Differential Voting Rights For Startups

The shares with Differential Voting Rights (DVRs) in a company means those shares that give the holder of the shares the differential rights related to voting, i.e. either more voting rights or less voting rights compared to the ordinary shareholders of the company. 

The equity share capital of a company contains the class of equity shares with differential rights relating to the voting power and dividend. There are two types of DVRs, i.e. shares with superior voting rights and shares with inferior voting rights. 

Generally, the equity shares with less voting rights carry a higher dividend rate, whereas the equity shares with higher voting shares carry a  lesser dividend rate. The equity shares with higher voting rights are issued to promoters, managing directors, key managerial persons, etc.

Differential Voting Rights Under Companies Act, 2013

The companies can issue equity shares with differential rights under Section 43(2) of the Companies Act, 2013 read with the Companies (Share Capital and Debentures) Rules, 2014, subject to the following conditions-

• The Articles of Association (AOA) of a company should provide for the issue of equity shares with differential voting rights.
• The company must obtain approval from the shareholders by passing an ordinary resolution in the general meeting.
• There should be no default by the company in filing its financial statements or annual returns for the last three financial years preceding the financial year of the issue of the DVRs.
• The company should not have defaulted in repayment of declared dividends or matured deposits to the shareholders. 
• In case the company is listed, the issue of differential shares should be approved by postal ballot.
• There should be no default by the company to repay the instalment of term loan taken from any state-level or public financial institution or scheduled bank. 
• There should be no default by the company in the redemption of its debentures or preference shares which are due for redemption and payment of any statutory dues of its employees.  

Differential Voting Rights For Startups

The promoters or the founders of a startup often lose control of the company when they dilute their stakes for raising multiple rounds of funding. This problem can be resolved by issuing the shares with DVRs.  They enable the promoters for retaining control over the company.

The DVRs equity shares allow superior or lower or fractional voting rights to public investors, enabling promoters to retain control of the company even when new investors come by. They are like ordinary equity shares, but it does not follow the common rule of one share-one vote.

The Companies (Share Capital and Debentures) Rules, 2014 was amended. The amendment provided that the condition for the issue of shares with differential voting rights should not exceed 74%, including equity shares with differential rights at any point in time. Earlier to the amendment, the rules provided that the condition for the issue of shares with differential voting rights should not exceed 26%. 

Now, the companies can have up to 74% of differential voting right equity shares in the total post issue paid-up share capital. This amendment which increased the limit for the issue of shares with differential voting rights up to 74% is beneficial to the startups. 

The amendment removed the condition that the company should earn distributable profits in the last three years to issue DVRs. However, the shares with superior voting rights must be held for a period of at least six months preceding the filing of the red herring prospectus.

The issue of DVRs will help the Indian companies and the promoters of startups that are identified by investors globally. These global investors can acquire controlling stakes in Indian companies/startups through DVRs. By issuing DVRs, the startups and Indian companies attract global investors and gain access to cutting-edge technology development and innovation undertaken by them. 

The DVRs will enable the promoters of Indian companies to retain control while raising equity capital from global investors and create a long-term value for shareholders and the company’s growth.

Points To Be Kept In Mind For Issuing Differential Voting Rights

The DVRs should be issued according to the conditions mentioned in the Companies Act, 2013 read with the Companies (Share Capital and Debentures) Rules, 2014 (As mentioned above in this article). Along with these conditions, the startups need to keep in mind the following points while issuing DVRs-

• If the AOA of the company/startup does not provide for the issue of the DVRs, then it must be amended and the AOA should include the authorisation of the issue of DVRs before issuing it.
• The company/startup should pass an Ordinary Resolution for the issuance of DVRs in the General Meeting of the shareholders.
• The voting power of DVRs equity shares should not exceed 74% of the total voting powers.
• There should be no default in filing the annual returns by the startups for the past three financial years.
• There should be no default in the repayment of loan borrowed or deposits or payment of declared dividend by the startups.
• There should be no penalty on the startups by any court or tribunal for any offence for the past three financial years.
• Once the shares with DVRs are issued, it cannot be changed later.

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