Maintaining control while embracing investments — How DVRs can help

SEBI is considering allowing Differential Voting Rights. Here’s why it's good news

One share — one vote. That’s the way it has always been in the Indian market (or at least for the most part). But things may change soon as the SEBI put out a consultation paper on “Differential Voting Rights”. Ever wondered what differential shares entail?

As one would have guessed, differential shares give you higher or lower rights, be it in terms of voting or dividend. This means that “the share has rights disproportionate to their economic ownership”.

But how would one benefit from owning these differential voting right (DVR) shares (as they call it in India) or Dual Class Shares (DCS) as known in international markets?

Maintaining control

A company would be interested in issuing DVR with superior voting rights if it aims to retain control and raise equity from the open market, so basically expansion without giving away the controlling stake.

Companies in India who function on asset-light models without much debt financing would be willing to issue DVR shares in order to retain the promoter’s interest. They can also act as a defense mechanism in hostile takeover situations (take the case of L&T-Mindtree?).

If we take the case of international markets, we see that giants like Berkshire Hathaway have issued class A and class B shares, wherein the class A shares are exorbitantly priced and entail higher voting rights (mainly reserved for insiders) while class B shares are affordable for the long-term investors who look for dividend growth and capital appreciation.

They are also widely used in the tech scene; Alphabet (Google), Facebook, Alibaba, and Snapchat have all issued shares with different voting powers.

In India, DVR shares with superior voting rights were present up until 2009. After 2009, SEBI changed its guidelines and stopped the issuance of DVR with superior voting rights, while continuing the issue of shares with lower voting rights in exchange for a higher dividend.

Currently, Tata Motors, Future Retail, Gujarat NRE Coke, and Jain Irrigation have issued differential shares in the past which entail lesser voting rights.

The issue of new DVR shares in India is proposed to be in two classes:

a) Shares with superior voting rights (SR)

b) Shares with fractional rights (FR)

Superior Voting Right (SR) shares are issued to promoters and will enable them to have greater voting rights as compared to ordinary shares, while fractional rights (FR) shares have lesser voting rights. FR shares will fetch higher dividend and are issued at a discount to ordinary shares.

The startup appeal

The idea of DVR shares is incredibly appealing to Indian startups. After endless rounds of funding, the founder’s stake is so diluted that they run the risk of losing their company (Bansals anyone?). It is very likely that companies such as PayTm and Ola will embrace DVRs wholeheartedly.

It will be interesting to see how high-growth companies get to use these DVR shares to create an autonomous space for managing and growing their business without capital-infusing investors over-supervising them.

However, we shouldn't forget that our country has a less than stellar reputation when it comes to corporate governance. In such cases, DVR shares will only add to shareholder misery.

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