10. Understanding Equity and Control¶

10.1 Executive Summary¶

• Voting power and economic ownership are separate: Founders can retain control with minority economic ownership through dual-class share structures
• Multiple share classes enable founder control: Class A/B/C structures allow 10x or even 100x voting rights per share
• Indian regulatory constraints: Companies Act 2013 restricts use of multiple voting share classes compared to US/Singapore
• Control mechanisms matter more than ownership: Board composition, protective provisions, and drag-along rights often matter more than voting percentages
• Case studies demonstrate extremes: From Facebook's balanced approach (55% voting control) to Theranos's abusive 99% control

Understanding the distinction between economic ownership and voting control is fundamental to navigating startup fundraising successfully. While dilution of ownership percentage is inevitable as you raise capital, loss of control is not. This chapter explores the mechanisms founders use to maintain strategic control while raising substantial capital, the legal structures that enable these arrangements, and the Indian regulatory constraints that shape available options.

10.2 The Fundamental Distinction: Economic Rights vs Voting Rights¶

Every share of stock in a company carries two distinct types of rights that can be structured independently:

Economic Rights¶

Economic rights determine what you receive financially from your ownership:

Dividend Rights: Your share of profits distributed as dividends. For startups, dividends are rare—capital is typically reinvested for growth. However, preference shares often have dividend provisions that accrue until exit.

Liquidation Rights: Your share of proceeds when the company is sold or liquidated. This is where the real value materializes in startups. Liquidation preferences (covered in Chapter 11: Dark Patterns) can mean that economic rights don't correlate directly with ownership percentage.

Preemptive Rights: The right to participate in future funding rounds to maintain your ownership percentage. Also called "pro-rata rights," these protect against dilution.

Example: An investor owns 20% of the shares and has 1x liquidation preference. In a $50 million exit:

• Economic right minimum: $10 million (the greater of 20% × $50M = $10M, or their investment amount)
• If they invested $5 million, they get $10 million (20% of proceeds)
• If they invested $15 million, they get $15 million (1x preference)

Voting Rights¶

Voting rights determine your ability to influence or control company decisions:

Board Election: The most critical voting right—the ability to elect directors who make day-to-day strategic decisions.

Major Decisions: Approval authority for significant corporate actions like acquisitions, IPOs, new financing rounds, or fundamental business changes.

Ordinary Resolutions: General business decisions requiring simple majority (>50% of votes).

Special Resolutions: Fundamental changes requiring supermajority (typically 75% in India under Companies Act 2013).

Example: Mark Zuckerberg owns approximately 13% of Facebook's economic value but controls 55% of voting power through Class B shares with 10 votes each. He can unilaterally block any proposal requiring majority approval despite owning a minority of the economics.

Why This Distinction Matters for Founders¶

Consider two founders after raising multiple rounds:

Founder A - Traditional Structure:

• Owns 25% of shares
• 25% of economic value
• 25% of voting power
• Cannot block board decisions alone
• Must build coalitions with investors

Founder B - Dual-Class Structure:

• Owns 15% of shares
• 15% of economic value
• 51% of voting power (through super-voting shares)
• Can control board elections
• Retains strategic autonomy

Founder B has significantly more control despite lower economic ownership. This is the power of separating voting from economics.

10.3 Dual-Class and Multi-Class Share Structures¶

How Dual-Class Structures Work¶

A dual-class structure creates two categories of shares with different voting rights but otherwise identical economic terms:

Class A Shares (Common/Low-Vote):

• 1 vote per share
• Issued to: Investors, employees (through options), public shareholders (at IPO)
• Full economic participation
• Standard liquidity and conversion rights

Class B Shares (Founder/High-Vote):

• 10 votes per share (typical) or higher
• Issued to: Founders and select early stakeholders
• Identical economic participation to Class A
• Often converts to Class A upon sale (locks in founder commitment)
• May have sunset provisions (convert to Class A at IPO or after certain years)

The Math:

Imagine a company with:

• 5,000,000 Class B shares (founder) with 10 votes each = 50,000,000 votes
• 15,000,000 Class A shares (investors/employees) with 1 vote each = 15,000,000 votes
• Total: 20,000,000 shares, 65,000,000 votes

Founder ownership: 5,000,000 / 20,000,000 = 25% of economics Founder voting power: 50,000,000 / 65,000,000 = 76.9% of votes

Despite owning only 25% economically, the founder controls over three-quarters of voting decisions.

Triple-Class Structures: Maximum Flexibility¶

Some companies create three share classes for additional flexibility:

Class A: 0 votes (public shareholders)
Class B: 1 vote (early investors, some employees)
Class C: 10 votes (founders)

Google implemented this structure in 2014. The rationale: founders retain control (Class C), early investors maintain traditional voting (Class B), and public investors access growth without governance (Class A).

Controversy: Snapchat's 2017 IPO took this to an extreme, issuing only Class A shares (zero votes) to public investors. Institutional investors like CalPERS publicly condemned this as "a banana republic-style approach to governance," but the shares still sold because of strong growth metrics.

Case Study: Facebook's Balanced Approach¶

Structure Implemented (2012 IPO):

Mark Zuckerberg, Dustin Moscovitz, and Sean Parker negotiated irrevocable proxy agreements with major early investors (Sequoia, Accel, Peter Thiel) before the IPO, granting Zuckerberg voting authority over their shares. Combined with his direct Class B holdings:

• Zuckerberg direct ownership: 28.2% of shares
• Voting control through proxies: 55.9% of votes
• Class B shares: 10 votes each
• Class A shares (IPO): 1 vote each

Key Provisions:

• Class B shares automatically convert to Class A upon transfer to anyone outside approved list (family trusts, philanthropic entities)
• This "transfer triggers conversion" ensures only committed insiders hold super-voting shares
• Prevents accumulation of voting control by outsiders

2016 Restructuring Attempt (Failed):

Zuckerberg proposed creating Class C non-voting shares to maintain control while selling down for philanthropy. Shareholder lawsuits challenged this as unfairly enriching insiders. Facebook withdrew the proposal in 2017.

Lesson: Even powerful founders face constraints. The failed restructuring shows that public shareholders can push back against excessive founder control mechanisms if the proposal seems self-serving.

Case Study: Google's Engineering of Perpetual Control¶

2004 IPO Structure:

Larry Page and Sergey Brin engineered a dual-class structure that has preserved their control for over 20 years:

• Class A: 1 vote (public shareholders, employees)
• Class B: 10 votes (Page, Brin, Eric Schmidt, John Doerr, David Drummond)
• Only five people hold Class B shares
• Page and Brin control 51.2% of votes while owning just 11.8% of shares (as of 2024)

2014 Stock Split:

To raise capital without diluting control, Google created Class C shares (zero votes). The company issued one Class C share for every Class A share held, doubling the economic share count but not the voting shares.

Result: Founders maintain majority control indefinitely while Google (now Alphabet) can:

• Issue new shares for acquisitions without diluting founder votes
• Grant employee stock without reducing founder control
• Raise capital at will

Lesson: Triple-class structures provide maximum flexibility for capital raises without control dilution. Warren Buffett reportedly advised the founders on this model, inspired by Berkshire Hathaway's own dual-class structure.

10.4 Indian Regulatory Context: Companies Act Constraints¶

While US and Singapore allow extensive use of multiple share classes, India's Companies Act 2013 significantly restricts these structures.

Companies Act 2013 Provisions¶

Section 43: Types of Share Capital

Indian private limited companies can issue:

1. Equity shares with voting rights
2. Preference shares with preferential rights to dividends and capital repayment

Section 47: Voting Rights

• Every equity share carries one vote per share as the default
• Differential voting rights (DVR) shares are theoretically permitted but heavily restricted
• Companies must maintain at least 74% of equity capital with equal voting rights
• DVR shares cannot exceed 26% of total equity capital (effectively a 1:3.5 ratio limit vs 1:10 in US)

Practical Limitation:

If a founder wants 2 votes per share on their holdings:

• Founder DVR shares: 26% of capital, 52% of votes (26% × 2)
• Investor ordinary shares: 74% of capital, 74% of votes (74% × 1)
• Total: 100% capital, 126% votes
• Founder control: 52% / 126% = 41.3% of votes

This is far less powerful than US dual-class structures where 10x or 100x votes per share are common.

Section 43(a)(ii): Restrictions on DVR Shares

DVR shares can only be issued if the company:

• Has distributable profits for the immediately preceding 3 financial years
• Has not defaulted in filing financial statements or annual returns
• Has not failed to repay deposits or interest
• Has not defaulted in redemption of preference shares or debentures

Reality: Most startups cannot meet these criteria, making DVR shares unavailable in practice.

Why Most Indian Startups Use Preference Shares Instead¶

Given DVR share restrictions, Indian startups structure voting rights through preference share terms:

Compulsorily Convertible Preference Shares (CCPS):

• Issued to investors with preferential economic rights (liquidation preference, dividends)
• Carry limited or no voting rights on ordinary business
• Convert to equity shares at exit, giving investors voting power only upon conversion
• Allows founders to maintain equity voting control while raising capital

Board Seat Allocation:

• Rather than super-voting shares, control is managed through board composition
• Founders typically negotiate majority independent directors or balanced boards
• Protective provisions give investors veto rights on specific major decisions (covered in Chapter 7: Term Sheet Analysis)

Example: Typical Indian Startup Structure

Pre-funding:

• Founders: 10,000,000 equity shares with 1 vote each = 100% control

Series A funding:

• Investors: 2,500,000 CCPS with limited voting rights
• Founders: Still 10,000,000 equity shares = 100% of equity voting (CCPS don't vote on ordinary matters)
• Economic ownership: Founders 80%, Investors 20%
• Voting control: Founders effectively 100% on ordinary resolutions, but investors get board seats and protective provisions

At exit or IPO, CCPS convert to equity shares and investors gain full voting rights proportional to ownership.

Regulatory Arbitrage: The Delaware/Singapore Flip¶

Many Indian founders facing these limitations pursue an entity flip:

Structure:

1. Create a Delaware C-Corporation or Singapore company
2. Transfer Indian operating company ownership to the foreign holding company
3. Issue dual-class shares at the holding company level (permitted in Delaware/Singapore)
4. Raise VC funding into the holding company
5. Indian operations remain a wholly-owned subsidiary

Advantages:

• Access to US-style dual-class voting structures
• Flexibility in capital structure and share classes
• Investor familiarity (US VCs prefer Delaware structures)
• Easier future M&A or IPO in US markets

Disadvantages:

• Complexity and cost (₹50 lakh to ₹2 crore for flip transaction)
• Dual regulatory compliance (India + US/Singapore)
• Loss of Indian benefits (DPIIT recognition, Section 80-IAC tax exemption)
• RBI and tax authority scrutiny during restructuring

Examples:

• Flipkart flipped to Singapore before raising from Tiger Global
• Most Indian unicorns (Ola, Swiggy, Paytm pre-IPO) used Singapore/Delaware structures
• Recent "reverse flips": PhonePe, Groww, Zepto moved domicile back to India as Indian markets matured

10.5 Beyond Voting: Board Control and Protective Provisions¶

While share class structures dominate public discussion, sophisticated founders recognize that true control comes from three levers:

Board Composition¶

The Critical Lever:

Boards make day-to-day strategic decisions. Shareholders vote only on major corporate actions (M&A, fundraising, fundamental changes). A founder who controls the board controls the company, regardless of voting percentages.

Board Composition: Founder vs Investor Control¶

Standard Structures:

Founder-Controlled Board (Early Stage):

• 3 seats: 2 founders, 1 investor
• Founders have majority
• Investor has observation rights and information access

Balanced Board (Series A/B):

• 5 seats: 2 founders, 2 investors, 1 independent
• No party has majority
• Independent directors act as tie-breakers
• Requires consensus decision-making

Investor-Controlled Board (Later Stage/Troubled Companies):

• 5-7 seats: 2 founders, 3-4 investors, 1 independent
• Investors have majority
• Founders effectively work for the board
• Common in down-round scenarios or when replacing underperforming founder-CEOs

Negotiation Strategy:

Founders should fight hardest for board composition, even accepting less favorable economic terms. A 3-seat board (2 founders, 1 investor) provides more control than 60% economic ownership with a 5-seat investor-majority board.

Indian Context:

Companies Act 2013 requires:

• Minimum 2 directors for private limited companies
• At least one resident director (in India for 182+ days annually)
• No independent director requirement for private companies (only public companies)

Protective Provisions¶

Protective provisions give investors veto rights over specific decisions, regardless of voting percentages. These create "negative control"—the power to block rather than initiate.

Standard Protective Provisions (Series A):

Requiring investor approval:

• Issuance of new shares (prevents dilutive fundraising)
• Sale of company or material assets (prevents fire sales)
• Amendments to articles of association (prevents changing the rules)
• Related-party transactions above threshold (prevents self-dealing)
• Annual budget approval (financial oversight)
• New debt above threshold (prevents over-leveraging)
• Changes to board size or composition (preserves governance balance)

Aggressive Protective Provisions (Problematic):

• Approval of business plan or strategy (operational meddling)
• Hiring/firing of executives (management interference)
• Approval of material contracts (slows execution)
• Approval of any new product lines (strategic straitjacket)
• Approval of any spending above low thresholds like ₹10 lakh (micromanagement)

Founder Perspective:

Standard protective provisions are acceptable—they protect investor capital against egregious founder actions. Aggressive provisions that give investors operational control are problematic and should be pushed back against.

Negotiation Tip:

If investors demand extensive protective provisions, request that they sunset after the company reaches profitability or specific revenue milestones. This aligns incentives: investors get protection when the company is risky, founders get autonomy when they've proven execution.

Drag-Along and Tag-Along Rights¶

These provisions control exit dynamics and can override founder preferences.

Drag-Along Rights:

If holders of X% of shares approve a sale, all shareholders must sell on the same terms.

Standard: 50-66% threshold (simple or supermajority)
Aggressive: 25-33% threshold (allows investors to force sale over founder objection)

Example:

• Investors hold 40% of shares and have drag-along rights at 40% threshold
• Investors identify acquirer willing to pay $50 million
• Founder wants to keep building, believing the company will be worth $200 million in 3 years
• Investors can drag the founder into the sale against their wishes

Tag-Along Rights (Founder-Protective):

If founders sell their shares, other shareholders have the right to sell on the same terms at the same price.

Purpose: Prevents founders from getting liquidity while leaving minority shareholders stuck.

Example:

• Founder approached by acquirer who wants to buy founder shares only for $10 million
• Investors tag along and sell their proportional share at the same price-per-share
• Protects investors from being left behind in partial acquisitions

Indian Regulatory Requirement:

SEBI (ICDR) Regulations require that any acquisition of 25%+ of a listed company triggers mandatory open offer to all shareholders. This provides tag-along protection by regulation for public companies. Private companies must negotiate tag-along rights contractually.

Cap Table Evolution: Seed to Series B¶

The following diagram shows how founder ownership dilutes across multiple funding rounds:

graph LR
    A[Seed Round<br/>$2M at $8M pre-money] --> B[Post-Seed<br/>Founders: 80%<br/>Investors: 20%]
    B --> C[Series A<br/>$5M at $20M pre-money]
    C --> D[Post-Series A<br/>Founders: 56%<br/>Seed: 14%<br/>Series A: 20%<br/>ESOP: 10%]
    D --> E[Series B<br/>$10M at $40M pre-money]
    E --> F[Post-Series B<br/>Founders: 44.8%<br/>Seed: 11.2%<br/>Series A: 16%<br/>Series B: 20%<br/>ESOP: 8%]

    style A fill:#e1f5ff
    style C fill:#fff3e0
    style E fill:#f3e5f5
    style F fill:#ffebee

Key Insights:

• Founders start with 80% post-seed, end with 44.8% post-Series B: Each funding round creates proportional dilution for all existing shareholders
• Each round dilutes everyone proportionally: Seed investors go from 20% to 14% to 11.2% as new rounds are added
• ESOP pool creates additional dilution for founders: The 10% ESOP pool carved out at Series A dilutes founders disproportionately (since it's typically created from founder shares)
• Understanding this progression helps plan for long-term ownership: Founders should model dilution through Series C or D to understand final ownership targets

Dilution Mathematics Example:

Starting with the Seed Round:

• Pre-money valuation: $8M
• Investment: $2M
• Post-money valuation: $10M
• Investor ownership: $2M / $10M = 20%
• Founder ownership: 80%

Series A creates dilution:

• Pre-money valuation: $20M (founders + seed investors own 100%)
• Investment: $5M
• ESOP pool: 10% created before money comes in (reduces existing shareholders proportionally)
• Post-money valuation: $25M
• Series A ownership: $5M / $25M = 20%
• Remaining 80% split between founders (56%), seed investors (14%), and ESOP (10%)

Series B continues the pattern:

• Pre-money valuation: $40M
• Investment: $10M
• Post-money valuation: $50M
• Series B ownership: $10M / $50M = 20%
• Everyone else diluted proportionally to 80% of previous holdings

Planning for Control:

With founders at 44.8% post-Series B, maintaining voting control becomes challenging without dual-class structures. This is why:

1. Board composition matters more than ownership: Even at 44.8%, founders can maintain strategic control through balanced board (2 founders, 2-3 investors, 1-2 independents)
2. Dual-class shares preserve control: In Delaware/Singapore structures, super-voting shares allow founders to maintain majority voting power despite minority economic ownership
3. Protective provisions create mutual veto: Rather than outright control, sophisticated founders negotiate protective provisions requiring their consent on major decisions

10.6 Case Studies¶

Case Study: Uber and the Limits of Founder Control¶

Background:

Travis Kalanick co-founded Uber in 2009 and raised over $24 billion in venture capital by 2017, reaching a $68 billion valuation. Kalanick negotiated strong control provisions:

Control Mechanisms:

• Super-voting shares with 10x voting rights
• Three board seats with "absolute right" for Kalanick to select directors
• Benchmark Capital and other early investors held super-voting shares but supported Kalanick

The Unraveling (2017):

Multiple scandals damaged Uber's reputation and operations:

• Waymo lawsuit alleging trade secret theft of self-driving technology
• Susan Fowler blog post exposing pervasive sexual harassment culture
• Greyball technology used to evade regulators revealed by New York Times
• Video of Kalanick berating Uber driver went viral
• Attorney General Eric Holder investigation found systemic cultural problems

The Ouster:

Despite Kalanick's voting control:

• June 2017: Investors representing 40% of voting power demanded Kalanick's resignation
• Five major investors (Benchmark, Menlo Ventures, Lowercase Capital, Fidelity, others) presented unified front
• Kalanick stepped down from CEO to chairman
• August 2017: Benchmark sued Kalanick for fraud, seeking removal from board
• October 2017: Board restructured with one-share-one-vote system, eliminating super-voting shares
• SoftBank invested $7.7 billion in January 2018, shifting power dynamics
• Kalanick sold most shares and resigned from board in 2019

Key Lessons:

1. Voting control has limits: When enough investors unite (40% in Uber's case), even super-voting shares can't protect a founder
2. Corporate culture matters: Scandals gave investors leverage they wouldn't have had with strong financial performance
3. Board seats are temporary: Kalanick's "absolute right" to select board members was overridden when investors threatened to sue
4. Late-stage capital shifts power: SoftBank's $7.7 billion investment diluted earlier shareholders and reset governance
5. Legal mechanisms can override founder rights: Benchmark's fraud lawsuit (later dropped) demonstrated that founder-protective provisions can be challenged

Indian Parallel:

Housing.com founder Rahul Yadav was ousted by the board in 2015 after similar cultural and strategic conflicts, despite being a major shareholder. The board (controlled by Softbank and other investors) removed him as CEO after a series of erratic public statements and strategic disagreements.

WeWork's Governance Catastrophe¶

Structure:

Adam Neumann maintained nearly total control of WeWork through:

• Super-voting shares giving him unilateral decision authority
• Board composition: Controlled by Neumann loyalists and celebrity directors without real estate expertise
• No meaningful investor checks on founder power

Abuses of Control:

1. Self-dealing: Leased properties he personally owned to WeWork, creating conflicts of interest
2. We trademark: Trademarked the word "We" personally, then licensed it to WeWork for $5.9 million
3. Pre-IPO liquidity: Took over $700 million in cash out through share sales and loans while company burned capital
4. Related party transactions: Numerous undisclosed transactions benefiting Neumann

The Collapse:

• August 2019: WeWork filed S-1 for IPO, revealing $1.9 billion loss on $1.8 billion revenue
• Public scrutiny exposed governance failures and questionable founder behavior
• Valuation cratered from $47 billion (January 2019) to $8 billion (September 2019)
• IPO withdrawn; Neumann forced out
• SoftBank rescue: Invested at $8 billion valuation, took 80% ownership
• Neumann received $1.7 billion package ($970M stock sale, $500M loan repayment, $185M consulting fee)
• November 2023: WeWork filed for bankruptcy

Governance Failures:

Celebrity Board Without Expertise:

• Board included celebrities and political figures without real estate or startup operations experience
• No independent directors with relevant domain expertise to challenge Neumann's strategy
• Board meetings were reportedly superficial without rigorous oversight

Unchecked Founder Power:

• Neumann could unilaterally approve related-party transactions
• No meaningful financial controls or budgeting processes
• Culture of "founder vision" prevented critical examination of unit economics

Lesson for Founders:

Control is valuable for building long-term value, but unchecked control enables abuses that ultimately destroy shareholder value. The WeWork board failed in its fiduciary duty by not providing meaningful oversight. Founders should welcome thoughtful, experienced board members who can challenge assumptions and improve decision-making.

Lesson for Investors:

Governance matters. SoftBank and other investors enabled Neumann's abuses by providing capital without demanding governance reforms. The $47 billion valuation was a house of cards built on governance failures.

10.7 Structuring Control: Practical Strategies for Founders¶

Early Stage (Pre-Seed to Seed)¶

Objective: Maintain maximum flexibility for future rounds while establishing founder control norms.

Tactics:

• Issue founders' shares with standard vesting (4-year, 1-year cliff) to signal alignment with long-term building
• Maintain 3-seat board: 2 founders, 1 lead investor or advisor
• Include standard protective provisions but resist operational controls
• Negotiate pro-rata rights for founders in all future rounds (maintains ownership percentage)
• Avoid giving multiple investors board seats at seed stage

Growth Stage (Series A/B)¶

Objective: Balance investor governance rights with founder strategic control.

Tactics:

• Negotiate balanced 5-seat board: 2 founders, 2 investors, 1 independent
• Independent director selection process: Founders propose, investors have approval rights (or vice versa)
• Limit protective provisions to major corporate actions (sale, new fundraising, material asset sales)
• Establish clear decision-making authorities: Board handles strategy, CEO handles execution
• Implement information rights for investors (monthly financials, quarterly board meetings) to maintain trust

Later Stage (Series C+)¶

Objective: Preserve strategic autonomy while accepting increased investor oversight.

Tactics:

• Consider 7-seat board if adding additional investor: 2 founders, 3 investors, 2 independents
• Establish board committees (audit, compensation) with mixed founder/investor representation
• Create clear guidelines for related-party transactions requiring special approval
• Implement formal budgeting and financial planning processes with board oversight
• Consider dual-class structure if planning IPO (requires Delaware/Singapore entity)

Pre-IPO¶

Objective: Prepare governance for public company standards while preserving founder influence.

Tactics:

• Clean up board composition: Replace friends/family with qualified independent directors
• Implement public company governance practices: Audit committee, compensation committee, independent chairman or lead director
• If using dual-class structure, prepare disclosure explaining rationale for public investors
• Establish sunset provisions for super-voting shares (e.g., 10 years post-IPO or when founder leaves)
• Ensure all related-party transactions are disclosed and arm's-length

10.8 Action Items¶

1. Understand your current structure: Review your cap table and shareholders' agreement to map out actual voting control vs economic ownership. Calculate what percentage of votes you control on ordinary vs special resolutions.

2. Analyze board dynamics: Count board seats, identify who has appointment rights, and map decision-making authorities. Determine what decisions require board approval vs CEO authority vs shareholder approval.

3. Review protective provisions: List all decisions requiring investor approval. Flag any that give investors operational control rather than protective oversight.

4. Model future dilution scenarios: Project how voting control and board composition will change through next 2-3 funding rounds. Identify at what point you lose effective control.

5. Consider entity structure: If operating as Indian private limited company, evaluate whether constraints on dual-class shares justify complexity of Delaware/Singapore flip.

6. Negotiate balanced governance: In next funding round, prioritize board composition and protective provision limits over marginal valuation improvements.

7. Build independent director relationships: Identify 3-5 potential independent directors with relevant expertise who could serve as neutral board members in future.

8. Document governance clearly: Ensure all control mechanisms are explicitly documented in shareholders' agreement and articles of association. Avoid reliance on informal understandings.

9. Establish board processes: Implement regular board meetings (quarterly minimum), formal minutes, and clear decision-making procedures to demonstrate professional governance.

10. Review Indian regulatory compliance: If using any DVR shares or complex structures, verify compliance with Companies Act 2013 Section 43 and 47 requirements.

10.9 Key Takeaways¶

• Voting control and economic ownership are independent variables that can be structured separately through dual-class shares, board composition, and protective provisions
• Founders can maintain strategic control with minority economic ownership, as demonstrated by Facebook (55% votes with 28% shares) and Google (51% votes with 12% shares)
• Indian Companies Act 2013 significantly restricts use of differential voting rights shares (26% maximum of capital, 2:1 maximum voting ratio) compared to US/Singapore (10:1 or higher ratios common)
• Board composition is often more important than voting percentages since boards make day-to-day decisions while shareholders vote only on major actions
• Protective provisions create "negative control" by giving investors veto rights over specific decisions regardless of voting percentages
• Unchecked founder control enables abuses and ultimately destroys value, as shown by WeWork and Theranos failures
• Balanced governance with thoughtful independent directors improves decision-making while preserving founder strategic autonomy
• Many Indian startups pursue Delaware/Singapore entity flips to access flexible multi-class share structures unavailable in Indian private limited companies

10.10 Red Flags to Watch¶

🔴 CRITICAL: Investor demands board control (majority of board seats) at Series A or earlier stages—sign of aggressive investor who may remove founder when difficulties arise

🔴 CRITICAL: Protective provisions requiring investor approval for ordinary operational decisions like hiring, contracts below $100K, or business strategy—creates management paralysis

🔴 CRITICAL: Drag-along rights at low thresholds (25-33%) allowing minority investors to force company sale over founder objection—risk of premature exit

🟡 IMPORTANT: Lack of independent directors on board creates appearance of governance weakness and may cause issues in future fundraising or exits

🟡 IMPORTANT: Related-party transactions without arm's-length pricing or board approval—creates conflicts and potential fiduciary duty violations

🟡 IMPORTANT: Complex voting structures (multiple share classes) without clear documentation in articles of association—risk of disputes and Indian regulatory violations

🟢 MONITOR: Tag-along rights with broad definition of "sale" that might be triggered by small secondary transactions—may complicate founder liquidity

🟢 MONITOR: Sunset provisions on super-voting shares that trigger too quickly (e.g., 3 years post-IPO vs 10 years)—reduces long-term control

10.11 When to Call a Lawyer¶

Situations REQUIRING Legal Counsel¶

1. Implementing dual-class share structure: Complex securities law implications, requires expert drafting of articles of association and shareholders' agreements
2. Negotiating board composition terms: Board appointment rights, removal provisions, and decision-making authorities require precise legal documentation
3. Delaware/Singapore entity flip: Multi-jurisdictional transaction requiring coordination between Indian, US/Singapore corporate lawyers and tax advisors
4. Investor requesting unusual protective provisions: Any provisions beyond standard list (fundraising, M&A, asset sales) require careful legal review
5. Disputes over voting or control: If investors and founders disagree about governance, immediate legal counsel essential before matters escalate

Situations Where Legal Counsel Optional¶

1. Standard balanced board composition: Common structures (2 founder, 2 investor, 1 independent at Series A) have precedent templates
2. Routine shareholder resolutions: Standard business decisions following normal procedures
3. Understanding current structure: Initial review of cap table and existing agreements can be done by founders with financial advisor

Legal Costs (India)¶

• Cap table analysis and control structure review: ₹50,000-₹150,000
• Dual-class share structure implementation: ₹200,000-₹500,000
• Entity flip (Delaware/Singapore): ₹10,00,000-₹50,00,000 (complex, multi-jurisdictional)
• Board governance documentation: ₹150,000-₹400,000
• Dispute resolution/litigation: ₹500,000-₹5,000,000+ depending on complexity

Recommended Law Firms¶

India: Trilegal, Khaitan & Co, AZB Partners, IndusLaw, Shardul Amarchand Mangaldas, Argus Partners

US (for Delaware structures): Wilson Sonsini Goodrich & Rosati, Cooley LLP, Gunderson Dettmer, Fenwick & West

10.12 Indian Context¶

Companies Act 2013 Differential Voting Rights Limitations¶

Section 43(a)(ii) permits companies to issue equity shares with differential voting rights, but imposes stringent conditions:

Eligibility Criteria:

• Company must have distributable profits in each of the immediately preceding three financial years
• Must not have failed to file financial statements or annual returns for three years
• Must not have defaulted in repayment of deposits, interest, redemption of preference shares or debentures

Capital Structure Limits:

• DVR shares cannot exceed 26% of total equity capital
• At least 74% of equity capital must carry equal voting rights

Practical Reality: Most startups cannot meet the three-year profitability requirement, making DVR shares unavailable. This is a deliberate policy choice to prevent abuse of voting control in unprofitable companies.

Compulsorily Convertible Preference Shares (CCPS) as Alternative¶

Since DVR equity shares are unavailable, Indian startups use CCPS to manage voting during growth phase:

Structure:

• CCPS issued to investors with preferential economic rights
• Limited or no voting rights on ordinary business matters
• Full voting rights on matters affecting CCPS rights (e.g., changes to preference terms)
• Automatically convert to equity shares at exit or IPO, giving full voting rights upon liquidity

Governance Through Board Seats:

• Rather than super-voting shares, founders maintain control through board composition
• CCPS terms typically grant investors specific board seats (1 seat per series)
• Protective provisions in shareholders' agreement give investors veto rights on major decisions

Example Timeline:

Pre-funding: Founders have 10,000,000 equity shares = 100% voting control

Series A: Investors receive 2,500,000 CCPS

• Economic ownership: 20% (2.5M / 12.5M fully diluted)
• Voting control: Founders retain near-100% of equity votes since CCPS don't vote
• Governance: Investors get 1-2 board seats, protective provisions on M&A, new fundraising

Series B: Additional investors receive 3,000,000 CCPS

• Economic ownership: Founders 64%, Series A 16%, Series B 20%
• Voting control: Founders still control equity votes
• Governance: Balanced 5-seat board (2 founders, 2 investors, 1 independent)

Exit/IPO: All CCPS convert to equity shares

• Founders now own 64% of shares with 64% voting
• Investors own 36% with 36% voting
• Standard one-share-one-vote structure

Entity Flips: Regulatory Considerations¶

Many Indian founders pursue Singapore or Delaware holding company structures to access flexible multi-class shares:

Regulatory Approval Required:

• RBI approval for overseas direct investment (ODI) by Indian residents
• Valuation of Indian operating company transfer to foreign holdco
• Tax implications: May trigger capital gains tax on deemed transfer
• FEMA compliance for transfer of shares to non-resident entity

2024 Reverse Flip Trend:

Indian entrepreneurs increasingly reversing previous flips:

• PhonePe: Completed reverse flip from Singapore to India (October 2022)
• Groww: Reversed US structure to India (May 2024)
• Zepto: Completed reverse flip from Singapore (January 2025)
• Meesho: NCLT approval for Delaware to India shift (June 2025)

Drivers of Reverse Flipping:

1. Maturation of Indian capital markets (robust IPO ecosystem, large domestic VC/PE)
2. India IPO valuation premium over US listings for India-focused companies
3. Simplified compliance (single jurisdiction vs dual)
4. Government tax incentives being considered for reverse flipping
5. Access to Indian rupee debt markets easier with Indian holding company

Implication for Founders:

Carefully evaluate whether complexity of foreign holding structure is justified. For primarily India-focused businesses planning India IPO, starting with or reverting to Indian structure may be optimal.

Board Composition Requirements¶

Companies Act 2013 Mandates:

• Minimum 2 directors for private limited companies (Section 149)
• At least one director must be resident in India (stayed 182+ days in previous calendar year)
• Maximum 15 directors (can be increased by special resolution)
• No mandatory independent director requirement for private limited companies (only for listed public companies)

Practical Governance:

Most venture-backed Indian startups implement:

• 3-seat board at seed: 2 founders (including resident director), 1 investor
• 5-seat board at Series A/B: 2 founders, 2 investors, 1 independent
• 7-seat board at later stages: 2 founders, 3-4 investors, 1-2 independents

Key Provision: Resident director requirement means at least one founder or director must maintain substantial physical presence in India, limiting full relocation for founding team.

10.13 References¶

1. Facebook Inc. S-1 Registration Statement. SEC Filing, February 1, 2012. https://www.sec.gov/Archives/edgar/data/1326801/000119312512034517/d287954ds1.htm

2. Alphabet Inc. (Google). "Founders' IPO Letter." SEC Filing, April 2004. https://abc.xyz/investor/founders-letters/2004-ipo-letter/

3. Snap Inc. S-1 Registration Statement. SEC Filing, February 2, 2017. https://www.sec.gov/Archives/edgar/data/1564408/000119312517029199/d270216ds1.htm

4. Harvard Law School Forum on Corporate Governance. "Snap and the Rise of No-Vote Common Shares." March 8, 2017. https://corpgov.law.harvard.edu/2017/03/08/snap-and-the-rise-of-no-vote-common-shares/

5. The Companies Act, 2013. Ministry of Corporate Affairs, Government of India. Sections 2(68), 43, 47, 149. https://www.mca.gov.in/content/mca/global/en/acts-rules/ebooks/acts.html

6. Benchmark Capital Partners v. Kalanick. Complaint, Delaware Court of Chancery, August 10, 2017.

7. Bloomberg. "Uber Investor Benchmark Sues to Kick Travis Kalanick Off Board." August 10, 2017. https://www.bloomberg.com/news/articles/2017-08-10/uber-investor-benchmark-is-said-to-sue-kalanick-over-board-seat

8. WeWork Companies Inc. Draft Registration Statement (Form S-1). SEC Filing, August 14, 2019.

9. Dr Wealth. "WeWork's $47 Billion IPO Failure Is A Lesson In Corporate Governance." December 17, 2020. https://www.drwealth.com/wework-ipo-failure-corporate-governance/

10. Darden Ideas to Action. "Why WeWork Didn't Work: 4 Lessons on Corporate Governance." January 21, 2020. https://ideas.darden.virginia.edu/why-wework-didnt-work

11. Ministry of Corporate Affairs. "Report of the Companies Law Committee on Differential Voting Rights." March 2020. https://www.mca.gov.in/Ministry/pdf/DifferentialVotingRights_05032020.pdf

12. SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018. Securities and Exchange Board of India. https://www.sebi.gov.in/legal/regulations/aug-2018/securities-and-exchange-board-of-india-issue-of-capital-and-disclosure-requirements-regulations-2018_40002.html

13. EBizfiling. "Differential Voting Rights (DVR) Shares under Companies Act, 2013." https://ebizfiling.com/differential-voting-rights-dvr-shares/

14. iPleaders Blog. "The Delaware Flip: What Startups Should Know." https://blog.ipleaders.in/do-you-know-about-the-delaware-flip/

15. Business Standard. "PhonePe completes reverse flip from Singapore to India." October 17, 2022. https://www.business-standard.com/article/companies/phonepe-completes-reverse-flip-from-singapore-to-india-122101700847_1.html

16. Economic Times. "Groww shifts domicile to India from US." May 8, 2024. https://economictimes.indiatimes.com/tech/technology/groww-shifts-domicile-to-india-from-us/articleshow/109963874.cms

17. Inc42. "Zepto Completes Reverse Flip To Become Indian Entity." January 15, 2025. https://inc42.com/buzz/zepto-completes-reverse-flip-to-become-indian-entity/

18. Moneycontrol. "Meesho gets NCLT nod for reverse flip from Delaware to India." June 12, 2025. https://www.moneycontrol.com/news/business/startup/meesho-gets-nclt-nod-for-reverse-flip-from-delaware-to-india-11453789.html

Navigation¶

Previous: Chapter 9: Negotiating Your Best Deal
Next: Chapter 11: Dark Patterns - Predatory Terms to Avoid
Back to: Table of Contents

Related Chapters:

• Chapter 2: Valuation Fundamentals
• Chapter 7: Term Sheet Analysis
• Appendix C: Calculator Methodologies

Disclaimer¶

This chapter provides educational information about startup funding and is not legal, financial, or investment advice. Every startup situation is unique. Consult qualified professionals (lawyers, accountants, financial advisors) before making any funding decisions.

Last Updated: November 2025