Equity Shares with Differential Voting Rights

Equity shares with differential voting rights (DVRs) are an intriguing financial instrument that allows companies to issue shares with varying levels of voting power. Unlike ordinary shares, differential voting rights are designed to offer different rights and privileges, often aimed at balancing control and raising capital. 

What Are Equity Shares with Differential Voting Rights?

Equity shares with differential voting rights are shares that confer different levels of voting power to their holders. Essentially, differential voting rights can either provide superior voting rights, granting holders more influence over corporate decisions or inferior voting rights, giving holders less voting power compared to ordinary shareholders. The main characteristics of differential voting rights include:

• Superior Voting Rights: These differential voting rights give shareholders more votes per share compared to ordinary shares, enhancing their control over company decisions.
• Inferior Voting Rights: These differential voting rights grant shareholders fewer votes per share, often attracting investors more interested in financial returns than in corporate governance.

Share capital of any company limited by shares is broadly categorised into two: equity share capital and preference share capital. Section 43 of the Companies Act specifies that equity share capital refers to all share capital not classified as preference share capital and is further divided into two types: equity share capital with voting rights and equity share capital with differential rights. 

Equity share capital with differential rights differs from ordinary share capital in terms of dividend, voting and other rights. Companies intending to issue such shares must adhere to conditions specified in Rule 4 of the Companies (Share Capital and Debentures) Rules, 2014. Note: Section 43 does not apply to private companies if provided in their memorandum or articles of association (Notification dated June 5, 2015).

Reasons for Issuing Differential Voting Rights

Companies opt to issue differential voting rights for several strategic reasons:

• Avoiding Hostile Takeovers: By issuing shares with inferior voting rights to the public while retaining superior voting shares within the controlling group, companies can protect themselves against hostile takeovers.
• Attracting Retail Investors: Differential voting rights with inferior voting rights often come with higher dividends, making them attractive to retail investors seeking better returns rather than control.
• Protecting Voting Rights from Dilution: Issuing differential voting rights allows companies to raise capital without significantly diluting the voting power of the existing shareholders.

Regulatory Framework on Equity Shares with Differential Voting Rights 

The issuance of differential voting rights is subject to regulatory conditions to ensure transparency and protect shareholder interests. Key regulatory requirements include:

• Authorisation in Articles of Association: The company’s articles of association must explicitly authorise the issuance of differential voting rights.
• Shareholder Approval: For listed companies, the issuance of differential voting rights must be approved by shareholders through a postal ballot.
• Time Frame Post Default: Companies can only issue differential voting rights five years after clearing any payment default, such as unpaid dividends or loan repayments.
• Voting Power Cap: Differential voting rights cannot exceed 74% of the total voting power, ensuring that the control is not overly skewed.

Provisions and Requirements for Issuing Equity Shares with Differential Voting Rights 

Applicable Provisions

• Companies Act, 2013: Sections 39, 43, 56, 96, 100, 173
• Companies (Share Capital and Debentures) Rules, 2014: Rules 4 and 5
• Companies (Incorporation) Rules, 2014: Rule 20
• Companies (Prospectus and Allotment of Securities) Rules, 2014: Rule 12
• SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015: Regulations 30 and 46
• Secretarial Standards: Secretarial Standards 1 and 2

Mandatory Requirements

1. Authorisation by Articles of Association (AOA): The company’s AOA must authorise the issuance of differential voting rights.
2. Approval from Members: Approval must be obtained by passing an ordinary resolution in a duly convened general meeting. For listed companies, shareholders must approve through a postal ballot.
3. Voting Power Limit: Differential voting rights issued must not exceed 74% of the total voting power, including any previously issued differential voting rights.
4. Compliance with Filing Requirements: The company must not have any defaults in filing financial statements and annual returns for the three financial years immediately preceding the financial year in which it decides to issue differential voting rights.
5. No Payment Defaults: The company must not have any subsisting defaults in the payment of a declared dividend, matured deposits or the redemption of preference shares or debentures due for payment. Additionally, there should be no default in the payment of dividends on preference shares or repayment of any term loan from public financial institutions, state-level financial institutions or scheduled banks. All statutory payments relating to employees and any due amounts to the Investor Education and Protection Fund must be up to date.
6. No Penalties: The company must not have been penalised by a court or tribunal during the last three years for any offence under the Reserve Bank of India Act, 1934, the Securities and Exchange Board of India Act, 1992, the Securities Contracts Regulation Act, 1956, the Foreign Exchange Management Act, 1999 or any other special act under which the company is regulated by sectoral regulators.
7. Disclosure in Board Report: The board report must disclose all necessary details for the financial year in which the differential voting rights were issued and completed.

Additional Notes

• Listed Companies: For listed companies, the issuance of differential voting rights must be approved by shareholders through a postal ballot.
• Five-Year Waiting Period: Differential voting rights can only be issued upon the expiry of five years from the end of the financial year in which any default regarding payment of dividends or repayment of any term loan was rectified.
• No Conversion of Existing Shares: The company cannot convert its existing equity share capital with voting rights into equity share capital carrying differential voting rights.
• Rights of DVR Shareholders: Shareholders with differential voting rights shall enjoy all other rights, such as bonus shares and rights issues, subject to the differential rights specified at issuance.

Procedure for Issuing Equity Shares with Differential Voting Rights 

Alteration in Articles of Association

Before issuing equity shares with differential voting rights, the company must ensure that its Articles of Association (AOA) authorise such an issuance. If the AOA does not have relevant provisions, the company must amend the AOA to include these provisions.

1. Board Meeting for AOA Amendment: Convene a Board meeting to propose amendments to the AOA. The proposal should include specific provisions for issuing differential voting rights.
2. General Meeting for Approval: Convene a General Meeting of shareholders to pass a special resolution approving the amendment to the AOA. Follow the detailed procedure for conducting a General Meeting.
3. Filing with ROC: File the special resolution with the Registrar of Companies (ROC) in Form MGT-14 within 30 days of passing the resolution.

Board Meeting for Approving the Issue of Differential Voting Rights

Once the AOA authorises the issuance of differential voting rights, the company must convene a Board meeting to approve the proposal for issuing equity shares with differential voting rights.

1. Board Resolution: Pass a Board resolution to:
   • Approve the proposal for issuing equity shares with differential voting rights.
   • Approve the allotment of these shares, including a list of allottees.
   • Authorise the Company Secretary or another designated officer to issue share certificates and take necessary actions.
2. Disclosure for Listed Companies: If the company is listed, disclose the outcome of the Board meeting to the stock exchanges where the shares are listed and update the company’s website within two working days.

Convene Extraordinary General Meeting (EGM)

An EGM must be convened to obtain shareholder approval for issuing equity shares with differential voting rights.

1. Notice of EGM: Issue a notice of the EGM to all shareholders, specifying the agenda to approve the issuance of differential voting rights.
2. Passing Resolution: During the EGM, pass an ordinary resolution approving the proposal to issue equity shares with differential voting rights. For listed companies, this approval must be obtained through a postal ballot as per the regulatory requirements.
3. Filing with ROC: File the resolution passed in the EGM with the ROC in Form MGT-14 within 30 days.

Filing Form PAS-3 with the Registrar of Companies

After the approval and allotment of differential voting rights, the company must file Form PAS-3 with the ROC within 30 days of the allotment.

1. Documents Required:
   • List of allottees, specifying names, addresses, occupations and the number of securities allotted, certified by the signatory of Form PAS-3.
   • Report from a registered valuer regarding the valuation of the consideration.
   • In cases of allotment for non-cash consideration, include a copy of the contract under which securities were allotted and any related contract of sale or services.
   • Copies of Board or shareholders’ resolutions authorising the issue.
   • Any other required documents.

Post-Allotment Obligations

After the issuance and allotment of equity shares with differential voting rights, the company has several post-allotment obligations.

1. Intimation to Depository: If the allotted shares are dealt with in a depository, inform the depository of the details of the allotment immediately.
2. Issuance of Share Certificates: Issue share certificates in Form SH-1 within two months from the date of allotment.
3. Payment of Stamp Duty: Pay the requisite stamp duty on every share certificate issued, as per the Indian Stamp Act, 1899.
4. Register of Members: Enter the particulars of each share certificate issued into the Register of Members, maintained per Section 88 of the Companies Act, 2013, including the names of the persons to whom the shares have been issued and the date of issuance.

Following these detailed procedures ensures compliance with legal and regulatory requirements, thereby facilitating the smooth issuance of equity shares with differential voting rights.

Advantages of Differential Voting Rights

For Companies

• Capital Raising without Losing Control: Differential voting rights enable companies to raise capital while ensuring that the founding or controlling group retains significant voting power.
• Strategic Investments: Companies can attract strategic investors who are more interested in the financial performance than in voting rights.
• Flexibility in Corporate Governance: Differential voting rights provide flexibility in corporate governance by allowing differentiated control mechanisms.

For Investors

• Higher Dividends: Differential voting rights with inferior voting rights often offer higher dividends, attracting investors seeking income over control.
• Discounted Prices: Differential voting rights are frequently priced lower than ordinary shares, providing an entry point for cost-conscious investors.
• Portfolio Diversification: Investors can diversify their portfolios by including differential voting rights, balancing their need for income with potential capital gains.

Disadvantages of Differential Voting Rights

For Companies

• Complexity in Management: Managing different classes of shares can add complexity to corporate governance and financial reporting.
• Market Perception: The issuance of differential voting rights might be perceived as a move to entrench control, potentially leading to negative market perception.

For Investors

• Lower Liquidity: Differential Voting Rights tend to have lower liquidity compared to ordinary shares, making them harder to sell quickly at market prices.
• Limited Voting Power: Investors in inferior voting differential voting rights have limited influence over corporate decisions, which can be a downside for those interested in corporate governance.
• Market Uncertainty: The market for differential voting rights is relatively nascent, leading to potential volatility and uncertainty in price movements.

Impact on Corporate Governance

The issuance of differential voting rights significantly impacts corporate governance dynamics. On one hand, differential voting rights can provide stability by preventing hostile takeovers and ensuring that strategic decisions align with long-term objectives. On the other hand, they can lead to concerns about entrenchment of control, where the controlling group makes decisions that may not always align with the broader shareholder base’s interests.

Balancing Interests

For differential voting rights to be effective and fair, it is crucial to strike a balance between the interests of controlling shareholders and minority investors. Regulatory frameworks and corporate governance policies play a vital role in ensuring this balance. Transparency, clear communication and fair dividend policies are essential to maintaining investor trust.

Difference between Shares with Differential Voting Rights and Ordinary Shares

Shares with Differential Voting Rights differ from ordinary shares in the following aspects:

• Voting Rights: Ordinary shares offer a 1:1 voting ratio (1 vote per share), while DVR shares can have higher or lower voting rights ratios.
• Dividend Rate: The dividend payout for DVR shares can be higher to compensate for reduced voting power, while it is fixed for ordinary shares.
• Suitability: DVR shares are suited for promoters and small shareholders to maintain control without owning a majority of shares, whereas ordinary shares are preferred by larger shareholders seeking equal voting power.
• Issue Price: DVR shares are often issued at a discount compared to their fair market value, whereas ordinary shares are issued at market price.

Conclusion

Equity shares with differential voting rights represent a versatile tool for companies looking to balance control with capital-raising needs. While they offer significant advantages, including higher dividends and protection against hostile takeovers, they also come with challenges such as lower liquidity and complex corporate governance. 

The successful issuance and management of differential voting rights require a careful balance of interests, transparent communication and adherence to regulatory frameworks. As the market evolves, differential voting rights are poised to play an increasingly important role in corporate finance, offering innovative solutions for companies and investors alike.