Bailing out group companies

We have had two interesting cases of promoters losing control. The first was the case of Zee wherein they pledged shares of the parent company to bail out some of the infrastructure projects of the Essel group. The other group to recently lose control was the Khaitans in the case of Eveready. Here again, trying to save McNally Bharat proved too costly for the Khaitans and eventually they had to allow Burman family to take control. 

It is true of start-ups too

Promoters losing control and almost becoming persona-non-grata in the very companies they founded are common. We saw the two original founders of Flipkart forced to exit the company after their stake in Flipkart became too small to have a significant say. It was the PE funds that were calling the shots; even the sale of Flipkart to Wal-Mart. Another recent case is that of Ashneer Grover losing control over Bharat Pe and being forced out of the board. Here again, it was a case of clear differences between the original promoter and the private equity investors. What are the reasons driving such loss of control in business? 

Debt and stock pledges

Too much debt has been a bad word from times immemorial. From the days of Polonius, the advice was “Neither a borrower, nor a lender be”. The cases of Zee, Dish TV, Eveready Industries are all cases in point. First, these companies take on too much debt and enhance the solvency risk. They reach a point, when the only way they can get funding to bail out their businesses is to raise debt by pledging promoters’ shares. In most cases, the promoters have struggled to repay the debt and that has led to the lenders selling the shares in the market. That is how the share of the Khaitans in Eveready fell from 44% to 4.84% in a span of less than few months. It can be a deadly combination for any business. 

Diluting too much as start-ups

This was the precise problem that the companies like Flipkart faced. Over time, they just kept diluting their stake and eventually, they did not have enough to have a say in matters. For instance, Paytm promoter Vijay Sekhar Sharma owns just about 10%. It is hard to see how he can exercise control and stand up to billion dollar institutions with deep pockets. That brings us to the basic question of whether bootstrapping is a better idea, but that is not the purpose of this debate. The bottom line is that losing control of the business you built from scratch is quite easy. Promoters have to now start building defenses!