By Ashish Aggarwal and Nalin Dhingra

In any negotiation for investment by any angel investor, PE fund, VC Funds, etc., most of the investors insist that it should be specifically carved out in the Shareholders/Share Subscription agreement etc. that the said investors shall not be classified as promoters. The said requirement evolves out of the fact that a lot of obligations are casted upon the promoters in various statutes and regulations framed thereunder. The investors do not want to be entangled or be bound by the said obligations.

In this regard, it is pertinent to mention Regulation 2(1)(oo) of the Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2018 which defines promoter as:

“promoter” shall include a person:

i)who has been named as such in a draft offer document or offer document or is identified by the issuer in the annual return referred to in section 92 of the Companies Act, 2013; or

ii)who has control over the affairs of the issuer, directly or indirectly whether as a shareholder, director or otherwise; or

iii)in accordance with whose advice, directions or instructions the board of directors of the issuer is accustomed to act:

Provided that nothing in sub-clause (iii) shall apply to a person who is acting merely in a professional capacity;

Provided further that a financial institution, scheduled commercial bank, foreign portfolio investor other than individuals, corporate bodies and family offices, mutual fund, venture capital fund, alternative investment fund, foreign venture capital investor, insurance company registered with the Insurance Regulatory and Development Authority of India or any other category as specified by the Board from time to time, shall not be deemed to be a promoter merely by virtue of the fact that twenty per cent. or more of the equity share capital of the issuer is held by such person unless such person satisfy other requirements prescribed under these regulations;”

It is pertinent to note that the SEBI in the aforesaid regulation has excluded financial institutions, scheduled commercial banks, foreign portfolio investors other than individuals, corporate bodies and family offices, mutual fund, venture capital fund, alternative investment funds, foreign venture capital investor, insurance company and Development Authority of India from the category of promoters.

However, this exclusion is not absolute.

At this juncture, we must make reference to Regulation 14 of the SEBI ICDR:

“Minimum promoters’ contribution

14. (1) The promoters of the issuer shall hold at least twenty per cent. of the post-issue capital:

Provided that in case the post-issue shareholding of the promoters is less than twenty per cent., alternative investment funds or foreign venture capital investors or scheduled commercial banks or public financial institutions or insurance companies registered with Insurance Regulatory and Development Authority of India may contribute to meet the shortfall in minimum contribution as specified for the promoters, subject to a maximum of ten per cent. of the post-issue capital without being identified as promoter(s).

Provided further that the requirement of minimum promoters’ contribution shall not apply in case an issuer does not have any identifiable promoter.

…

(3)The promoters shall satisfy the requirements of this regulation at least one day prior to the date of opening of the issue.

(4) In case the promoters have to subscribe to equity shares or convertible securities towards minimum promoters’ contribution, the amount of promoters’ contribution shall be kept in an escrow account with a scheduled commercial bank, which shall be released to the issuer along with the release of the issue proceeds: Provided that where the promoters’ contribution has already been brought in and utilised, the issuer shall give the cash flow statement disclosing the use of such funds in the offer document;

…”

Upon a conjoint reading, it is clear that in the event an issuer company has an identifiable promoter, the Promoter shall hold at least 20% of the post – issue capital. The SEBI has kept this minimum cap so as to ensure that the promoter has ‘skin in the game’ and the listing is not merely a sole attempt to liquidate the shareholding to gain profit.

However, with the ever growing trend of start-ups, the promoters may not have enough equity to satisfy the above criteria. Many investors put money in start-ups so as to make listing gains; and founders who are raising money part with increasing chunks of their equity in multiple rounds of investing.

In such an event wherein the promoter is unable the fulfil the said criteria, the Proviso to Reg. 14 allows AIFs, foreign VCs, SCBs, public financial institutions or insurance companies registered with IRDAI to contribute up to 10% to the said minimum requirement without being classified as promoters.

A conjoint reading of Reg. 2(1)(oo) and Reg. 14 of the ICDR would lead to a conclusion wherein in case the post-issue shareholding of the promoters is less than twenty per cent., and in order to fulfil the said deficiency, alternative investment funds or foreign venture capital investors or scheduled commercial banks or public financial institutions or insurance companies contributed more than 10% of the post issue capital, to meet the shortfall in minimum contribution then the said investors can be specified as promoters by SEBI.[1]

Recently, SEBI in a professionally managed company, classified the founders as promoters in the case of Health- vista India Ltd.

A bare perusal of the Draft Red-Herring Prospectus of Health- vista India Ltd. shows that the company has not identified any individual as promoters declaring itself to be a “professionally managed company and does not have an identifiable promoter”. However, SEBI, has intervened to get the founders to be reclassified as promoters.

This marks a turning point in the SEBI’s approach as even the definition of promoter under ICDR carves out an exception for a person who is acting merely in a professional capacity. SEBI has, in this instance, exercised its power to issue directions to require the founders to be classified as promoters. If the same approach is adopted by SEBI towards investors who may exercise special rights under the articles or by the quantum of their shareholding, it will act as a major dissuading factors for investors and prove to be a hurdle for start-ups attempting to raise funds.

We are of the opinion that in the following circumstance, even the investors, i.e. AIFs, foreign VCs, SCBs, public financial institutions or insurance companies etc. can be classified as promoters:

1. Wherein the investors have contributed more than 10% of the post issue capital, to meet the shortfall in minimum contribution as specified by SEBI; or,
2. They have control over the affairs of the company, directly or indirectly whether as a shareholder, director or otherwise; or if in accordance with their advice, directions or instructions the board of issuer company is accustomed to act.

[1] Reg. 16 of the SEBI ICDR imposes an 18 month restriction on transferability of the minimum promoters’ contribution which shall include the specified securities, if any, contributed by AIFs, VCs, SCBs, etc.