Founders May be Able to Dilute Stakes Without Losing Control

In what way SEBIs reviewing SR clauses shall help those startups which will be publicly listing themselves in the future?


Even though 2020 looked grim for several businesses, few unicorn startups like Nykaa, Delhivery, Zomato, PolicyBazaar and Paytm rose to the occasion by launching their IPOs in the stock market. A successful listing of internet-first companies will encourage other startups as well to opt for releasing IPOs to raise capital in the future.  

To boost the listing of startups, market watchdog SEBI (Security and Exchange Board India) is considering easing rules on superior voting rights to solve legacy issues for startup founders to publicly list their companies.

SEBI to protect founders’ ownership powers

The proposal to ease rules is in the interest to protect a founder’s ownership powers in the firm. New technology firms typically employ an asset-light business model where the firm owns relatively fewer capital assets as compared to the value of its operations. The firms prefer equity over debt capital and while raising equity periodically they tend to lose the founders stake.

Startups, where the founders are instrumental in the success, are robbed of their decision-making skills. Therefore a structure is required which will enable them to retain decision-making powers and rights vis-à-vis other shareholders. The proposals have the potential to help founders dilute stakes without losing control, make tax structures more efficient and help in succession planning.

However top-tier startups such as Paytm, Zomato, PolicyBazaar, Nykaa and Delhivery, which are expected to launch their initial public offerings (IPOs) in 2021 will not be availing the benefits as the proposals are still at their primitive stage. 

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SEBI is bringing reformations in SR clauses where founders may be able to dilute stakes without losing control.

What can this mean for the Startups listing their IPOs in the Future? 

SEBI has received a suggestion from the market to bring flexibility to three key areas. Below are the areas which SEBI is currently reviewing: 

  1. Net worth requirement of the promoters
  2. Minimum holding period of SR shares 
  3. Structures eligible for SR share issuances

About the first point, current SR (Superior Rights) shares can be issued only to founders who are not part of any promoter group and whose collective net worth is more than Rs 500 crore. While determining the collective net worth, the investment of SR shareholders in the shares of the issuer company shall not be considered. 

In this clause, the family members of SR shareholders may also hold stakes and such investments as per the current guidelines can not be excluded while calculating the net worth of the SR shareholder.

SEBI has also received feedback on whether holding companies, registered family trusts, or partnerships where promoters or founders are in control or sole trustees, can also be permitted to hold SR shares so long as such promoters or founders or trustees continue to hold executive positions in the issuer company.

Regarding the minimum holding period, SEBI has reduced the period of holding of 25 percent of pre-issue capital of the issuer company by eligible investors to one year from the current requirement of two years. 

The regulator is considering bringing in relaxations with the timelines for founders to issue SR shares before an IPO. Currently, founders should issue SR shares six months before going public.

For the community of entrepreneurs, SEBIs proposals are progressive and a welcome move to provide impetus to SR shareholders, especially those who want to go public and strengthen a founder’s rights. 

DU Desk
DU Desk
Stories from DU Desk are the collective efforts of our in-house authors, guest authors and subject matter experts who collate and distill their ideas and thoughts to bring out actionable insights for our readers.

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