The recent events that have unfurled with India's Coffee King VG Siddhartha, CCD founder, is a clear example of the expectation gap between the Venture Capital and Private Equity firms on the one hand and the promoters and founders on the other hand.
It is not that the promoters need the investors most. In fact, the investors and promotors, both need each other. Investors have surplus funds to be invested in the promising start ups and promoters need assistance, guidance and funds for setting up their business. The investors enter into the relationship with an expectation in mind and the promoters live with a different expectation or sometimes the promoters are not able to match up to the expectation of the investors. That is where the gap arises and precisely this is where Siddhartha got struck up.
It seems one of the private equity partners was forcing him to buy back shares. He wanted to dilute the holdings in Mindtree and buy. But it seems he also faced trouble from income tax department that blocked him from selling Mindtree shares. This forced Siddhartha to borrow money from personal sources to partially buy back the shares.
The investors make deals, find exits and raise capital with a five-year horizon. The investors usually try to come out of any investment within these five-year and make as much money as possible. If they overshoot this notional five-year term, then the investor get restless and put as much pressure on the promotor as possible to get an early exit unscathed. Heavy competition among the investors have risen the expectation bar among the investor circle. Spotting pockets of excellence and growth has been a challenge for investors. From due diligence to exit planning the investors plan out meticulously to get an "x return" on the investment which will be higher than their benchmark returns. The total value of buyout across the globe in the year 2018 was $582 billion which was about 10 percent growth over the previous year. So, we see a steady growth year on year of the private equity investor space. The expectation by the investors also sees a steady growth year on year.
Investors sometimes do not restrict themselves to just injection of funds but also extend to input of managerial persons, structuring and running the company. It is a typically pure commercial relationship between the investor and the promoter where the investor is just interested in getting a substantial return on his investment and the promoter interest extends to not just return, but also managing, branding, employee return etc. For the promoter he looks at the business as his child and would like to see it grow long term. The Investor on the other hand is looking for quick returns.
In most of the case, the promoters become minority shareholders in their own company with the external investor holding a majority chunk. The promoters are also outnumbered in the board by the investors. On multiple occasion the promoters are left as just salaried employees in their company. From a position where they had the liberty to run the business and take decisions to be a salaried employee or being outnumbered in the decision of the board is a big fall from the heights. All these plays on the mind of the promoter both emotionally and sometimes financially too. The investors further go strength to strength by consolidating their shareholding by having "Pre-emptive Rights" and "Right of first Refusal". Thus, diluting their stakes from the company is also not a viable option for the promoters. The investors also insist on having the right to call for extraordinary shareholders meeting and/or to introduce a shareholder’s resolution at their choice. The investors further insist on having a tight leash on maintaining the books of accounts. The investors also insist on having the Affirmative shareholders vote even when they go below 50% shareholding in the company. The investors literally make the promoters dummies in their own company leading to lot of pressure and stress on them.
But we, the guardians of the legal system, have foreseen all these. We have adequate protection in the law for the minority shareholders. Chapter XVI of the Companies Act 2013 has adequate protection for the minority shareholders. Application to Tribunal for relief in cases of oppression (Section 241), Powers of Tribunal (section 242).
But despite all the provisions of the law, as minority shareholders, the promoters are oppressed and come under severe stress by the investors. This is exactly what may have happened to Siddhartha who was forced to buy out the shares to meet the investor expectations of a decent return on investment. Siddhartha having failed to meet the investor expectation, shareholder expectation etc was forced to take the extreme step. Is it time to rein in the investors? Is it time to have a strict code of conduct for the investors?
K Satish Kumar is a keynote speaker, author, the Global Head of Legal and Chief Data Protection Officer of Ramco Systems. Among the many awards he has received, the coveted are “Top 50 Legal Leaders 2019” by Legal IP Gorilla in Singapore, “GC PowerList India 2018” by London-based Legal 500 , “Legal Counsel of the Year -2018” by INBA. He is actively involved in many pro bono activities through Chennai Lawyers. The author can be reached at firstname.lastname@example.org.