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Recommendations on Changes to SEBI ICDR Regulations for Ease of Doing Business – Missing the Point

On January 11, 2024, SEBI issued its consultation paper on interim recommendations of its expert committee to harmonise the SEBI ICDR and LODR regulations.  The public has been invited to share comments on this paper.

This blog is restricted to the review of certain modifications to the SEBI ICDR Regulations proposed by the expert committee. 

Inclusion of equity shares from underlying convertible securities in calculating securities eligible for minimum promoters contribution: The ability of convertible securities to be included for the calculation for promoters’ contribution if held for a period of one year is a welcome clarification. Given that in most cases, such securities would have been held for a number of years, recognising the eligibility of such securities in the regulation would provide more clarity. While one could argue that this was already permitted, in light of Regulation 14 of the SEBI ICDR Regulations already allowing promoters to meet the requirement through subscription to convertible securities, and Regulation 15 talking about the ineligibility of ‘specified securities’ (which include convertible securities), the recommendation of the expert committee will make this explicitly clear.

Permitting non-individual shareholders to contribute towards minimum promoters’ contribution without being categorised as a promoter:  Currently, regulated entities such as AIFs, FVCIs, Scheduled Commercial Banks and insurance companies are permitted to contribute shares (up to a maximum of 10%) if the promoters do not hold 20% of the post issue equity share capital of the issuer company. The proposed amendment suggests extending this to allow any non individual public shareholder holding a minimum of 5% to contribute towards the minimum promoters’ contribution. 

Whilst, in simplistic terms, the proposal would substantially widen the number of entities eligible to contribute equity shares, it raises some questions which the committee may be best placed to consider before finalising its recommendations. 

  • The SEBI ICDR Regulations and the Companies Act, 2013 define a ‘promoter’ of a company as a person (i) identified as such; or (ii) who has control over the affairs of the company, whether as a shareholder or otherwise; or (iii) in accordance with whose directions the board of directors of the company acts. Further, the SEBI Takeover Regulations define control to mean the right to appoint the majority of directors on the board or to control management or policy decisions of the company (including by way of shareholding or contractual arrangements), and specify a threshold of 25% of the voting rights that triggers a takeover offer. The implication is clear – a promoter needs to have shareholding control or board control of the issuer company, and an indicator of shareholding control is 25% of the voting rights of the company. So, in a situation where no entity or individual holds 20% or more of the post-issue equity share capital of the issuer company or has the right to appoint the majority of the board, can such a company be said to have a promoter at all? This is acknowledged in the proviso to Regulation 14(1) of the SEBI ICDR Regulations, where it states that the requirement of minimum promoter contribution shall not apply where there is no identifiable promoter.
  • The concept of minimum promoter’s contribution was mooted in order to ensure that persons in control of the company and who were instrumental in getting the company listed (and accessing public funds) should continue to have ‘skin in the game’. This was meant to deter fly-by-night operators and provide public investors the assurance that the person controlling the company is just as invested in the company’s success post its listing. The underlying presumption behind this was that the promoter would hold more than 20% of the equity share capital of the issuer company post listing, which is bolstered by the takeover trigger under the SEBI Takeover Regulations. The proviso to Regulation 14(1) that permits regulated entities to contribute towards the requirement was introduced to accommodate exceptional cases, or for situations where not all of the promoter’s shareholding in the company was eligible for the promoter’s contribution. It was never intended to cater to a situation where none of the shareholder held sufficient shareholding to satisfy the requirement. Given the diverse shareholding patterns of companies nowadays, we are increasingly seeing situations where companies do not have large individual shareholders, but widespread investor bases with financial investors holding reasonably large chunks. Founders/individuals in such cases often hold low single digit shareholding post listing. In such situations, do the recommendations address the real concern, namely ensuring the promoters have ‘skin in the game’ post listing? Or will it amount to artificially creating a class of promoters who are not in control of their companies? For example, if A, B and C started a company in which each of them hold between 3-4% stake, aggregating to approximately 10.5%, will they be classified as promoters? And will other institutional shareholders be required to contribute the remainder 9.5% for lock up in order for the company to undertake an initial public offering? 
  •  Given the restrictions on receipt of employee stock options by promoters under applicable SEBI regulations, by forcibly categorising such individuals as promoters who hold barely 4% or 5% stake in a company, will the recommendations of the expert committee not deprive them from receiving further equity in the company? In the event these recommendations are incorporated into the SEBI ICDR Regulations, going forward we will have a class of ‘promoters’ of listed companies holding negligible shareholding post listing. This could lead to intriguing complications. For example, founders typically hold executive roles in such companies, and will face the risk of removal from their positions by shareholders. Such an outcome can adversely impact a listed company, as it will result in not only a loss of control by the promoters, but also the absence of an executive role. Before amending the SEBI ICDR Regulations in such a manner, the committee should undertake a deeper discussion on strengthening the Board versus prioritising identification of a promoter.

An alternative approach: An easier solution could perhaps involve mandating companies to maintain a post-IPO equity lock in of 20% (or even higher) of the stake held by pre-IPO shareholders for a period of 18 months, while allowing companies with ‘founders’ to be categorised as ‘’promoterless’ companies. This would satisfy the ‘skin in the game’ concern of the regulator and public investors. To bolster protection and clarity, the offer documents could incorporate a risk factor and specific disclosures, informing investors that the company has no promoters, and therefore, no single person/set of persons will control the company post listing. 

The committee’s interim recommendations thus raise more questions than answers. The extension of the pool of shareholders who can contribute to the minimum promoter contribution requirement, without being named as promoters, raises uncertainties. Will it aid the listing process for companies or could it potentially result in companies seeking to identify a promoter where there is none?