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Dematerialised woes await the MSME sector of India

Dematerialised woes await the MSME sector of India

25The government’s decision to also dematerialise all stocks of unlisted companies could create insurmountable obstacles in the path of already gasping small units

~By Sujit Bhar

The benefit of floating a limited liability company is in ensuring that in the unfortunate incident of a fire sale or forced liquidation, the promoters’ personal assets can, to a large extent, remain beyond the legal purview of attachment. In India, a Private Limited Company, or even the new Limited Liability Partnership Company format can provide this escape route.

However, it is not just for setting up an escape route that most businesspersons decide on a private limited stock company. The principal among the other options is the desire to hold the shareholding pattern close to one’s chest. That is not an illegal act, not by a mile. Such shareholding will have to be disclosed in the case of applying for a loan and/or in debt restructuring. The banks and company law authorities are well aware of the innards of a privately held company.

However, the government’s new idea of dematerializing stocks of a privately held company would mean a paradigm shift in the system. When public money is not involved in the promotion of a particular company—it being a privately held company—there remains a freedom in the underwriting of stocks by shareholders who would be doing this for the sheer benefit of the company. There is also the issue of the promoter refinancing the company, dipping into his or her personal assets.

The privacy issue is always at hand, especially with the recent Supreme Court’s nine-judge bench judgment—a whopping 9-0 verdict—that privacy is indeed a fundamental right. However, more importantly, there is the issue of the government probably refusing to accept that promoters of private companies in general lack the honesty and integrity in business. That is, to put it mildly, not a fair assessment of the entrepreneur class of the country.

Then there is the problem of how such stock would be dematerialized, and who would hold such stock in its dematerialized form and how. Also, who would be privy to such information? Listed companies’ stocks have all been dematerialized—all 6,000-odd of them. Such stocks are held in SEBI-government authorized depositories. This made sense, especially when quick transfer and sales is in question, as also when futures and options do come into play. It is also useful in the formation of portfolios of mutual funds because shareholders and the general public are aware of what the components of the bond look and feel like.

Stock-holding patterns of all listed companies are available on the respective stock exchange sites. However, if stocks of a private company are held in a depository in an electronic form, each and every stock of all the 16 lakh-plus registered companies would be up for scrutiny.

The government has admitted that scrutiny is the principal reason why this dematerialisation of privately held stocks is being considered in the first place. Nobody doubts the intention, but this being India, and corrupt practices being the main plank of administration, such  information can easily be used to  delve into a private company, blackmail its promoters and play havoc with its financial structure.

Shell companies are a menace, no doubt about it—the government has struck off 2.09 lakh companies from its registry already. But, quite like GST and Aadhaar, the government has not even thought about a fool-proof method to secure private information from prospective wrongdoers. Unlike publicly held and joint stock companies, the internal structure of a private company can change quickly and completely. This enables the company to sometimes handle big projects with meagre resources. If every move has to be immediately passed through electronic checkpoints, this will become difficult.

Also, going by the government’s track record in GST it will, probably, initiate the entire process in one go, with systems upending and breaking down, completely derailing business activity for a small entrepreneur. The MSME sector, already gasping for breath due to the fallouts of GST and demonetisation, will be the worst affected.

And talking about the MSME sector, we come to the intransigence of the banks. Even if the stocks are in dematerialised form, realising the value of a stock of a private company will remain as difficult, if not impossible, because market forces will not be acting on them. That would mean that providing for capital expenditure could remain as difficult for a small company, if not worse. The question is, what would be the end benefit of this mammoth task and increased paperwork for the small company? Indian banks, stoic in lending as they are, could place demands for changes in stockholding pattern and more, before they part with a penny. They will, effectively transfer all risk to the entrepreneur. Small firms survive on such debt.

Media reports have indicated that the Ministry of Corporate Affairs and Sebi are already talking about the huge number of issues that are set to come up in implementing the Companies Act, 2013.

The government has to remember that while the dematerialisation process for listed entities started in the mid-1990s it took a long time to formally put in place the elements and to tighten the millions of nuts and bolts.

The midnight-GST approach will spell doom for the MSME sector. It will be the second doom for them after demonetisation.

The ministry of Micro, Small and Medium Enterprises (MSME), says that the sector remains an “untapped high growth segment”. It says that by current estimates the entire MSME sector, spread across rural and urban India, comprises 51 million units and provides employment to over 117 million persons. The sector contributes 7 percent to India’s GDP while accounting for 45 percent of the total manufacturing output and 40 percent of the exports from India.

However, it has been found in independent studies that this sector’s contribution to the GDP has actually fallen by 0.5 percent in recent years and is slated to go down even further. At the same time, the study found, that 18.7 percent more MSME units have been added between 2014-15 and 2015-16. This means that the number of employees in them too has shot up. That was how the figure of 117 million was arrived at, starting from 81 million. This includes the organised sector, as well as an estimate of the unorganised sector.

If anything, it is the moral obligation of the government to nourish this sector, to keep all those people employed. Frankly, adding roadblocks in the paths of progress is certainly not one of them.

Big companies have the stomach to weather huge changes. Smaller ones don’t. In an age where banks are quickly distancing themselves from collateral-less units, more sorrow is not welcome.