The acquisition of Flipkart by the Bentonville behemoth Walmart is giving rise to all sorts of doomsday predictions by experts across various industries. Economists, newspaper editors, investors etc., are all predicting the eventual 'colonisation' of the Indian internet economy by foreign companies. The reasons offered range from the government not offering sufficient protections, archaic regulations that prevent Indian founders from protecting themselves or cash rich businesses in India not being supportive enough. This article is not intended to dispel all claims put forward by various experts.
However, it is important to dispel a notion that the regulatory regime is inadequate for Indian start-up founders to protect their interests. The Government of India (GoI) could certainly provide greater regulatory flexibility to businesses. But, the often-quoted reason for an impending colonisation of the internet economy appears to be the inability of domestic internet companies to issue shares with differential voting rights (DVR Shares). Many commentaries have repeatedly hailed the concept of DVR Shares as the tool with which founders of the Facebooks and Alibabas of the world have managed to retain control over their entities. The argument advanced is that, as per Indian law, DVR Shares are not permitted. This is an inaccurate description of the actual position under law!
Only listed companies and unlisted public companies are subjected to conditional restrictions for issuing DVR Shares. All private companies can easily issue shares with differential voting rights! Interestingly, almost every major Indian company in the internet space is a private company. The few that have listed their shares, have listed shares of an offshore group company in foreign markets.
It is indeed quite surprising that none of the founders of Indian internet companies have opted to structure investments using DVR Shares. Especially, when the law provides for the ability to do so. Could it be that Indian founders who have raised billions of dollars of foreign/domestic capital are unaware of the enabling provisions under Indian law? This seems highly unlikely; given the army of advisors marshalled by all parties on such transactions. It could certainly not be the case that advisors have not offered these options to founders. The real question therefore is; would any institutional investor accept a share with superior dividend or preference rights, but inferior voting rights? In all probability, investors may not accept these structures for their Indian investments, although they may readily accept similar structures in other markets.
To be fair, investors in India should not be blamed for their discomfort with a DVR Share structure. Having voting rights by virtue of the shares held in an investee company allows a better level of statutory protection compared to contractual rights. Investors in developed markets may be comfortable with differential voting rights, provided certain basic contractual protections are in place. However, in an Indian context, relying solely on contractual rights may not be as effective. India is ranked at 164 out of 190 for 'enforcement of contracts' as per the World Bank's ease of doing business 2018 report. The time taken in Indian courts to resolve a contractual dispute is a major deterrent for any potential litigant. During the years 1995-2008 many institutional investors had invested in the India growth story, until the financial crisis engulfed world markets. The resulting adverse conditions exposed the fallacies in the Indian enforcement system, when investors were left to dry by their business partners. Many business partners conveniently reneged on their contractual obligations by exploiting the delays in the Indian legal system. There have been several high-profile cases where investors despite having won favourable arbitral awards are still awaiting its enforcement by an Indian court. It is little wonder that investors may be averse to the idea of diluting their statutory protections in investee companies, by adopting DVR Share structures.
The fault, to a large extent, lies with the GoI in being unable to provide an efficient enforcement system. But, this is not a new-found problem and has plagued India for decades. Successive governments have neglected the judiciary and corresponding enforcement mechanisms, which has led to the present state of affairs. Hence, to predict a takeover of the internet economy by foreign entities and pinning the blame on a particular regulatory inflexibility is akin to 'missing the woods for the trees'. The need of the hour is comprehensive and holistic reforms. Piecemeal tweaks to a specific law will not convert India overnight into a developed market.
As for those founders who wish to explore DVR Share structures the regulatory regime is very much available. The challenge may be to find an investor willing to accept such shares as part of their deal structure.
Ajay Joseph is a Partner at Mumbai-based law firm Veyrah Law.