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Differential Voting Rights

With Differential Voting Rights [DVR] in place, the founders can now get additional funding and continue managing their operations without losing control. The investors too are assured of their involvement in the strategic decisions. Thus this move is a win-win for both the founders and the investors.

The names Flipkart, Ola, Oyo and Paytm evoke an intense feeling of pride for being examples of the ‘brainchild’ of Indian entrepreneurs. All have successfully established themselves in ‘the internet world’ and are started by Indian entrepreneurs. But do they continue to be run by them? Sadly, not always.

History shows that entrepreneurs are a different breed altogether. Propelled by their inner desire to prove themselves, they plunge headlong into their chosen project. At some point, they realise that their financial resources and passion are not enough to enable their ventures to keep floating. Or, if they have met with early success, they realise they need heavy finance infusion to capitalise on their first-mover advantage. Fund-raising in a startup is definitely an inherent activity. Accordingly, they invite friends, family members, angel investors and venture capitalists to invest. In this process, they end giving up the total control of their project.

For an entrepreneur, giving up a project is not as easy as it is the brainchild of an entrepreneur. Only he has the vision about the opportunity, product or service and in developing a business model. Ownership is something he does not mind giving up, but not control. And when additional finance infusion as required is available only on dilution of his control, he pops up the question: “Is there no way I can get additional capital without giving up my control?”

Global examples do exist of entrepreneurs with very small financial holding remaining in control of their enterprises. How do they manage it?

Even with minority share…..

Jack Ma manages to control almost 100 per cent of Alibaba through an innovative Variable Interest Entities scheme. The USA has perhaps the longest startup history. They have permitted firms with Dual Class Shares to list. Founders of Lyft and Pinterest, two well-known startups, have been issued shares carrying 20 votes to every share of their other investors.

Facebook has issued to the Founders Class F stock, carrying 10 votes per share rather than 1 vote per share for the common Class A stock. Hong Kong permits Listing of firms with Weighted Voting Rights (WVR). Singapore too has similar provisions for funding of startups. Though provisions like non-voting shares, minority protection clauses, etc. have been tried, the most popular method world over is through the concept of Differential Voting Rights (DVR). Normally one ordinary share entitles the shareholder to one vote. A DVR share is just like an ordinary share but provides for higher or fewer voting rights to the shareholder. Superior DVR provides for votes larger than one while Fractional DVR shares have less than one.

Founders generally like to go in for Superior DVR shares. An ordinary shareholder, who is not particular about voting rights and interested only in his return may not mind subscribing to Fractional DVR shares, especially when such shares are eligible for a higher dividend. In either case, founders are benefitted as it enables them to raise capital without diluting their control.

DVR implementation

Until mid-August this year, the startups in India could raise capital through DVR shares only to the extent that it did not exceed 26 per cent of post-issue capital; and if in public unlisted domain, they had to have distributable profits in the preceding three years. These were highly restrictive provisions and naturally not utilised at all. Meantime, a number of Indian startups like Paytm and Ola had to surrender their controlling interest in their quest for additional financing. And foreign investors have greatly benefitted.

Now the restrictive clause relating to three years distributable profits has been removed. And the capital raised through DVR shares has been upped to a limit of 74 per cent of post-issue total voting power. Listed companies have also been benefitted now. While fractional DVR shares were permissible, Superior DVR shares had been disallowed in 2009. This restriction has now been removed while at the same time imposing some regulating clauses.

This move will benefit many of the startups who are believed to be waiting for such a measure. The Founders can now get additional funding and continue managing their operations without losing control. The investors too, by virtue of the “74 per cent of total voting power” clause are assured of their involvement in the strategic decisions. Thus this move is a win-win for both the Founders and the Investors.

Hopefully, we could now look forward to the shaping of Indian founded and Indian controlled Digital Giants.

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