The founding fathers of Infosys may have been reduced to being minority shareholders, but they still have the power to question the management that runs the company.
The founding members of Infosys have all but gone away, but they had enough power to get answers from the management under Sections 44 and 35 of the Companies Act, 2013, which protects minority shareholder interests. To their credit, the Infosys management and board did speak out in the open and justify the company's decisions. However, what everyone failed to catch on in the hurried press conference held recently was whether the Nominations and Remunerations Committee (NRC) had okayed the severance packages given out by the company. Usually, NRC signs off on huge paychecks offered to senior management, and now that the initial noise surrounding the Infosys issue has abated, it is important to question what Jeffrey Lehman, chairperson of NRC, did or say about the severance package.
The Infosys board admitted at the press conference that the severance package given to Rajiv Bansal — the IT giant's former CFO who left the company last year — was indeed very high and said it was going through a legal process to stop the payment of around Rs 17 crore. The point to note is that if NRC had given a go-ahead for the amount, as per Bansal's contract, Infosys is bound by law to pay the same, and cannot stop at the Rs 5 crore it has paid out so far. This becomes an interesting issue of governance and could spiral into a legal issue if such a contract of payment is reneged upon.
At the press meet, the company did not reveal why the package was accepted or rejected by NRC; neither did it state if it was part of Bansal's contract. A few months before he quit Infosys he had won the CFO of the Year award and was copiously praised by Sikka in one of the quarterly results in 2015.
In a World Bank study on 'minority shareholders interests' released in 2014, India ranks seventh in the list of countries that protect individual shareholders from the might of corporations. But the Infosys example stands as a lesson on upholding shareholder interests above those of the management and above the power of the board. In the startup world, too, young entrepreneurs have to get used to legal recourse in order to safeguard their interests, The balance is usually tipped toward the investors, so much so that even when founders become minority shareholders, founders may have no say in the company, having signed away most rights to the investor.
Lessons for startups
So, how do VCs use 'minority shareholding' to protect themselves against startups so effectively and veto decisions made by founders even though they (founders) have a majority in the board and have majority shareholding. There are, rightly so, covenants in the shareholder agreement that protect the investor's investment, and right from selling securities to issuing shares to raising debt capital everything is run by the VC. They also have the right of first refusal and the right of first offer.
But moving away from the technicalities of the shareholders' agreement, one can also observe the dismal trend of founders leaving their companies completely in the hands of the VC. Says Ganesh Prasad, Partner at Khaitan and Company,
“The constitution of the board and the powers that come with shareholding depends, completely on the legal contracts drawn up. The founders have to negotiate well with VCs.”
Flipkart is a classic case of how the original founders moved out and did not carry any powers either as majority shareholders or, later, as minority shareholders while running the company. Even on leaving, none of them have the rights of the minority shareholders, like the promoters of Infosys, to ask about the way their company is run.
"Startup founders make the mistake of taking the money quickly and do not realise that they will be a minority in a few years. They sign away all the rights to the investor community in the beginning. That's where they need to understand legal issues of being minority shareholders related to their journey," says Perikal Arjun, Partner at J Sagar Associates.
Even today many founders are still in the dark about terms like 'drag-along' and 'tag along' rights and struggle to make sense of jargon crucial to their interests and that which figure in legal contracts.
Anish Basu Roy, co-founder of Shotang, a technology company that works with small retail businesses, says,
"I made it a point that before I sign on a piece of paper with investors, I understood the terms and conditions of an agreement. It's your signature that decides your future in your very own company."
Anish adds that he worked with lawyers, chartered accountants and company secretaries for changing capital structures of the company.
It works best when a startup gets a VC who understands the business. "When we raised funds we went to an investor who knew the way a retail and distribution business works and who was willing to stay longer. This gives us enough momentum to build our business without having to worry about the next round," says Vikas L, co-founder of Mcaffeine, a personal care company.
So, know your rules, consult your lawyers. You may own 50.01 percent of your company, but you can still get voted out. You can own 74.9 percent yet you may not get the power to pass any special resolutions. And all this is because of the veto rights that investors protect themselves with. However, if the business is bad the minority shareholders have the right to question company decisions. Founders, too, would be able to raise questions as minority shareholders as and when they get there.
But, initially, investors tend to have the legal power to run things their way. The 'board' at a startup is just an illusion. This may, perhaps, be the reason why Narayana Murthy and the others don't want the board to be an illusion and want it to take control of governance at Infosys.
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- Anish Basuroy
- Board room squabbles
- Jeffrey Lehman
- Nominations and Remunerations Committee
- minority shareholder rights