SEBI has currently imposed restrictions on issuance of DVR to new tech companies, impacting companies like Tata Motors which previously issued DVR shares. Despite strong investor interest and NIFTY membership, Tata Motors now faces delisting due to revised rules. While regulations aim to protect retailers, they unintentionally penalize credible large companies and risk diluting market depth.


As the Naresh Chandra Committee  observed, dominant Indian promoters routinely act as de facto managers, controllers of the management, supervisor of the management and in several cases even promoters of management.


The Indian corporate experience carries profound scars of minority shareholder exploitation by promoters misusing unrestrained powers. The prevalence of promoter-led family conglomerates like Reliance Industries, Tata Group and Adani Enterprises have long concentrated enormous unchecked decision authority with insider owners. This was evident during feuds within Reliance’s founding Ambani family over succession control. More recently, the acrimonious power struggle at Tata Sons led to Cyrus Mistry’s ouster from the Chairmanship as promoters exercised disproportionate voting rights.


These repeated cautionary episodes showcase unilateral exercise of disproportionate voting rights by promoters facilitating self-interest, managerial entrenchment and oppression of minority shareholders. The SEBI (Listing Obligations and Disclosure Requirements) Regulations 2015 has sought to address such risks by provisions such as Regulation 38 mandating minimum public shareholding and crucially Regulation 41 expressly prohibiting issuance of equity shares with differential rights, enforcing one share one vote uniformity.


Furthermore, leading cases such as Dale and Carrington Investments (Private) Limited v. PK Prathapan reinforced restrictions on disproportionate voting rights citing oppression of minority investors. This showcases how Indian judiciary has strongly upheld shareholder democracy protecting equitable participation.


Yet, 7 decades since independence, India’s startup ecosystem remains dwarfed next to China and USA. As development demands promotion of globally competitive entrepreneurship and reduction of procedural complexities, calls for reviewing stringent prohibition of dual class structures allowing founders to preserve strategic control, now intensify.

 

Rethinking Dual Class Shares for India's Startup Ecosystem


Proponents argue innovative companies benefit immensely from founder-led oversight over long investment timelines, rather than pressures for immediate profitability from dispersed shareholders. These structures supposedly allowed visionaries such as Steve Jobs cement absolute authority at Apple during tumultuous early decades, stabilizing definitive brand identity and product philosophy.


Globally, over 85% of key technology companies including Alphabet, Meta and Snap Inc. have adopted dual class models with sunset provisions allowing superior insider shares convert into ordinary equity. 30% of overall US IPOs from 2017-2019 leveraged such structures to sustain management control navigating market volatilities. In an Indian context, Tata Motors Limited raised growth capital through dual class equity issuances balancing founder voting sway.


Advocates argue greater founder autonomy through dual class structures focused decision-making on ambitious product development and bold investments rather than profit optimization. Furthermore, Chinese experience demonstrates controlled companies historically outpaced market performance. Such correlations with persevering phenomenal innovation, potentially make narrow regulatory stances around uniform voting outdated for startups in this decade.

 

Precedents in India Supporting Context-Based Relaxations


India boasts diverse precedents demonstrating the feasibility of implementing selective exemptions against stringent regulatory provisions in order to uplift sector-specific economic priorities, while also embedding adequate checks and balances to control misuse risks.


For instance, the government recently introduced a Production Linked Incentive Scheme across 14 industrial sectors such as electronics, telecom and white goods to boost domestic manufacturing and exports. The scheme offers calibrated incentives and subsidies linked to incremental sales from India, thus advancing the Make in India agenda. However, structured safeguards are also embedded in terms of approving beneficiaries based on transparent selection criteria, such as mandating investment thresholds (minimum investment amount, investment in targeted sectors/activities, timeline for deployment of funds) and instituting regular performance audits (regular financial and operational audits, achievement of pre-defined milestones) to prevent misuse of fiscal support.


Similarly, while foreign ownership norms traditionally imposed 26% overseas equity limits on the insurance sector, the government relaxed this ceiling to 74% in 2021 in order to attract capital and technical expertise from global insurers to strengthen penetration in an under-served domestic market. Nonetheless, ownership control safeguards for Indian promoters through general and Indian-owned holdings being mandated majority equity holders ensured balance.


Regulatory sandboxes introduced by the Reserve Bank of India also demonstrate the viability of ring-fenced spaces easing stringent compliance requirements for sunrise sectors like fintech startups on experimental basis while still safeguarding consumer interests through appropriate data security norms, exposure thresholds and grievance redressal stipulations.


Carefully managing sectoral development goals and steering clear of broad regulatory loosening, provide a solid basis for considering exemptions. These exemptions can be introduced to support fast-growing sectors like technology entrepreneurship, using tools such as dual share classes. The goal is to prevent unchecked accumulation of power solely within the hands of founders.

 

Weighing Adapted Regulatory Approaches for India

 

Defining acceptable extents of disproportionate control (Sweden, France)


Sweden allows non-voting preferential shares for founders up to permissible thresholds but restricts disparities in voting rights between share classes up to ratio of 1:10. Similarly, France legally enables dual-class shares through "loyalty shares" rules that grant long-term investors double voting rights. Setting acceptable ceilings acknowledging some disproportion may promote innovation but avoiding extremes mitigates economic incentive misalignment risks. Indian regulations can similarly outline graded degrees of flexibility.

 

Growth stage conditional exemptions (Singapore, Hong Kong)


Making rules more flexible can happen in a strategic way. This means allowing certain companies, especially those in technology and backed by venture capital, to have special dual class shares. The SGX dual class share framework, for example, limits these special shares to companies that prove they need them for innovation. It is not a one-size-fits-all approach, and we need extra safeguards for shareholders. The idea is to carefully consider these rules for areas where giving companies more freedom is most important for the economy.

 

Implementing innovation as incentive (Singapore)


In Singapore, there are rules that make special shares turn into regular ones after a certain time when a company goes public. This is done to align with the transition from private to public ownership. However, in India, it might be better to have a longer transition period to support innovative plans. This can be balanced with triggers related to share transfers or ownership changes to ensure a smooth transition.

 

Suggestions


Structure carve-outs for targeted sectors


Given control versus accountability varies across industries, structure exemptions allowing dual class which predominantly focus on environments such as innovation-centric tech startups where decision-making autonomy seems most beneficial should be adequately implemented.


Augmenting shareholder participation rights


To protect investors, we can use stronger oversight measures. This includes sustaining channels for dissenting communication as well as ensuring board representations. We can also improve communication through open meetings and dedicated online platforms, and give important decision-making powers to  minority shareholders.

 

Conclusion


In dynamically evolving startup ecosystems, controlled share structures hold unique promises empowering founders to transform traditional industries unhindered by cautious restraints. As pressures grow globally for controlled structures, balancing both founder discretion and investor protection is crucial. SEBI must reexamine formulating selective carve outs upholding equity on shareholder democracy without undermining innovation engines.

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