By Taponeel Mukherjee
The recent decision by the Ministry of Corporate Affairs (MCA) to amend the Companies Act and raise the cap on differential voting rights (DVRs) to 74 per cent has ramifications much beyond just the technology industry in India. The demarcation between control and capital is one that can unleash the next phase of entrepreneurial activity in this country.
The impact of the changes in DVRs is much beyond just businesses termed as “tech-businesses”. The changes allow a variety of entrepreneurs to benefit by accessing capital that can help boost businesses. While tech-businesses in capital intensive sectors will get a boost, so will entrepreneurs in other industries ranging from industrials to pharmaceutical research. The critical component is that the new regulation will allow an entrepreneur to marry their operational and entrepreneurial skills with the capital of a large investor, without necessarily having to part with significant control.
Additionally, entrepreneurs with substantial capacity to generate value through aggregating businesses in fragmented industries through a platform structure will also be able to utilise the higher cap on DVRs to create platforms that can generate value for all. Such platforms are applicable across sectors, where financial and operational inefficiencies exist.
The new rules regarding DVRs attempt at resolving the excessive debt dependence that Indian businesses have been vulnerable to, in the past, especially the reliance on bank loans. Reliance on bank loans was in part driven by a nascent corporate bond market and related factors that made bank loans a more attractive proposition for credit and in some cases, perhaps the only available option. On the other hand, the excessive dependence on debt by Indian companies was also driven by the need to avoid dilution of control that is a necessary concomitant of equity-based funding.
DVRs will allow firms to create more efficient capital structures by avoiding excessive leverage, a strategy wrongly used to prevent equity dilution in the past. The new DVR rules should be implemented for both private and publicly listed companies, to help shore up the capital structure regime in India. Critics of DVRs have pointed out that there are corporate governance issues concerning DVRs, whereby superior voting rights may lead to lower compliance standards. It is essential to differentiate between the various implications of a policy. The aim must be to improve corporate governance standards across the spectrum, but the benefits of DVRs in terms of allowing flexibility for entrepreneurs to push for capital, while still driving the company forward must not be underestimated.
Essentially, to state the obvious, the market must price an asset for the value delivered. In layman terms, if a shareholder with a share that has lesser control versus the shares held by a founder, then the shareholder needs to demand a higher return. Correct pricing of an asset relative to its risk is an issue that is applicable across asset classes. The question the investors must ask is how will the entrepreneur or the business compensate us for the fact that we own a share that has lesser voting rights? The question regulators must ask is how do we ensure that the regime and regulations that allow businesses to compensate shareholders with lesser rights are implemented effectively? DVRs can deliver value when the different stakeholders ask the right questions. Efficient financial markets will ensure that the stakeholders can all generate the maximum value for themselves.
In an Indian context, DVR rules are especially crucial for privately held companies operating in industries that aren’t structurally built for being publicly listed. Public listing isn’t necessarily a precursor for large-scale growth. For instance, infrastructure businesses that generate value through long-term targets need not be under the constant glare of quarterly results that is a necessary concomitant of being a publicly-traded company.
Primarily, businesses that have an asset profile that is long-dated with lumpy payment schedules, will struggle in the public domain. Mind you; such companies deliver all the requirements that one expects from a business of investments, job creation, paying taxes and engaging in impactful CSR activities. DVRs have a significant role to play in providing such industries access to capital.
As India needs to both boost growth and create capital markets that generate value for all stakeholders, innovation such as DVRs is essential. As with all policies, effective implementation of DVR policy is as important as the content in the policy per se. DVRs have the potential to create Indian enterprises that have the capital structure stability to truly compete globally.
(The views expressed in this article are personal and that of the author. The author heads Development Tracks, an infrastructure advisory firm. You can contact him at [email protected] or @Taponeel on Twitter)