During recent discussions with book running lead managers and other advisers, the Securities and Exchange Board of India (SEBI) indicated that, in an initial public offering of equity shares (IPO), it would categorise founders with a stake of 10 per cent or more as promoters in the offer documents filed by a company. While the SEBI has yet to introduce a consultation paper or any amending regulations to put this view into practice, its apparent position has significant implications for companies that have gone through multiple rounds of fund raisings from private equity and venture capital investors. The founders of such companies will usually have been reduced to holding only minority stakes, with no control over the companies’ boards of directors.
Equity Partner
Shardul Amarchand Mangaldas & Co
Under the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018, as amended (ICDR regulations), the term promoter includes persons who have been named as such in an offer document or identified by the issuer company in its annual return filing under the Companies Act, 2013; persons who, directly or indirectly, have control over the affairs of the issuer company whether as shareholders, directors or otherwise or persons in accordance with whose advice, directions or instructions, boards of directors are accustomed to act. The term control has the subjective meaning set out in the SEBI (Substantial Acquisition of Shares and Takeover) Regulations, 2011, as amended, which includes the right to appoint majority directors or control the management or policy decisions.
The ICDR regulations require the promoters to hold at least 20 per cent of the post-issue capital, which is subject to a longer lock-in requirement of an 18-month period compared to the share held by any other pre-IPO non-promoter shareholder, which is subject to a lock-in obligation of only six months. In addition, to meet the stipulation of the 20 per cent post-issue capital lock-in, promoters holding less than 20 per cent will also need to get the agreement of eligible shareholders, as specified in the ICDR regulations, that they will allow their shares to be subject to a similar lock-in. Adding to the lock-in requirements of the ICDR regulations, the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015, as amended (LODR regulations), impose continuous compliance requirements on promoters.
Partner
Shardul Amarchand Mangaldas & Co
One possible explanation for the view taken by the SEBI is that there is a requirement under the LODR regulations that a promoter seeking reclassification is not to hold more than a 10 per cent shareholding together with the persons related to them and is not to have any representation on the board of directors. However, the 10 per cent threshold for declassification as a promoter is different from applying the same threshold when categorising someone as a promoter in a public listing. More and more new age startups, which are now planning to undertake an IPO, have completed multiple fund-raising rounds from private equity and venture capital investors during the past few years.
As a result, the erstwhile founders have diluted their stake in such companies to anywhere from 10 per cent to 20 per cent and have also given up board control. In many such companies, professional C-suite executives have become responsible for running the day-to-day operations. Sometimes the founders also act as such executives under the supervision of their boards of directors. These companies are, in a real sense, professionally managed companies, where the role of the founders has shifted from being promoters to being shareholders acting as professional managers under the supervision of their boards.
Under such circumstances, there needs to be a debate whether it is reasonable to classify the founders of such companies as promoters and subject them to promoter-related obligations. It remains to be seen whether the SEBI will introduce a bright-line test to determine who are the actual promoters in relation to an IPO. Alternately, the SEBI may prefer to be able to make a fluid determination on a case-by-case basis.
The SEBI should continue to take the initiative to ensure that the apprehensions and concerns of founders who hold only a minority stake and exercise no board control over the issuer company, are appropriately addressed and put to rest.
Abhishek Guha is an equity partner and Jagriti Mohata is a partner at Shardul Amarchand Mangaldas & Co.
Shardul Amarchand Mangaldas & Co
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