BOARD EVALUATION – SEBI GUIDANCE NOTE

Board Evaluation – what does the term mean and signify? Do the boards of the companies too need an evaluation of their performances? Why such an evaluation is necessary when it is presumed that the board works with only one objective – maximization of company’s profits? Who will evaluate them? Will the evaluation be independent, non-biased and honest? And, most importantly, why it should be made mandatory by the legislators and regulators alike? These were some of the questions which came to my mind when I saw the latest Circular of SEBI in my mailbox. After going through the contents of the Circular, I was left with no doubts on the importance and necessity for such an evaluation of the boards of directors of the companies.

Historically, the companies’ management or the board of directors have had a free run in running and managing their companies. The investors are only concerned with the return on their invested money and gunning for maximum dividends and high share prices. Due to this reason, the companies did all they could, right or wrong, lawful or not, to report heavy profits, declare hefty dividends and thus making the share price spiral. However, off late, especially since the financial crisis of 2008, the management and the boards have increasingly felt the heat of the shareholders on the one side and regulators and the government on the other. This has forced the governments across the world to open their eyes and take note of the corporate governance practices and disclosures. Corporate governance is the new buzzword of the game, compliance culture and compliance risk management has taken a centre-stage. Board Evaluation is one such tool in good corporate governance and compliance risk management.

The companies listed on the NYSE must have and disclose a set of corporate governance guidelines and principles addressing, among other things, board evaluation under Listed Company Manual Section 303A.09 and Commentary (NYSE Listing Rules). The NYSE Listing Rules also recommend that the “board should conduct a self-evaluation at least annually to determine whether it and its committees are functioning effectively.” On the other hand, companies listed on NASDAQ do not have similar requirements, but many still engage in self-evaluation as a matter of good governance practice.

Now, the Securities and Exchange Board of India has come out with a Guidance Note on Board Evaluation for guiding the listed companies on the process and procedure for conducting board evaluation. The Guidance Note is just that – a guidance to help companies plan and put in place an effective system for board evaluation since it has now become mandatory under the Companies Act, 2013 and SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015. Several provisions under both the Companies Act, 2013 and SEBI Regulation have made it mandatory for companies to do an annual evaluation of their boards and various committees, with disclosers to stock exchanges where they are listed.

Board Evaluation is an important corporate governance tool as it provides the board and its committees a bird eye-view of the performance and the improvements required wherever necessary so that the danger of falling into complacency or stasis may be avoided. The most significant concern is the composition of the board with re-nomination of directors and their increasing tenure, which leaves little scope for improvement to meet the business complexities. Hence, the goal of the board evaluation must be an honest and thorough scrutiny of the board, individual directors, independent directors, the CEO/Chairman and various committees for the purposes of performance evaluation and to meet the expanding challenges of the businesses.   

Foreign Direct Investment in Indian Start-Ups: Opening up the Flood Gates

The Reserve Bank of India (India’s apex bank) (“RBI”) has recently amended and notified its Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) (Fifteenth Amendment) Regulations, 2016 (the “Regulations”) whereby it is now easier for the foreign investee to invest in Indian start-ups by issuing Convertible Notes.

The Amendment now permits Indian start-ups to raise early-stage funding by issuing Convertible Notes (the “Note”). The Note is an instrument which is issued as an instrument of debt which later gets converted into equity if and when certain specified conditions are met. If the contingent event does not take place, the instrument continues to be held as a debt which the issuing start-up will have to repay. Uptil now, the start-ups were not permitted to issue Convertible Notes and could raise funds only by way of equity participation.

The RBI has outlined certain key features of these Notes which are briefly explained as under:-

·       Definition of Note: The Note has been defined as an instrument which is issued by an Indian start-up to a foreign investor investing in the start-up on receipt of the money initially as a debt and which later gets converted into equity shares when certain specified conditions as mentioned in the Note are met. This conversion has to take place within 5 years from the date of issue of the Note. Alternatively, the holder of the Note has the option to continue it as a debt which becomes repayable by the start-up as per the terms and conditions stated therein.

·       Definition of a start-up: The start-ups for the purposes of these Regulations has been defined as a private company incorporated under the Companies Act, 2013 and 1956 and has been recognised as a start-up by the Department of Industrial Policy and Promotions, Ministry of Commerce. Effectively, this means that the start-up company must not be older than 5 years from the date of its incorporation and turnover of which has not exceeded INR 25 million in any financial year.

·       Minimum Amount: The minimum amount which the foreign investor needs to invest under the amended Regulations is INR 25,00,000 in a single tranche. Non-resident Indians may acquire the Notes but on non-repatriation basis in accordance with the Regulations.

·       Remittances: The amounts shall be received by the start-ups through normal banking channels or by debit to the NRE/FCNR (B) accounts. Additionally, the Regulations permit opening of the Escrow accounts for this specific purpose. Such Escrow accounts shall be closed immediately after the requirements have been met or not later than six months from the date of opening of the account.

·       Issuance of Equity: The equity shares shall be issued as per the provisions of the Regulations.

·        Transferability: The Notes are transferable. A person resident outside India may acquire or transfer, by way of sale, from or to, a person resident in or outside India, provided the transfer takes place in accordance with the pricing guidelines as prescribed by RBI. Prior approval from the Government shall be obtained for such transfers in case the start-up company is engaged in a sector which requires Government approval.

·       Compliances: The reporting of the issuance of the Notes by the start-ups have to be made to the RBI as prescribed in the Regulations.

Gray Areas

·       The start-ups engaged in the sectors where foreign investment is permitted on government approval, have to take prior approval of the government for issuance of convertible Notes. This may make the whole process more time-consuming and tedious.

·       The non-repatriation restriction for NRIs may make the instrument less attractive to them for investing and this may prove to be a substantial loss to the start-ups.

·       The Regulations are silent on the pricing/interest rate at the time of issuance of the Notes.

·       The Regulations are also ambiguous on the five-year period within which the Notes must be converted, if opted for conversion by the holder. Do they become compulsorily convertible at the end of the 5-year term?

Conclusion

All said and done, these amendments do open a new avenue for raising early-stage funding by the Indian start-up companies and also for foreign investment to come into India. Foreign investors too can rest at peace with their funds because if the start-up does well, they have an option to be a shareholder and reap benefits on their investments.

India is witnessing a surge in entrepreneurship and start-ups with the young technocrats eager and raring to take risks with their technological innovations. These Regulations surely seem to be a step in the right direction.