Non-public Fairness Comparative Information – Corporate/Industrial Legislation

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1 Legal framework

1.1 Which general legislative provisions have relevance in the private equity context in your jurisdiction?

In India, a plethora of legislative provisions at federal, provincial and local or municipal level intermesh and have relevance in the private equity context. The key statutes – in particular, at the federal level – that have territorial application across India, both horizontally across industry sectors and vertically through all segments of (especially) foreign or cross-border private equity investments into India, include the following:

  • The Companies Act, 2013 governs, in particular, the conditions and procedures relating to the issuance and transfers of shares and other securities, as well as providing for governance provisions for boards and shareholders.
  • The Income Tax Act, 1961 governs all direct taxation-related aspects of private equity transactions, including applicable taxes on income generated, capital gains tax, tax benefits, exemptions from tax liability and methods to determine the valuation of shares and other securities – this legislation is to be read together with the applicable double taxation avoidance treaty or agreement (if any).
  • The Foreign Exchange Management Act, 1999 (FEMA) enables the Reserve Bank of India (RBI), India’s central bank, to monitor and regulate all foreign investments into target companies in India, acting in this regard under or pursuant to powers granted to it under the Reserve Bank of India Act, 1934 and related banking laws and regulations.
  • The Consolidated Foreign Direct Investment (FDI) Policy is issued and amended from time to time by the Department for Promotion of Industry and Internal Trade of the government of India, along with various rules, regulations, guidelines, master circulars and other delegated provisions issued either by the government of India or by the RBI, especially pursuant to FEMA, in particular regulating FDI into India.
  • Regulations issued by India’s securities markets regulator, the Securities and Exchange Board of India (SEBI), govern and regulate private equity investments into a listed entity, such as:
    • the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018;
    • the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations 2011; and
    • the SEBI (Alternative Investment Funds) Regulations, 2012.
  • In relation to the due diligence processes and reviews typically conducted in connection with and prior to the conclusion of private equity transactions, the laws typically relevant include all labour laws, environmental laws and rules providing for necessary registrations with various governmental authorities, subject to the industry or field in which the target carries out its business and operations.

1.2 What specific factors in your jurisdiction have particular relevance for and appeal to the private equity market?

Over the decade and a half after liberalisation of the India economy in the early 1990s, the Indian private equity market at first witnessed smaller investments in technology-oriented companies, before evolving in the past decade or so into a fully equipped and knowledgeable field with a wide range of funding structures for private equity investments across various industries. In particular, today’s Indian private equity market has evolved into a larger, more mature and more diverse market of a wide range of targets for such investments; almost akin to structures typically found in developed markets across the world.

In light of these circumstances, three specific factors are of particular relevance and appeal in the Indian private equity market. First, India – much like the rest of the Anglo-Saxon world – is a common law jurisdiction encapsulating legal principles largely similar to, and incorporating key regulatory and enforcement structures found in, the United Kingdom and the United States. Familiarity is therefore a key facet of the Indian legal system, especially when viewed from overseas.

Second, the Indian legal system as regards the commercial world is based on the principle of freedom of contract, coupled with the principle of the due and proper enforcement of contractual provisions freely entered into (operating, of course, within a democratically ordained legal order, subject to the rule of law and the freedom of the judiciary). This makes it easier for foreign investors to understand, enter, navigate and exit the Indian market.

Third, in the decades since liberalisation, the regulatory authorities have introduced and developed meticulous procedures and rules to govern private equity transactions of different types – a clear sign of the maturity of the Indian market in this regard. As a result, Indian companies in general, and particularly overseas private equity investors, benefit from growing certainty and increasing exactitude in the regulatory environment in India.

2 Regulatory framework

2.1 Which regulatory authorities have relevance in the private equity context in your jurisdiction? What powers do they have?

Various regulatory authorities are relevant in the private equity context, including at the federal level:

  • the Ministry of Corporate Affairs;
  • the Reserve Bank of India (RBI);
  • the Department for Promotion of Industry and Internal Trade (DPIIT); and
  • the Securities and Exchange Board of India (SEBI).

All private equity transactions are governed by the applicable provisions of the Companies Act and the rules, regulations, directions and other circulars issued thereunder by the MCA. They are therefore regulated by the Registrar of Companies (RoC) under the authority of the MCA having territorial jurisdiction over, and at the place of incorporation of, the Indian target entity.

For listed companies, and in respect of transactions occurring in the public markets, SEBI, as India’s securities’ markets regulator, is empowered to regulate the substantial acquisition of shares and the takeover of public companies, as well as public offerings of securities on India’s stock markets (as well as overseas listings of Indian companies).

The RBI – as an autonomous central bank – is empowered to frame detailed regulations and rules in respect of all foreign exchange transactions under the Foreign Exchange Management Act (FEMA), and acts in this regard in tandem with the government of India, through the DPIIT.

In certain circumstances, depending on the quantum and the types of transactions or the industry sector of the target or other factors, private equity transactions are also regulated by other regulatory authorities such as the following:

  • the Competition Commission of India (CCI);
  • the Insurance Regulatory and Development Authority; and
  • the Pension Fund Regulatory and Development Authority.

The CCI in particular, is empowered to issue directions to curb and prohibit, as it may determine, industry practices which may have an appreciable adverse effect on competition within industries, which may be read with the Consolidated Foreign Direct Investment (FDI) Policy to the extent applicable.

The powers of each of these authorities to govern private equity transactions in their domains are dependent on the nature of the investment transactions, the parties involved and other factors that trigger the various regulatory requirements.

2.2 What regulatory conditions typically apply to private equity transactions in your jurisdiction?

General conditions and regulatory approvals: Private equity transactions in India are primarily governed by the Companies Act and, where a foreign investor or seller is involved, the FEMA regulations and other regulations, guidelines and similar issued by the RBI from time to time.

The Consolidated FDI Policy regulates the inflow of foreign investment into India and imposes general conditions as well as sector-specific limitations, conditions and other restrictions on such investments. It distinguishes between:

  • the ‘automatic’ route, where no prior investment approvals are required (although in order to properly make the investment and secure the proper benefit of the non-approval investment route, certain reporting and compliance requirements post-completion of the funding must be met); and
  • the ‘government’ route, which requires the prior approval of investments in companies in certain industries or beyond certain sectoral caps.

Most investments into India today fall into the former category, which means that the lists of industries and types of transactions for which prior approval is needed, and the limitations on the percentage of foreign investment in India entities, are quite limited. However, since a recent change to the Consolidated FDI Policy in April 2020, any investments from all foreign investors or beneficial owners of an investor who is a resident of a country that shares a land border with India:

  • can be completed only after obtaining government approval; and
  • must be completed at or above the fair market value of the shares as determined under applicable law.

The Companies Act prescribes certain conditions and approvals for the issuance of fresh shares and for the transfer of existing shares, including:

  • advance internal approval by the board of directors and shareholders of the company, as set out in the articles of association of the company; and
  • all advance approvals required under the Companies Act.

Such actions include:

  • increasing or modifying the authorised share capital of the company;
  • obtaining shareholder consent for the issuance of shares;
  • filing these resolutions with the RoC; and
  • other such corporate or filing actions.

The target must also obtain necessary industrial licences based on the market in which it operates.

The FEMA regulations specify the conditions applicable to any issuances or transfers of securities of an Indian company to or by a person resident outside India, including pricing guidelines, remittances of sale proceeds and mandatory reporting requirements to assess and verify the fulfilment of applicable conditions. For instance, the RBI has introduced:

  • an ‘entity master form’, which is a record of the details of companies taking or having taken foreign direct investment; and
  • a ‘single master form’, which is to be updated by such companies each time there is an issuance or transfer of its shares to a foreign investor under a Form FC-GPR (in cases of issuances) or Form FC-TRS (in cases of transfers), respectively.

Valuation: The Companies Act, the Income Tax Act and the FEMA regulations, as applicable, set out specific conditions to determine the fair market value of the shares of a company, which shall be determined by a registered valuer, subject to the company’s financial status and business operations. This determines the price at which most issuance or transfer transactions must be consummated.

Registrations: All investment-related agreements must be duly stamped under the relevant stamp statute, whether state or federal; and, to the extent applicable, registered under the Indian Registration Act, 1908.

3 Structuring considerations

3.1 How are private equity transactions typically structured in your jurisdiction?

In one or multiple tranches of investment, involving either Indian residents only or both Indian residents or foreign residents (or any combination thereof), a private equity investor may choose to directly subscribe to in primary mode, or to acquire (in secondary fashion), the shares of an Indian target by investing onshore in India as follows, at a price per share determined based on a valuation provided by a registered valuer:

For a primary investment by subscribing to fresh shares issued by the Indian target:

  • the target must ensure that it has the authorised share capital to issue such fresh shares and if not, it must duly increase its authorised share capital under the Companies Act by passing the appropriate resolutions and making the requisite filings (along with the payment of the necessary fees) with and to the RoC; and
  • shares are then issued on a ‘rights basis’ or pro-rated basis in accordance with the existing shareholding (where new investors come in after such rights are refused, declined or lapse), or through a private placement process by making an offer to investor(s), subject to and in accordance with the Companies Act. Most private equity transactions follow the ‘private placement’ route for such primary issuances, as there are both regulatory and taxation related complications in adopting the ‘rights basis’ issuance route in cases involving foreign investors or entities that are not already shareholders or members in the Indian entity.

For a secondary investment by purchasing existing shares of an Indian target from its existing shareholders:

  • the selling shareholder(s) must disclose any encumbrances or charges on the shares being purchased by the investor(s) or confirm that such selling shareholder(s) has the rights, title and interest in such shares to transfer the same; and
  • the parties must sign the share transfer form for the transfer of physical shares or, in case of transfer of dematerialised shares, follow the necessary procedures in place with their respective depositories to complete the transfer in such dematerialised form, in accordance with applicable law, including notifying the company to record such transfer in the statutory registers as applicable.

A combination transaction is a combination of a primary investment and a secondary investment.

In terms of transaction structuring, private equity investors may also consider an ‘externalisation’ structure or an ‘offshore’ structure, distinct from the direct onshore investment structures described above. As far as India is concerned, private equity investors primarily resort to this in order to avoid being caught up in Indian regulations and restrictions, and to legally sidestep both the Indian legal system (and its legendary delays) and India’s often notorious bureaucracy.

This ‘externalisation’ structure involves the promoters of the Indian target entity establishing an overseas or foreign holding company – typically in a tax or regulatory-friendly jurisdiction, or one which has a close connection commercially with India, such as Mauritius or Singapore respectively – which then holds 100% of the operating Indian entity. All private equity investment then occurs at the overseas holding company level, with a flow-through contractual structure put in place to regulate the Indian wholly owned subsidiary and downstream the private equity investors’ rights at the overseas level through to the operating Indian entity. While this structure appears to achieve the objective of avoiding the Indian legal system mentioned above, the various issues and potential downsides of such a transaction structure are outlined in question 3.4.

3.2 What are the potential advantages and disadvantages of the available transaction structures?

A primary investment where a private equity investor subscribes to fresh shares of a target company will almost certainly ensure that the shares are not encumbered (it would be prudent though, to ensure that such shares are duly authorised and properly issued at the threshold); while a secondary transaction for the purchase of existing shares may carry the risk of losing or limiting the title to the shares so purchased, depending on the acts or omissions of the seller, which may have the effect of encumbering or restricting the rights to such shares so transferred. In both cases, appropriate due diligence should reveal any concerns that can then be suitably addressed prior to the transaction’s completion.

Since the target is also the direct recipient of the primary investment, it becomes easier to achieve and realise the value of the investment, given that the company can be sued directly for loss of any such value; and, importantly, all rights vis-à-vis the shares and the investment can be directly enforced through the company’s articles of association against the company itself and its shareholders. On the flipside, in a secondary transaction, it may become difficult to follow the selling or exiting investor, as that person may no longer be within the jurisdiction of the target, for the private equity investor to sue and recover from both the target entity and its previous shareholder, simultaneously.

Both primary and secondary investments require extensive due diligence on the target, the promoters and, as applicable, the selling shareholder. Such due diligence is subject to a fair share of risks and uncertainty in relation to various aspects of the target, including the assets of the target, its financial position, taxation issues and claims and litigation.

Undoubtedly, the ‘externalisation’ structure has the greatest advantage of not being subject to any potentially restrictive or prohibitive Indian legal conditions or stipulations. That said, the various issues and potential downsides of such a transaction structure are discussed in question 3.4.

3.3 What funding structures are typically used for private equity transactions in your jurisdiction? What restrictions and requirements apply in this regard?

Private equity investors may invest into India offshore directly from their overseas fund – in which case the type of funding structure is classified as FDI into India. In other words, the investor utilises as its investment vehicle its overseas fund directly – as incorporated or typically situated in a country with which India has a favourable double taxation treaty – so as to legitimately obtain the benefits thereunder. Such an offshore funding structure enables the investor to pool its funds overseas and invest into India without the need to register its overseas investment vehicle in India. This has proven to be a cost-effective strategy and has been adopted by the vast majority of private equity investors into India.

By adopting this offshore route of funding, a private equity investor benefits significantly from not being required to register its investment vehicle in India. That said, two important restrictions or requirements arise:

  • It is vital for the private equity investor to establish that it is a resident only of the country in which it is incorporated overseas, so as to ensure that it can take full advantage of the benefits of the double taxation treaty between the place of its incorporation and India; and
  • Depending on the offshore type of funding structure it has in place, the investor will continue to be subject to the Indian pricing regulations as regards the valuation at which it may either invest in, or subsequently transfer its shares of, the Indian entity. In other words, as such an offshore investor, the private equity investor can invest in or exit from India only by adhering to the fair valuation mechanisms and prices of the Indian entity’s shares, as stipulated and as calculated in accordance with applicable Indian regulations, depending, among other things, on the residential status of the transferee.

Alternatively – and, critically, depending on whether the sources of its funds or its own limited partners are foreign vehicles investing in US dollars or other foreign currency or Indian domestic investors investing in Indian rupees – private equity investors may also consider setting up an alternative investment fund (AIF) under the Securities and Exchange Board of India (SEBI) (AIF) Regulations, 2012, to pool their investment funds onshore in India and invest therefrom not as FDI, but as a domestic rupee-based investment.

In following an onshore funding strategy, the private equity investor must register the AIF in India and thus becomes subject to various reporting and other requirements which are typically applicable to entities governed and regulated by the registering authority in India – in this case, SEBI. However, AIFs benefit from the free pricing mechanism available under Indian law as regards investments in, or transfers of the shares of, an Indian entity.

However, the SEBI guidelines for AIFs and other fund structures, the Foreign Exchange Management Act (FEMA) guidelines impacting on overseas investments (including in relation to pricing) and the tax implications must be closely examined prior to the transaction; and the conditions thereunder must be satisfied.

3.4 What are the potential advantages and disadvantages of the available funding structures?

The advantages and disadvantages of various funding structures are based on the type of fund or investor and the applicable registration requirements under the applicable SEBI regulations. The pricing guidelines under the Companies Act, FEMA and the Income Tax Act must also be considered in relation to the private equity investment based on the type of funding structure.

However, various restrictions and guidelines are in place to ensure that no shell companies retain income outside India despite the company’s management taking place in India. For instance, the concept of ‘round-tripping’ – whereby Indian funds held in overseas entities are reinvested in an Indian entity as FDI – is generally prohibited under FEMA. Additionally, if a company’s place of effective management is in India, it will be treated as an Indian resident and its global income will be taxable in India.

In order to curb round-tripping of funds, regulations of the Income Tax Department of India, the Reserve Bank of India (RBI) and the Enforcement Directorate, along with the general anti-avoidance rules, apply to any situation where a particular route of investment through a foreign entity is chosen with the intention of evading or avoiding taxes under Indian law.

Foreign or non-resident taxpayers involved in such transactions should seek advice on the tax payable in India for potential transactions in India, including in light of any double tax treaty between their tax region of residence and India. Subject to the existence of double taxation treaty benefits, any taxes paid by the foreign tax resident on the transfer of shares in its country of residence may be evidenced to the Indian tax authorities by providing a foreign tax credit document along with all documents prescribed under applicable law; and any excess tax payable in India must be duly paid by such foreign tax resident.

3.5 What specific issues should be borne in mind when structuring cross-border private equity transactions?

Cross-border private equity transactions are governed by regulations issued by the RBI, specifically under FEMA. Key factors to be considered in cross-border private equity transactions are pricing regulations (including the method to determine valuation of shares) and taxation laws applicable to the transaction, as explained previously above. The shares issued to or purchased by a foreign investor are closely monitored by the RBI through the mandatory filings and disclosures made by companies through the single master form on the RBI website and/or the annual return for foreign liabilities and assets of a company which is filed with the RBI, in particular.

The RBI also restricts and regulates payment processes in private equity transactions. For instance, the RBI restricts deferred payment for the purchase of shares between a resident buyer and non-resident seller and vice versa, as follows:

  • Not more than 25% of the total consideration for the purchase of shares shall be deferred; and
  • Such deferred payment must be made within 18 months of the date of execution of the transfer agreement.

In addition, the tax status of a foreign investor or seller must be appropriately warranted by such foreign investor for the purpose of determining the tax implications of such cross-border transactions, which may also be affected if India is a party to a double taxation treaty with such country.

3.6 What specific issues should be borne in mind when a private equity transaction involves multiple investors?

Where multiple investors are involved in a single round of private equity investment into a target, it may become operationally challenging to obtain individual consent from each investor for certain decisions of the target, or to convene meetings for the exercise of their voting and governance rights. Most companies execute shareholders’ agreement with their investors to categorise and divide their investors into similar groups, which may then potentially jointly exercise their rights in the company.

The following key factors must be considered prior to documenting the rights, obligations and restrictions of such investors in a transaction document and making appropriate filings in relation thereto:

  • Differentiation based on classes of shares: If different investors subscribe to or purchase different kinds and classes of shares, the terms of such shares shall differ between the investors; and
  • Differentiation based on categories of investors: The rights associated with the shares issued to or purchased by investors (eg, veto rights, exit rights, transfer restrictions, governance rights and liquidation or distribution preferences) may vary among different types or classes of investors and/or may depend on the value (and timing) of their respective investments.

In the case of multiple foreign investors, it is important to determine which investor requires governmental approval for investments into companies in certain industries and sectors, as specified in the Consolidated FDI Policy, and which may invest through the ‘automatic’ route. For instance, as earlier mentioned, the Consolidated FDI Policy was revised in April 2020 to mandate prior government approval for all investments from all foreign investors or beneficial owners of an investor that are registered in or citizens of a country that shares a land border with India. The pricing for such investors must also be at or above the fair market value of the shares of the company.

4 Investment process

4.1 How does the investment process typically unfold? What are the key milestones?

A typical private equity investment transaction in India generally involves the following key steps and milestones along the way:

  • Term sheet: The parties may set out their commercial agreement or understanding of their respective rights and obligations in a non-binding term sheet or letter of intent.
  • Due diligence: Once the term sheet is in place, the investor usually conducts legal, financial and business (and sometimes, an operations and technical) due diligence on the target and does a background check on the promoters of the target.
  • Investment documents: The parties finalise investment agreements pursuant to the provisions of the term sheet, subject to any modification or negotiation of terms or conditions based on the due diligence reviews conducted by the investor(s). This usually includes:
    • a share subscription agreement (for a primary transaction);
    • a share purchase agreement (for a secondary transaction); and
    • a shareholders’ agreement to govern the rights and obligations of the parties involved in relation to the company and among themselves, as shareholders.
  • The findings from the due diligence are incorporated into the investment agreements as conditions precedent or requisite indemnities, along with necessary consents or closing actions or conditions subsequent, depending on:
    • the nature of the issues raised by the due diligence;
    • the timelines required or envisaged to complete the deal;
    • the action items to comply with to remedy any particular issues; and
    • the commercial understanding between the parties.
  • Once finalised, the investment agreements are duly stamped under applicable Indian stamp laws and executed by the parties.
  • Closing or completion: Subject to the conditions precedent to the investment transaction being complete or waived by the investor(s), the investment is completed and the shares are issued or acquired by the investor, alongside the wiring or injection of the investment funds simultaneously, in accordance with the Companies Act and the rules thereunder.
  • Post-closing actions/conditions subsequent: The target and the promoters, or the selling shareholders, as the case may be, are obliged to complete all post-closing actions required to complete the issuance or acquisition of shares (typically, the reporting requirements, alluded to above), and any other conditions subsequent required by the investor and agreed upon in the investment agreement, including the actions and conditions arising from the due diligence conducted by the investor.

4.2 What level of due diligence does the private equity firm typically conduct into the target?

The due diligence conducted into the affairs of the target usually includes legal due diligence, financial and taxation due diligence, and business/commercial or operational due diligence, with IT due diligence, HR due diligence and IP due diligence sometimes occurring depending on the nature of the business of the target. The advisers engaged by private equity firms to carry out the due diligence classify risks identified through the due diligence review and usually categorise them as high risk, medium risk and low-risk issues.

While the general and stated objective of such due diligence enquiries is to verify the basis for the valuation of any particular private equity investment deal (and to provide any adjustments thereto depending on the due diligence findings), the legal obligation created thereby is one of knowledge – actual or constructive – that may be affixed on the private equity investor(s) as a result, thereby affecting the indemnification rights of such investor(s), arising from any breaches of representations and warranties provided by the sellers of the target.

The scope, depth, range and extent of the due diligence depend on:

  • the operations of the target;
  • its vintage;
  • the field in which it is active (in particular, where it operates in a highly regulated environment);
  • the extent of its compliance (or otherwise); and
  • more generally, how well run and managed it has been, or is perceived to be.

In addition, most investor(s) run a background check on the sellers of the target, although any such forensic audit of the target and its sellers is often less instructive than similar processes in the developed world, because the available databases and the strength of such information in India can be quite patchy in comparison.

As in most common law jurisdictions, it is in the hands of the private equity investor to observe the principle of ‘buyer beware’, and ensure that it is satisfied (or otherwise) as to the state of affairs of the target and the extent of its liabilities and obligations on closing, in order to claim necessary protections through indemnities provided by the target. In other words, any reliance on representations and warranties provided by the target will be caveated by the extent of the knowledge of any pre-existing liabilities (whether actual or implied), and how such knowledge can be excluded legally. This is typically coupled with a range of disclosures that the sellers or issuer makes in response to or caveating, as appropriate, the representations and warranties it provides. Here again, much depends on the negotiations between buyer and sellers as to how pre-existing risks and liabilities are handled and adjusted between the parties in the context of completion of the investment transaction.

4.3 What disclosure requirements and restrictions may apply throughout the investment process, for both the private equity firm and the target?

Private equity investor(s) seek a comprehensive set of representations and warranties from a target and its promoters (or, in case of a secondary transaction, from the target and its promoters, as well as the selling shareholders) in relation to:

  • the capacity to execute the investment agreements and complete the transactions contemplated therein;
  • business warranties;
  • corporate governance warranties;
  • tax warranties;
  • warranties in relation to litigation against or by the company; and
  • any other warranties that may be required from the target in relation to its business or the type of industry in which it is involved.

While private equity investors seek representations and warranties pursuant to their due diligence on a target, most warranties are sought from the target regardless of any due diligence conducted by the private equity investor and the scope of such due diligence, and the target is given the opportunity to make any disclosures against such representations and warranties to the investor, except for title warranties and other warranties which are fundamental to successful completion of the investment transaction and ancillary actions.

As in most other common law jurisdictions, the target and any selling shareholders have no general duty to disclose – except, crucially, where the investor has sought an explanation or information and the same has been denied or ignored, a situation tending towards fraud or wilful concealment. In other words, it is in the best interests of the target to make the maximum possible disclosures in order to obviate or reduce its obligation to indemnify the investor – subject, of course, to any confidentiality obligations it may have with regard to any such disclosures, in which case advance consent for such disclosures may be required. As mentioned in question 4.2, much depends contractually on where and how the risks and liabilities are allocated or adjusted between the buyer and the sellers, as well as on the negotiating strengths or weaknesses of either party. In the absence of such contracts to the contrary, the underlying principle of Indian law is ‘Buyer beware’.

Private equity firms must typically ensure that the representations and warranties are true and accurate, especially as regards the source of the target’s funds, so as not to fall foul of India’s anti-money laundering laws in particular. Such entities must also ensure that the investment transaction is duly authorised for them to enter into and execute or complete.

4.4 What advisers and other stakeholders are involved in the investment process?

Other than the target, its promoters, any selling or existing shareholders of the target and the investors, the advisers and other stakeholders involved may include, without limitation:

  • directors of the target;
  • employees of the target (generally key employees or managerial persons);
  • creditors and debtors of the target;
  • customers of the target; and
  • legal and financial advisers.

5 Investment terms

5.1 What closing mechanisms are typically used for private equity transactions in your jurisdiction (eg, locked box; closing accounts) and what factors influence the choice of mechanism?

An investor may require the fulfilment of certain conditions precedent prior to closing the transaction, as specified in the negotiated investment agreement. If these conditions precedent are not fulfilled (or are not waived by the investor), the investor is not obliged to complete the transaction and may terminate the investment agreement.

Conversely, the target or the selling shareholders may seek either specific performance of completion of the transaction or damages for any expenses incurred if the investor chooses not to invest once the conditions precedent have been satisfied by the target and/or the selling shareholder(s). Conditions precedent may include:

  • legal and regulatory approvals;
  • third-party consents, such as consent from lenders;
  • confirmations on compliance with tax laws and other requirements under applicable law; and
  • conditions arising from the due diligence conducted on the target.

In addition, private equity investors generally seek closing accounts from the target which indicate the financial position of the company on the closing date (ie, the date of completion of the transaction). Private equity investors may also negotiate a ‘locked-box’ mechanism with the target, whereby the investment amount is fixed based on historical financial statements in the investment agreement and is protected through the covenants, warranties and indemnities provided by the target or the selling shareholder(s) to the investor.

The parties may agree upon permitted reductions to the valuation of the target (‘leakages’) between the date of execution of the investment agreement and the date of completion of the investment transaction. The advantage of the locked-box concept is that the investor has visibility and control over the price of shares being issued or purchased without any significant variance between the date of execution and the date of completion of the transaction. However, this may not be feasible if the period between the execution date and the completion date is too long and the target attempts to cover any major costs as permitted reductions (which remains a matter of commercial negotiation). Furthermore, the private equity investor may choose alternative protective mechanisms, such as the escrow of consideration payable or the dematerialisation of physical shares ahead of closing. However, the escrow mechanism may be expensive in certain cases, depending on the timeframe for completion of the transaction. In addition, the escrow of a portion of the consideration cannot be deferred beyond 18 months from the transfer agreement date; and not more than 25% of the total consideration may be escrowed in accordance with the Foreign Exchange Management Act regulations.

5.2 Are break fees permitted in your jurisdiction? If so, under what conditions will they generally be payable? What restrictions or other considerations should be addressed in formulating break fees?

Break fees are deal protection measures whereby a party to a transaction agrees to pay a fixed fee to the other party if the transaction is not consummated due to the occurrence of a specific event. Although not very common, break fees are permitted in Indian private equity transactions and are a contractual agreement between the parties. The parties may agree on break fees and specific performance measures in the investment agreement if either party voluntarily disrupts or chooses not to complete the transaction.

The break fees are generally held in escrow, and the parties may agree on the events that trigger payment of the break fees (subject to any exceptions recorded in the investment agreement), such as the following:

  • The target or a selling shareholder chooses a different investor;
  • Either party decides to stop negotiations; and/or
  • Any disclosures are made or facts arise in the due diligence process which may affect the investor’s decision to consummate the transaction.

An important exception that must be considered in this regard is the extent of the application of any ‘force majeure’ events, such as the recent modifications to the foreign direct investment regulations requiring prior government approval of any investments from neighbouring countries, aimed at Chinese investments into India.

5.3 How is risk typically allocated between the parties?

Investor risk: A private equity investor enters into a transaction with a target or a selling shareholder based on representations and warranties provided by the seller and covenants provided under the relevant investment agreements. Any breach of such representations and warranties which may cause losses to the investor entitles the investor to seek indemnification under the commercial agreement with the company and/or its promoters. Investors also seek contractual and specific voting or decision-making rights in relation to specific matters and may restrict the promoters (especially in the case of earlier stage entities) from transferring their shares for a fixed period following the investment.

Company/promoter risk: The promoters and existing shareholders of the target may be diluted by the private equity investment and the rights in relation to their shares may be reduced as a result. The target and the promoters are obliged to provide an exit for the private equity investors within a timeframe specified in the relevant investment agreement; but this may be difficult if the business of the company is adversely impacted. The target and its promoters will also make necessary disclosures to the investor against the representations and warranties made under the investment agreement at the time of making such representations and warranties; and will agree to indemnify the investor in case of any issues or claims that arise in relation to such representations and warranties.

Indian law allows for an investor to rescind an investment agreement for misrepresentation – however, a misrepresentation (even a fraudulent one) does not entitle the investor to rescind the agreement to invest if it could have discovered such misrepresentation through ‘ordinary’ diligence. Breaches of warranties, on the other hand, give rise to a claim in damages, but not to a right to repudiate the contract of investment. Whether a stipulation in a contract of sale is a condition or a warranty depends in each case on the construction of the contract. A stipulation may be a condition, though called a warranty in the contract. To that extent, therefore, Indian law – like English law – distinguishes between a misrepresentation and breach of a warranty; although it remains to be seen how much Indian law has actually moved away from this distinction through the use of the ubiquitous indemnification remedy, rather than damages.

All parties involved in an investment transaction may be affected by a material adverse change in the business and operations of the target – that is, the occurrence of any event or change which may adversely affect the business or operations, financial conditions, assets or performance of the target. If a material adverse change occurs, the private equity investor may choose to opt out of the investment or reduce the investment amount.

5.4 What representations and warranties will typically be made and what are the consequences of breach? Is warranty and indemnity insurance commonly used?

An investment agreement generally includes representations and warranties, which are statements of facts that are true at the time of execution of the agreement and at the time of consummation of the transaction. These include:

  • extensive statements on the capacity of the parties to enter into the agreement;
  • business and corporate existence warranties;
  • financial and tax warranties; and
  • warranties in relation to compliance with laws, intellectual property, real estate and policies.

The scope of the representations and warranties provided by the target and its promoters and/or any selling shareholders depends on the type and size of the transaction. The investor will also seek indemnification from the target and its promoters in case of any breach or misrepresentation of the warranties provided by them; and may also seek specific indemnification for certain issues or non-compliance of the target which may affect the return on the investment. The target and its promoters may provide necessary disclosures against the representations and warranties sought by the investor from the target and/or the promoters and/or the selling shareholders.

Certain companies and promoters may choose to obtain insurance for any indemnity claims arising from the breach of representations and warranties to limit their losses from indemnity claims. This indemnity insurance may be structured based on:

  • the consideration involved in the transaction;
  • the insurance obtained by the company;
  • the indemnity caps agreed between the transacting parties; and
  • other transaction-specific factors.

Similarly, the investor may also obtain insurance for any breach of warranties if the indemnity provided by the seller is limited. However, while the indemnification obligation may be contractually agreed, it remains independent of any claim in relation to damages under applicable law.

6 Management considerations

6.1 How are management incentive schemes typically structured in your jurisdiction? What are the potential advantages and disadvantages of these different structures?

Targets generally offer the following management incentives to ensure that the management-level personnel use the private equity investment to meet the milestones agreed with the investor(s).

Employee stock options (ESOPs): ESOPs are the equity compensation which is granted to the employees and executives of the target. The target sets out a vesting schedule and provides the employees with the right to buy shares in the company at the specified price within the specified timeframe. ESOPs are granted under a governing ESOP plan approved by the board of directors and cannot be issued to independent directors, promoters of the company (which is an important exception) or any director holding 10% or more of the shares of the company, among other criteria, exceptions and conditions.

Stock appreciation: These are rights granted to the employees of the company as a form of bonus. The employees need not pay any exercise price are entitled to a sum of the increased stock price, either in cash or in equity. This mechanism is also beneficial for the company, as there is no dilution of the shareholdings of the company and the bonus is paid subject to the company’s performance.

Sweat equity shares: These are rights granted to employees for the ‘sweat of the brow’ – in other words, their performance – to show appreciation for their efforts. A company granting sweat equity shares will generally specify the performance parameters on the basis of which the sweat equity shares may be granted or exercised.

A company may issue sweat equity of a maximum of 15% of the paid-up equity capital or INR 50 million in a year, whichever is higher, without prior government approval. The total issued sweat equity shares in a company cannot exceed 25% of the total paid-up capital of the company at any time. Registered start-ups are exempt from this rule and may issue sweat equity shares up to 50% of the paid-up capital for a period of five years from the date of incorporation. Sweat equity shares are locked in and non-transferable for at least three years from the date of allotment, in accordance with the Companies Act and the rules established thereunder.

The advantages and disadvantages of these structures may vary based on the type of company and the industry in which it operates, as well as any commercial policies that the company and its investors may implement to incentivise its employees. Subject to the company’s performance and preference, the company may determine the percentage of such options and incentives (on a fully diluted basis) and the vesting period for the same.

6.2 What are the tax implications of these different structures? What strategies are available to mitigate tax exposure?

ESOPs: ESOPs are considered perquisites at the time of their exercise, where the difference between the fair market value and the exercise price is taxable and is treated as income from salary. If the ESOP holder decides to sell any shares from the exercise of his or her ESOPs, the difference between the fair market value and the sale amount shall be taxed as capital gains earned during that financial year. For the company, the issuance of ESOPs may be considered a general expense which may be deductible under the Income Tax Act subject to certain conditions thereunder.

Stock appreciation: The value from stock appreciation rights is taxable as a part of the total income from salary of the employee holding such rights. At the time of exercise of the SARs by the employees, the difference in FMV of the shares allotted and the exercise price is treated as a perquisite. The company may claim the amount of appreciation paid to the employee in cash as expenses under the IT Act, and the company is obligated to deduct tax at source, on such payment of compensation to the employee.

Sweat equity shares: Sweat equity shares are also taxed as perquisites under the IT Act, subject to the conditions set out thereunder.

While the strategies to mitigate tax exposure may vary based on the quantum of the exercise price or the value of the options, companies typically draw out the vesting period of such options to reduce the tax burden during each financial year.

6.3 What rights are typically granted and what restrictions typically apply to manager shareholders?

Manager shareholders are generally given:

  • governance rights (a seat on the board of directors of the company being the key one);
  • transfer rights such as tag-along rights;
  • pre-emptive rights; and
  • other general rights as may be agreed between the shareholders of the company, subject to the shareholding percentage of the manager shareholders.

The shares of manager shareholders may be subject to various transfer restrictions, including:

  • a lock-in for a fixed period to ensure continued employment and engagement with the company;
  • an obligation to offer their shares to the investor prior to offering them to any third party; and
  • consequences of termination of their employment (whether for ‘cause’, as defined under the agreement, or voluntarily by either the company or the manager).

The manager shareholders are usually subject to non-compete and non-solicitation clauses in the investment agreement, to protect the company from any losses due to competition by the manager after leaving the company.

6.4 What leaver provisions typically apply to manager shareholders and how are ‘good’ and ‘bad’ leavers typically defined?

Investors are drawn to companies with an able management and core team, which should enable them to gain larger returns on their investments. In other words, investors rely on management to ensure the financial growth of the company post-investment.

For this reason, most investor seek covenants from, and protective provisions in relation to, the manager shareholders of a company (and from other key employees, depending on the commercial understanding) and their continued employment with the company. If any manager shareholder leaves, the company may be adversely affected, which may have a knock-on effect for the investor.

The parties to the investment transaction will construct and define the distinction between ‘good leavers’ and ‘bad leavers’ in the investment agreement – all matters which are typical of contractual agreement and commercial negotiation.

A ‘good leaver’ may be a manager who voluntarily (and through due process) leaves the employment of the company due to ill health or retirement, or for other personal reasons, and typically will be entitled to sell and transfer his or her shares in the company at or above the fair market value determined at such time.

A ‘bad leaver’ is a manager who is terminated from employment with the company for fraud, misconduct, wilful negligence, significant non-performance or such other reasons as may be specified in the investment agreement and/or the relevant employment agreement. The sale and transfer of a bad leaver’s shares in the company are typically completed at a nominal value.

7 Governance and oversight

7.1 What are the typical governance arrangements of private equity portfolio companies?

Private equity investors seek assurance and comfort from portfolio companies that their governance and policies are compliant with applicable laws and will protect the interests of shareholders. To this end, they will negotiate with the target and appoint a nominee director to the board of directors (or alternatively, seek an observer seat in order to keep abreast of board matters, proceedings and issues. However, it is important to ensure in law that no observer becomes, or is considered to be, a director in fact or effectively a ‘shadow’ director).

Private equity investors also set out a list of veto matters for which their express consent must be sought by the company. Some private equity investors may also require the company to adopt policies in relation to:

  • environmental laws;
  • social laws and labour governance laws;
  • anti-corruption and whistle-blower policies; and
  • activities in relation to corporate social responsibility.

The most common governance arrangements between private equity investors and portfolio companies are the information and inspection rights sought by the investors. The company is required to provide an extensive list of periodic information and documents to the investors – including financial statements, management information system reports, budgets and performance reports – for verification and vigilance.

Private equity investors may also seek to amend the terms of employment of company employees. For instance, they may introduce or amend the non-compete and non-solicitation clauses in the employment agreements for the key managerial persons of the company, including the promoters of the company. They may seek indemnification from the company and/or its employees for any loss or disclosure of confidential or proprietary information by the employees.

7.2 What considerations should a private equity firm take into account when putting forward nominees to the board of the portfolio company?

Private equity firms may negotiate and seek the right to appoint their nominees to the board of directors of companies in which they invest, to ensure that they have complete visibility on the affairs of the company and are involved in the decision-making process. Private equity firms must consider the following factors when nominating directors to the boards of portfolio companies:

  • The interests of nominee directors must be disclosed in accordance with applicable law to identify related parties;
  • The past conduct of the nominee director must be disclosed, including any litigation for some fraudulent or other related activities;
  • As executive directors, nominee directors are also liable in their fiduciary capacity to work in the best interests of the company with the objective of growing the company; and
  • Nominee directors cannot make decisions in the exclusive interests of the private equity investor, as this may affect the company. They must ensure that all decisions are taken in the best interests of the company as a whole and all of its stakeholders.

The company must also discuss the terms of such appointment, such as:

  • the director being appointed in a non-executive capacity or not being considered an ‘officer in default’;
  • any indemnification obligations of the company towards such directors; and
  • any directors’ and officers’ liability insurance to be procured for such indemnification obligations.

An ‘officer in default’ under the Companies Act is an officer such as:

  • a full-time director;
  • a key managerial person;
  • any other person authorised by the board of directors (or under whose instructions the board is accustomed to act) to undertake certain obligations and actions to prevent any defaults under applicable law, who is liable to be penalised in case of any default or contravention of the Companies Act by the company; and
  • any director who is aware of a contravention, as proven by his or her receipt of proceedings of the board in writing form or attendance at the board meeting, or by his or her consent to an action leading to a default. For this purpose, it is typically advised that nominee directors appointed by private equity investors be appointed as ‘non-executive directors’ who are entitled to be indemnified by the company.

7.3 Can the private equity firm and/or its nominated directors typically veto significant corporate decisions of the portfolio company?

Subject to the commercial agreement between the target, its promoters and the private equity investors, private equity investors (especially those without a significant ownership stake) seek and are given contractual veto rights in respect of matters that may affect them, such as:

  • corporate restructuring;
  • alteration of the founders’ rights;
  • fund raising;
  • any material diversion, redemption or buy-back or cancellation of securities;
  • related-party transactions;
  • the incurring of indebtedness;
  • the creation of encumbrance over company assets, including IP rights;
  • the disposal of assets;
  • the appointment and removal of key managerial team members;
  • litigation;
  • a change in business;
  • any initial public offerings;
  • the purchase or lease of property; and
  • the liquidation or dissolution of the company.

Under Indian law, the grant of veto rights is not deemed to give ‘control’ of the company to the veto rights holder. Instead, the veto rights are treated as protective provisions. In the absence of any powers to appoint majority directors on the board or to exercise control over day-to-day operations or policy decisions of the company, a shareholder with veto rights is not considered a ‘controlling’ shareholder merely by virtue of the veto rights, as Indian law currently stands.

The private equity investor may oblige the company and its promoters to seek its written consent in relation to such veto matters or seek consent at shareholders’ meetings or board meetings (where the private equity investor has a nominee director on the board). These veto rights may be sought by investors with a smaller stake in the company, which may be unable to influence any decisions taken by simple majority.

Such terms as are contractually agreed between the parties should be incorporated into the articles of association of the company, to ensure that all shareholders’ rights and obligations are appropriately captured in the governing charter document and avoid any confusion where the contractual agreements provide something different from the charter document, as the law provides that in the event of any conflict or inconsistency between a contract and the articles, the latter shall prevail (and the Companies Act prevails over both).

7.4 What other tools and strategies are available to the private equity firm to monitor and influence the performance of the portfolio company?

Governance rights: The private equity investors may participate in the operational and strategic decision making of the company through a nominee director appointed to the board and/or veto matters with the portfolio company and other shareholders. They may also consider appointing a nominee director with the requisite knowledge and understanding of the business of the portfolio company to better contribute to its operations.

Information/veto rights: The investors may be entitled to specific information or inspection rights in accordance with the terms of the investment agreements, to ensure that they have visibility on the company’s performance. The investors may also seek veto rights on certain matters.

Employment and operational activities: The investors may be involved in the hiring and compensation of employees, and conduct periodic reviews of compliance and company policies.

Non-compete and non-solicitation covenants: Private equity investors may ask portfolio companies to seek non-compete and non-solicitation covenants from anyone (eg, an employee, director or shareholder) who is exiting the company that he or she will not work with or set up a competing business and/or solicit employees of the company.

Confidentiality: This is an important aspect that should always be addressed in an agreement or through appropriate non-disclosure agreements to ensure that none of the company’s confidential information is disclosed to anyone who is not intended to have access to such information (and is always subject to the same level of confidentiality and non-disclosure).

8 Exit

8.1 What exit strategies are typically negotiated by private equity firms in your jurisdiction?

Private sales and initial public offerings (IPOs): IPOs remain the exit route of choice for most private equity investors, as they ensure greater access to capital in international and domestic public markets and free transferability of shares, which allow investors to seek an exit within a defined timeframe. However, it is important to ensure that investors are subject to no lock-in requirements stipulated under applicable law in relation to such IPOs.

Strategic sale/third-party sale: The sale of a significant or controlling stake in the company to a third party involved in similar businesses and/or interested in taking control of the operations of the company.

Drag-along rights: The sale of all shares of the private equity investors to a third party by ‘dragging’ or obliging other existing shareholders to sell their shares to that third party, depending on the commercial understanding between the parties. This right is usually given to and exercised by private equity investors if all other exit options fail or are not fulfilled by the company and the promoters.

Buyback/put option: Buybacks (the purchase and extinguishing by a company of its existing shares) and put options are typically used to end the private equity fund’s investment in an unsuccessful or distressed company. That said, repurchase of the investors’ shares is often seen as a last-ditch attempt to ensure an ‘exit’.

A management equity holder or promoter that is ‘locked in’ as a promoter and employee of the company in the deal document in lieu of a private equity investment cannot leave (or engage in fraud, embezzlement, wilful breach, misconduct, wilful negligence, any crime involving moral turpitude or significant non-performance leading to termination) for such lock-in period. Subject to the transaction structure, in the event of termination of the employment or engagement of a manager or promoter during such lock-in period, a private equity investor may negotiate an accelerated exit either through a buyback by the company or through a drag-along right as specified above.

8.2 What specific legal and regulatory considerations (if any) must be borne in mind when pursuing each of these different strategies in your jurisdiction?

Each of the exit strategies specified above is subject to the regulations set out in the Companies Act and the rules framed thereunder; and, in the case of an IPO, must accord with the Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2018. There are various conditions and restrictions on such transfers of shares under the Companies Act. For instance, a buyback by a company must be authorised by the articles of association (or appropriately amended by special resolution passed by the shareholders) and approved by the shareholders, subject to various conditions, including the following:

  • The buyback must be less than 25% of the total paid-up capital and free reserves of the company; and
  • The buyback cannot be initiated less than a year after the completion of the last buyback by the company.

In case of an IPO, the red herring prospectus issued by the company initiating the IPO must specify the types of securities and persons selling in the IPO, in accordance with the articles of association of the company (in case of any contractual limitations) or in accordance with applicable law.

9 Tax considerations

9.1 What are the key tax considerations for private equity transactions in your jurisdiction?

Primary investments in Indian companies are not taxable at the time such investments are made, in the hands of investors, unless the shares have been issued below fair market value. In such case the investor is taxed on the difference between the acquisition price and the fair market value of the shares, as this is treated as income in the hands of the investor. The transfer of shares of an Indian company is taxable depending on whether the transfer was completed at lower than or higher than the fair market value. If the consideration is lower than the fair market value, the buyer is taxed on the capital gain, which is the difference between the consideration and the fair market value. Similarly, if the consideration is higher than the fair market value, the seller is taxed on the capital gains calculated in the same manner.

Subject to certain exemptions available under relevant tax treaties between India and the country of residence of the investor, a non-resident investor is taxed in India. The gains from the sale and transfer of shares are taxed (or not taxed at all, depending on the tax treaty) based on the period of holding, the type of holder, the type of company and other factors.

As specified in question 3.3, the parties to cross-border private equity transactions must also consider the implications of the place of effective management of the overseas investor deemed as being in India, as this may lead to the ‘round-tripping’ of funds or being regarded as a tax resident of India.

9.2 What indirect tax risks and opportunities can arise from private equity transactions in your jurisdiction?

The risks and opportunities in relation to indirect taxes applicable to private equity transactions may be determined based on the nature of the transaction. All parties involved in an investment transaction generally obtain tax advice to structure the transaction in a cost-effective, tax-friendly manner. Every investee company must obtain a valuation report determining the price per share prior to consummation of the investment transaction, to ensure that it is compliant with all pricing guidelines under the Income Tax Act and the Companies Act, and where applicable, the Foreign Exchange Management Act regulations.

While the Goods and Services Tax (GST) Act, 2017 affects the transfer of business by way of ‘slump sale’ or the purchase of assets of a company as a going concern, if a business is acquired through the transfer or sale of shares, there will be no GST implications, given that the definition of ‘goods’ and ‘service’ excludes stocks, shares and similar from its ambit. In the event of a merger or demerger or the amalgamation of companies, again no GST is attracted, as this is the transfer of an entire business on a going-concern basis. However, as with all taxation issues, it is best to seek specific and tailored advice as to the particular facts and circumstances involved in each case, as the taxation position may vary accordingly.

Under the Income Tax Act, if shares are issued at a price that is higher than fair market value, the company issuing such shares will be taxed on the premium or excess amount. If a resident investor subscribes to or acquires shares of a company at a price lower than fair market value, however, the investor shall be taxed on the difference between such prices. While the conversion of securities into equity may be deemed taxable in the hands of the holder of such securities, Indian tax law specifically exempts the conversion of convertible debentures and convertible preference shares into equity shares from capital gains tax.

9.3 What preferred tax strategies are typically adopted in private equity transactions in your jurisdiction?

The Income Tax Act states that all income accruing or arising, directly or indirectly, through or from any business connection in India, any property in India or any asset or source of income in India, or through the transfer of a capital asset situated in India, including shares in an Indian company, shall be deemed “income accruing or arising in India” for the purposes of the Indian tax laws. Such income is taxable in India as capital gains for both residents and non-residents. However, a non-resident who is a tax resident of a country with which India has a double taxation treaty may offset the tax paid in its country of residence against the tax payable in India for such capital gains. Generally, all foreign investors obtain tax advice in relation to the applicability of the Income Tax Act and attempt to invest through an entity incorporated in a country with which India has double taxation treaties.

Private equity investors will also seek indemnification from the target or the seller if a claim arises from the tax authorities for not withholding taxes from the consideration amount paid by the investor to the target or the seller. These tax indemnities must be carefully navigated by both parties; the investor may receive the demand notice from the tax authorities for any non-payment of taxes and penalties in relation thereto, and must be adequately protected under the relevant investment agreement; and the target must protect itself with a limitation on its liability.

10 Trends and predictions

10.1 How would you describe the current private equity landscape and prevailing trends in your jurisdiction? What are regarded as the key opportunities and main challenges for the coming 12 months?

India has seen significant growth in various industries and offers start-ups certain exemptions and relaxations under law, which has led to an increase in the number of new businesses. As a result, the number of private equity firms and interested investors has also spiked over the last decade. However, in 2020 the global pandemic has impacted on all industries and businesses, which has slowed down transaction processes and created uncertainty as regards the financial health of a target.

The prevailing issues for private equity investments in India are as follows:

  • conducting thorough due diligence on targets and obtaining comprehensive representations and warranties;
  • private equity firms being more involved in governance issues and in major decision-making activity of their portfolio companies;
  • increasing interest in investing in stressed companies (strategic investments);
  • increasing numbers of buyouts;
  • increasing numbers of investments where limited partners invest along with general partners; and
  • certain industries – such as technology-driven industries and e-commerce/retail businesses – being more attractive to investors.

We appear to be in a situation of over-supply of capital, with plenty of money being invested – the Jio and Reliance Retail mega ‘transaction-after-transaction’ are indicative of this trend. While this may mean that available opportunities or assets are overpriced, thereby reducing the spread that private equity investors would make over time, the opportunities in India today for most investors are arising in consumer/consumption-driven industries and those leveraging digitisation. We are seeing greater investment interest in India in the consumer, education, medical and healthcare, and retail sectors, and a strong convergence in favour of online transactions.

10.2 Are any developments anticipated in the next 12 months, including any proposed legislative reforms in the legal or tax framework?

During the ongoing COVID-19 pandemic, various exemptions from regulatory compliance were introduced for Indian companies, although these did not extend to investment transactions. They include:

  • conducting board meetings and shareholders’ meetings via video conference; and
  • relaxing the quorum requirements of the Companies Act, which may require the physical presence of a minimum number of persons attending to meet quorum.

On 18 April 2020 the government revised its foreign direct investment policy to clarify that all foreign investors (whether registered in, if legal persons, or citizens, if natural persons) or beneficial owners of an investor residing in a country that shares a land border with India may invest in Indian companies only with prior governmental approval. This has increased the timeframe for such transactions. The onus of declaring that the potential foreign investor is not restricted by this rule rests with the potential foreign investor, which is then certified to the authorised dealer bank of the company with evidence of such declaration. It is advised that the transaction documents detail the split of such liability between the parties.

With effect from 1 April 2020, the multilateral instrument became effective in relation to various double taxation avoidance agreements entered into by India to prevent base erosion and profit shifting by companies seeking to set up holding entities in ‘no tax’ or low-tax countries.

11 Tips and traps

11.1 What are your tips to maximise the opportunities that private equity presents in your jurisdiction, for both investors and targets, and what potential issues or limitations would you highlight?

While transactions arising from heightened private equity and venture capital interest, and more recently debt fund interest, in Indian industry continue to increase, the governance of such transactions is also changing as the industry grows. This includes regulations in relation to anti-competition, tax exemptions and benefits, and prohibition of stock manipulation. One would do well to consider sectors that have advanced significantly as a result of the COVID-19 pandemic and its regulatory and economic repercussions, such as robotics and automation, other deep technology entities, online education and education more broadly, healthcare and medical – all of which are now more relevant than ever before.

In closing, two specific aspects appear to impact on the maximisation of opportunities while managing potential issues or limitations in the Indian context:

  • the need for both private equity investors and targets to manage more effectively, for their respective benefit, both the due diligence and the disclosure processes, in order to identify, address and contain or adjust pre-existing liabilities and especially any pre-existing unknown risks that may subsequently arise; and
  • the need to construct systems, processes and mechanisms within the target that promote growth while being mindful of good corporate governance and transparency in operations and outcomes, so as to unlock value in a way that is sensitive to all stakeholders, internally and externally, in the wider society and polity.

Co-authored by Nitya Jain, Associate and Unnati Deva, Associate.

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