InvestorQ : What is really driving this situation and why are promoters losing control of the companies that they built?
Dilmini Mercia made post

What is really driving this situation and why are promoters losing control of the companies that they built?

Dawn Cherian answered.
12 months ago

Broadly, there are 2 reasons why the promoters lose control. If you look back at any of the recent cases, it is either due to too much debt or it is because of very little promoter stake in the company. I am not counting companies that defaulted and went bankrupt. They are not included in our base case for defence mechanism. Let me outline the two key reasons why Indian promoters have lost control in the recent past in the companies they built.

The first is a deadly combination of too much debt, group company guarantees and stock pledges beyond 50% of holdings. Too much debt has been a bad word from ages. Zee, Dish TV, Eveready Industries are all examples. These companies took on too much debt and enhanced solvency risk.

At some point, lenders are unwilling to lend unless the promoters pledge their shares. That is where the problems start. When promoters struggle to repay the debt, lenders sell the shares in the market. Khaitans stake in Eveready fell from 44% to 4.84% in a span 3 months. This is the most common reason for loss of control.

The other reason is that promoters end up diluting too much of their stake, because in every successive fund raising, the PE funds are able to bring in funds but the founders are not able to infuse funds leading to loss of control. This was the problem that the start-up companies like Flipkart faced. Over time, they kept on diluting their stake and eventually, they did not own enough stake to have a say in matters.

Look at the case of companies like Paytm. Vijay Sekhar Sharma owns just about 10%. It is hard to see how he can exercise control when fresh funds have to be infused and he is not in a position to participate. The bottom line is that losing control of the business you built from scratch is quite easy, while being extremely painful. Promoters have to now start building defences and the domestic institutions have to lend support, as in the past.