Equity Shares with Differential Rights

What are equity shares with differential voting rights?

Equity shares with differential voting rights (DVRs) are the kind of shares issued by a company that offers shareholders varying levels of the voting power. This means that some shareholders have more voting power than others and this can significantly impact the control and decision-making capabilities of the company. In India, the Securities and Exchange Board of India (SEBI) first introduced the concept of DVRs in 2000. However, they are not so popular in India.

Companies can issue DVRs with different voting rights in two ways:

Inferior Voting Rights: Under this scheme, a company can issue shares with fractional voting rights. For example, a shareholder may be given 1:5 rights, meaning they get 1 vote for every 5 shares owned.

Superior Voting Rights: Under this scheme, a company can issue shares that offer multiple votes per share. For example, shareholders may be given 5:1 rights, which makes it 5 votes per share owned.

Why do companies issue DVR shares?

There are three reasons for the issuance of equity shares with differential rights:

1. Prevention of a hostile takeover

DVR shares provide limited voting rights to certain shareholders, which means that they do not have the same voting power as the promoters or controlling shareholders. This can help prevent the dilution of the promoters' voting rights and make it more difficult for hostile takeovers.

2. Welcoming passive or retail investors:

Passive investors do not involve themselves in the management’s decision-making. Investing for profit is the preferred mode of shareholding for most people. Since superior voting rights are not allowed in India, DVR shareholders can simply remain invested for dividend income without concerning themselves with management decisions. Moreover, these are issued at a discount and get a higher rate of dividend as compared to common shares so investors can purchase a larger quantity and maximize their dividend income.

3. Protecting equity dilution

Onboarding outside investors in the company for additional funds results in equity dilution, thereby also diluting voting rights. Hence, DVRs can be a useful tool for companies that want to raise capital without giving up control and diluting voting rights.

Eligibility to issue DVR shares

In order to issue DVR shares, companies must meet the following criteria:

• The Article of Association of the Company should have approved the issuance of the DVR shares.
• The issuing companies should have a 3-year record of well-distributed profits.
• Issuing companies should not have defaulted on filing their annual returns during the last 3 years.
• There should be no instance of defaulting on the repayment of loans, deposits, or dividends.
• The tribunal or judiciary should not have slapped any penalty on these companies in the last 3 years.
• DVR shares must not exceed 26% of the post-issue paid-up equity capital.

Advantages and Disadvantages of Differential Voting Rights Shares

Advantages for the Company:

1. Retain Control: DVRs allow companies to raise capital while retaining control over the decision-making process. Founders and promoters can retain control over the company and prevent hostile takeovers or unwanted interference from third parties.
2. Raising Capital: The issuance of DVRs attracts investment from retail investors who are not interested in controlling the company but are invested in its growth potential.

Advantages for Shareholders:

1. Investment Opportunity: DVRs provide an investment opportunity for retail investors who may not be interested in actively participating in decision-making roles but want to participate in its growth story.
2. Enhanced Returns: DVRs are issued at discounts and may also offer a higher rate of dividend, hence, are hence scooped up in larger quantities, thereby offering a higher dividend yield than ordinary equity shares.

Disadvantages for the Company:

1. Negative Perception: The issuance of DVRs can be viewed negatively by investors, who may perceive it as an attempt by the company to retain control over the decision-making process, even at the expense of shareholder rights.
2. Limited Participation: DVRs limit the participation of shareholders in the decision-making process, which can lead to reduced transparency and low accountability.

Disadvantages for Shareholders:

1. Reduced Voting Rights: Shareholders who hold DVRs with lower voting rights may feel that their interests are not being adequately represented in the decision-making process.
2. Limited Exit Opportunities: The issuance of DVRs may limit the exit opportunities for shareholders, as other investors may be less willing to invest in a company that has a complicated share structure.

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 1:1 voting rights (1 vote per share), whereas DVR shares can have a higher or lower voting rights ratio.
• Dividend Rate: The dividend pay-out of DVR shares can be higher or lower, whereas it is fixed for ordinary shareholders.
• Suitability: DVR shares are better suited for promoters and other small shareholders, whereas ordinary shares are preferable for larger shareholders.
• Issue Price: DVR shares are issued at a discount, whereas ordinary shares are issued at their fair market price.

In conclusion, equity shares with Differential Rights (DVRs) are a powerful financial instrument that can be used by companies to raise capital while retaining control. It is important for investors to carefully consider the potential risks and benefits associated with DVRs before making any investment decision.