Dual voting rights allow promoters to raise funds without diluting control thus serving as a defence mechanism against any hostile bid that would lead to a change in ownership
Mindtree conundrum brings dual class shares in the spotlight
SUNDEEP KHANNA
Even as the battle for control at Mindtree draws to its inevitable conclusion, attention has been drawn to the options available to vulnerable founders for warding off hostile threats to their ownership of the companies they started.
The framing of the discussion around the Bengaluru-based IT services company is of course slightly flawed. In the first place L&T, which has been cast in the role of avaricious acquirer, bought the first tranche of shares in a free and consenting transaction with V.G. Siddhartha. Nor can the engineering major be seen as a typical predator in the mould of the fictional Gordon Gecko or the more real Carl Icahn (who’s repeated but unsuccessful efforts to buy Clorox are the byword in hostility) or even India’s original corporate raider, the late Manu Chhabria who in the 1980s cast a malevolent eye on companies like Shalimar Paints, Mangalore Chemicals & Fertilisers and Gammon India. Interestingly, at one point, the Dubai-based tycoon also picked up a 2% stake in the then Ambani-controlled Larsen & Toubro.
L&T bears little resemblance to any of these figures. It is a professionally-run company not a promoter-led one and it already has the required pedigree in the IT business with its two companies L&T Infotech and L&T Technology Services. What’s more it revealed its intentions to actively pursue opportunities in the sector when it made an ultimately unsuccessful bid during the auctioning of Satyam in 2009.
Still, the Mindtree promoters have a right to feel aggrieved at the turn of events wherein they face loss of control in a company they set up and nurtured with great care over 20 years. While their ability to ring-fence their ownership of the company can be questioned, their commitment towards its customers, shareholders and employees, is above reproach.
Their predicament has also brought to the fore the subject of shares with dual voting rights, which allow promoters to raise funds without diluting control thus serving as a defence mechanism against any hostile bid that would lead to a change in ownership.
Indian markets regulator, SEBI has recently issued a consultation paper on the subject which talks of the need to enable issuance and listing of shares with differential voting rights. A part of the paper reads, “In promoter/founder led companies where promoters/founders are instrumental in the success of the company, such structures enable them to retain decision-making powers and rights vis-à-vis other shareholders either through retaining shares with superior voting rights or issuance of shares with lower or fractional voting rights to public investors."
Over the last 10 years, since a form of such shares was allowed in India, only a handful of companies have exercised the DVRs option. Among them, Tata Motors which was the first to do so in 2008 followed by others like Gujarat NRE Coke, Jain Irrigation Systems and the lesser known trading company Stampede Capital. Investors haven’t taken a shine to these, leading to a huge price differential between ordinary shares and those with DVRs.
In the US, Berkshire Hathaway’s Class A and Class B equity shares which have fewer voting rights are a prime example of successful dual class shares. Similarly, Facebook has issued Class A shares (listed through the IPO and held by public shareholders) which carry one voting right while the unlisted Class B shares which carry 10 votes each are held by Mark Zuckerberg and affiliates and have no sunset clause, a contentious issue in such a structure.
In particular, the mechanism clearly serves the interests of entrepreneurs who have started taking listing calls based on whether or not an exchange gives them that option, a notable case being that of Alibaba which chose the New York Stock Exchange over Hong Kong for its IPO, precisely because of this reason.
Exchanges like Nasdaq and NYSE, have actively promoted dual class listing while Hang Seng and Singapore have agreed more reluctantly. A July 2017 paper, issued by Nasdaq says “Dual class structures allow investors to invest side-by-side with innovators and high-growth companies, enjoying the financial benefits of these companies’ success."
Sebi’s recent approach seems to suggest it is also looking at more widespread use of these instruments on the Indian bourses, at the minimum by removing some of the existing ambiguities.
The problem though is that such a structure may not be particularly relevant in India since the Mindtree situation isn’t a typical case. The combination of a group of promoter managers of a well-run company, with their collective stake lower than the largest financial investor isn’t too common outside of the start-up world where in any case most entrepreneurs look to be building to sell. For the rest, in companies looking to buy scale, and lacking in free cash flow, the promoters will need to dilute their stake as they go along. Mostly, they would look for investors with longer term horizons.
Mindtree’s large investors include index funds as well as those in it for the long term. It could also be argued that Siddhartha belonged to the latter category having held a part of his shares for 19 years. Faced with near-bankruptcy, his options were limited forcing him to sell to the most willing buyer.
