Private Equity 2022

Last Updated July 26, 2022

India

Law and Practice

Authors



Bharucha & Partners has offices in three cities, with 15 partners and more than 100 associates, who offer rich experience and creativity. The firm has established a formidable reputation in the private equity space for working on large and complex transactions within very tight timelines, with services covering the entire investment cycle, from fund formation, downstream investment, follow-on transactions and the restructuring of holdings, to exit from the investment. The firm’s lawyers structure transactions across publicly traded and private companies, consortium deals, management buyouts, pre-IPO placements, and private investment in public equity (PIPE) deals covering the financial services, technology, hospitality, media, research and development, telecoms, energy, roads, pharmaceutical and real estate sectors. The firm acts for a variety of financial investors, including private equity and venture capital funds, portfolio investors, angel investors, family offices and foundations, as well as acting for target companies and founders on the full range of transactions.

India is one of the largest private equity markets in the Asia-Pacific region. 2021–22 saw a record high in terms of private equity and venture capital investment deals, with an increase of approximately 32% in terms of deal value and approximately 50% in terms of volume.

COVID-19

A catastrophic second wave of the COVID-19 pandemic ravaged the country in the first quarter of 2021, but its economic implications were not as severe as the first wave; the third wave had even less of an economic effect on the private equity market in India. In its annual report and financial stability report, the Reserve Bank of India (RBI – India’s central bank) noted that the Indian market remained on the path to recovery despite uncertainties arising out of, inter alia, the war in Ukraine, front-loaded monetary policy normalisation by central banks in response to persistently high inflation and multiple waves of the COVID-19 pandemic.

ESG

The shift in global financing practices has also led to an increased focus on ESG parameters for private equity investments, with their inclusion becoming the norm. From financial year 2022–23, the top 1,000 listed entities in India based on market capitalisation are required to comply with reporting requirements describing initiatives taken by them from an ESG perspective. The Securities and Exchange Board of India (SEBI – India’s securities market regulator) has also recently constituted an advisory committee on ESG and, in light of the lack of transparency and the risk of green washing, is proposing the regulation of ESG rating agencies.

ESG reporting by private unlisted companies is rare as it remains voluntary.

In its "India Private Equity Report 2022", Bain & Co provides insight into how fast Indian investments grew in 2021. There were a record number of buyout deals and an increase in growth-stage deal activity, especially in technology, fintech and edtech companies. Late-stage deal activity also saw positive movement, with various marquee investors contributing to the growth. The IT/BPO subsector in particular saw significant growth, as did the consumer tech, IT, IT Enabled Services (ITES) and healthcare sectors. According to the report, digital IT services are expected to grow at about 18–20% in 2022.

The competitive market in India is driving up valuations, with 2021 witnessing a 25–30% increase over past averages. With a greater number of funds investing in India along with limited partners, the strategy seems to be evolving by expanding deal sizes, target relationships and the setting up of portfolio teams.

The insurance sector has seen significant regulatory developments, including life insurance companies now having the flexibility to launch products without regulatory approval. This is in line with relaxations previously provided to health and general insurance companies; even the registration process for new insurance companies has been made easier. These measures are aimed at enabling greater private sector participation while keeping the interests of the policy holders in view.

Key Foreign Exchange Law Developments

In May 2021, SEBI increased the aggregate cap on the investments that may be made by all alternative investment funds (AIFs) registered in India in securities of overseas companies from USD750 million to USD1.5 billion. However, the cap has already been hit and several applications are still pending before SEBI to further increase the limit.

Foreign portfolio investment (FPI)

In September 2019, SEBI issued new guidelines re-categorising foreign portfolio investors into two categories:

  • Category-I includes regulated entities (banks, insurance companies, investment managers, etc), pension funds and regulated funds from Financial Action Task Force-compliant countries; and
  • Category-II entities are all foreign portfolio investors not classified as Category-I.

In light of the COVID-19 pandemic, SEBI has eased the threshold for foreign portfolio investors registering as Category-I to boost portfolio investments. Category-I entities enjoy lower compliance requirements than Category-II entities.

SEBI recently approved the participation of foreign portfolio investors in exchange-traded commodity derivatives. Previously, only Category III AIFs, portfolio management services and mutual funds could participate in these derivatives.

Foreign direct investment (FDI) policy

Foreign investments in India are made under either the "automatic route" (ie, without regulatory approval) or the "approval route" (ie, requiring specific consent from the relevant sectoral regulator). The Consolidated FDI Policy has been amended to liberalise foreign investments in sectors such as contract manufacturing, single-brand retail trading and digital media. The cap on investment in the defence and insurance sectors has been increased from 49% to 74% under the automatic route, subject to specific conditionalities. In addition, the time for converting convertible notes issued by start-up companies into equity shares has been increased from five to ten years, and a new sector has been added specifically for the Life Insurance Corporation of India, with an investment cap of up to 20% of FDI under the automatic route.

To curb the opportunistic acquisition of Indian companies following the COVID-19-induced economic slow-down, prior government approval has been required since April 2020 for (direct and indirect) investment into India by persons resident in a country with which India shares a land border (ie, China, Afghanistan, Bhutan, Myanmar, Nepal, Pakistan and Bangladesh). This restriction was previously applicable only to investments from Pakistan and Bangladesh. The operation of this amendment, however, has raised queries that remain unanswered, such as the threshold for beneficial ownership that will trigger the requirement for government approval and the impact, if any, on FPI and investment by venture capital funds. Stakeholders have sought clarification in this respect, but the government has not yet responded.

On 23 March 2022, the Ministry of Commerce and Industry issued a press release clarifying that a beneficial owner of an investment based in any country sharing a land border with India can invest only under the government route. The requirement of government approval would also apply to any transfer of ownership that resulted in direct or indirect beneficial ownership by a person based in such a country. Amendments have also been brought by the Ministry of Corporate Affairs, whereby:

  • any person from a country sharing a land border with India who seeks to become a director is required to obtain prior security clearance from the Ministry of Home Affairs;
  • an Indian investee company is not allowed to invite a body corporate incorporated in a country sharing a land border with India to subscribe to its securities unless prior government approval is obtained under the extant rules for foreign investment in non-debt instruments; and
  • in form PAS-4 (private placement offer letter) and form SH-4 (securities transfer form), the applicant or transferee (as the case may be) must declare that they are not required to obtain approval in respect of the aforementioned foreign exchange rules, or, where they require approval, that such approval has been obtained and enclose a copy of the same.

Media reports indicate that, as of June 2022, the government has approved 80 of the 382 applications that it has received. These approvals seem to be provided to entities that are not connected to politically exposed persons proposing to acquire minority stakes without any special rights such as veto, board seat, etc, and many of these approvals pertain to the manufacturing sector.

In March 2022, RBI updated its Master Directions on Foreign Investments to clarify that a debenture or preference share that is not compulsorily convertible will be treated as debt. However, this has created confusion as to whether investment in optionally convertible debentures by Foreign Venture Capital Investors (FVCI) (which is otherwise recognised as investment in equity) would be treated as debt or equity.

Key Taxation-Related Developments

Start-ups incorporated on or prior to 31 March 2022 were eligible for tax incentives; these tax incentives have now been extended to start-ups incorporated on or prior to 31 March 2023. Similarly, tax benefits for newly incorporated manufacturing entities have been extended to newly incorporated companies that commence manufacturing on or prior to 31 March 2024.

As part of the Union Budget 2022–23, the government has introduced a tax on virtual digital assets (broadly, cryptocurrencies, non-fungible tokens and other virtual digital assets notified by the government). Income arising from the transfer of virtual digital assets is now subject to tax at the rate of 30% without any deductions other than the cost of acquisition. Such tax is applicable regardless of the asset in question, whether it is held as a capital asset or as a stock in trade. In addition, a person acquiring a virtual digital asset from a person resident in India must deduct 1% tax of the consideration at source.

Key developments from SEBI

SEBI has introduced certain amendments with respect to initial public offerings (IPOs). In the case of an offer for sale, a shareholder with more than 20% of the pre-issue shareholding cannot sell more than half their stake, and an investor with pre-issue shareholding of less than 20% cannot sell more than 10% of the shareholding of the company on a fully diluted basis.

Furthermore, SEBI has prescribed a code of conduct for investment managers and members of the investment committee of registered AIFs, which sets out their fiduciary and regulatory responsibilities.

SEBI has also amended existing guidelines regarding infrastructure investment trusts (InvITs) and real estate investment trusts (REITs) to increase investor participation in these sectors, including by:

i) introducing a framework for privately placed unlisted InvITs; and

ii) permitting the issuance of listed commercial paper by larger InvITs and REITs.

In India, private equity investments are not regulated per se. However, certain private equity transactions may be subject to regulatory compliance or approvals, depending on the nature of the target, the industry in which the target is engaged and/or the size of the target.

India-domiciled private equity investors invest through AIFs, which must be registered with SEBI, while foreign investors may invest through any of the following routes:

  • FDI: investment in an unlisted company or in 10% or more of the fully diluted capital of a listed company by any person resident outside India;
  • FPI: investment in under 10% of the fully diluted capital of a listed company by a person registered with SEBI as a foreign portfolio investor; or
  • foreign venture capital investment: investment in an Indian company engaged in any of the ten specified sectors or in a start-up, regardless of the sector in which it is engaged by a person registered with SEBI as an FVCI.

There is no specific regulatory framework for the acquisition of unlisted companies, but acquisitions of listed companies must comply with the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (Takeover Regulations).

A transaction may require approval from the Competition Commission of India, India’s antitrust regulator, if the assets or turnover of the target and the investor (and, in some cases, the investor’s group) exceed specified thresholds. Investment in or acquisition of a target whose assets do not exceed INR350 crore (approximately USD43 million) or whose turnover does not exceed INR1,000 crore (approximately USD125 million) is exempt from approval until 27 March 2027.

Residents Outside India and Foreign Investors

The Indian rupee is not freely convertible, and transactions between Indian residents and persons resident outside India are regulated under Indian law. Foreign investment in certain sectors, such as gambling and real estate, is prohibited, while foreign investment in certain other sectors is capped (eg, media) or permitted only with the approval of the relevant sectoral regulator (eg, defence). In addition, guidelines have been prescribed in relation to the price at which transfers between foreign investors and Indian residents can occur.

A private equity transaction is usually preceded by detailed legal due diligence on the target and its subsidiaries.

The diligence period generally covers the three preceding financial years, and the key focus areas include:

  • review of the charter documents, of the existing shareholder arrangements for any restrictions on admitting new shareholders, and of the material agreements and financing arrangements entered into by the target for any onerous obligations and/or liabilities and consent requirements;
  • compliance with foreign exchange laws, if applicable; and
  • intellectual property rights and compliance with information technology laws.

In India, many shareholders continue to hold physical share certificates, and ascertaining clear title of shares is important in the case of a secondary market transaction. While due diligence is conducted primarily on the basis of the information and documentation provided by the target, it is also common to conduct public searches in respect of corporate filings, intellectual property rights, litigation and materially adverse media reports.

However, challenges arise where the target is a public listed company. Under extant insider trading regulations, the sharing of unpublished price-sensitive information (UPSI) is prohibited. Whilst certain exceptions exist for the conduct of due diligence, UPSI shared during the course of due diligence usually needs to be made public prior to the transaction being completed. This requirement may disincentivise listed targets from sharing information during the diligence process.

Vendor due diligence is common in auction sales, although the private equity investor is often given an opportunity to conduct a top-up diligence to verify the findings of the vendor diligence. Furthermore, the vendor's advisers do not usually permit reliance on the vendor diligence reports by investors and/or their advisers, and vendor due diligence reports are consequently afforded limited credence.

While acquisitions of majority interest and asset purchases by private equity funds are uncommon in India, it is common for the majority of the shareholding to be held by multiple private equity funds and not necessarily by the founders of the target, especially in the case of early-stage companies. Private equity transactions are typically undertaken through private sale and purchase agreements for a minority stake. A transaction may also involve a court-approved scheme when it contemplates a pre-sale reorganisation of the target to streamline its businesses.

Private equity funds typically seek exclusivity with the target for an agreed period. While not common in India, auction sales are held occasionally, in the case of secondary market transactions for shares of companies listed on a stock exchange. In such cases, the scope for negotiation tends to be lower than in the case of exclusively negotiated transactions.

Private equity funds typically set up special purpose vehicles to invest in targets. The fund’s representative will then be appointed to the board of the target. The fund is not, however, party to the acquisition or sale documentation, and its direct involvement, if any, is typically limited to the issue of a commitment letter providing a backstop on the indemnity obligations of the special purpose vehicle, which is a selling entity.

Private equity transactions are typically funded through the injection of equity by the private equity fund into the special purpose vehicle. However, funds do not generally provide equity commitment letters certifying certainty of funds for the transaction.

While investments in convertible notes are permitted in India, these have not gained popularity owing to regulatory uncertainty on whether such notes are to be considered as "securities" requiring companies to undertake a valuation at the time of issue of the notes (thereby defeating the purpose of the structure).

The RBI prohibits banks from granting loans for the purchase of shares. Non-banking finance companies may grant loans to private equity funds, but this remains uncommon in India. The issuance of non-convertible debentures is less regulated than other modes of debt financing, so it is common for private equity investors to raise debt financing, where necessary, through the issue of debentures.

Where the target is a subsidiary of a foreign company, investors often enter into an agreement with both companies to reserve a percentage of the share capital of the holding company, the acquisition of which is achieved at or immediately prior to a liquidity event through a put option.

Private equity transactions involving consortia of private equity sponsors are increasing in India. For example, TPG, ChrysCapital and Premji Investments formed a consortium for their investment in FirstCry, and PAG has agreed to buy a controlling stake in the Optimus group (a pharmaceutical company), along with consortium partners CX Partners and Samara Capital.

There is also a growing trend in co-investments involving the acquisition of passive stakes by limited partners that are already investors in the target, alongside the fund.

In India, private equity funds typically invest with fixed-price and/or locked-box consideration structures. The involvement of private equity funds as sellers or buyers does not affect the type of consideration mechanism used. Furthermore, while earn-outs or deferred consideration are becoming a common feature of private equity transactions, per RBI guidelines, the deferred component cannot exceed 25% of the total consideration and must be paid within 18 months of the execution of the transaction document.

Locked-box consideration structures are becoming more prevalent in the context of private equity in India. Where a locked-box mechanism is used, interest is charged on an agreed set of leakages, including transaction costs, payment of dividends and payment of bonuses to employees.

A dispute resolution clause specifically for the consideration structure is not common in India. However, the agreement customarily includes a generic, overarching dispute resolution clause for all disputes, including those on the consideration structure. In addition, referral to an expert or third party to break a deadlock on the consideration structures is also often included in the transaction documentation.

Private equity transactions in India are typically subject to regulatory, third-party consents and other conditions, such as shareholder approval, lender consent, intimation to contracting parties and compliance with an investor’s internal policies. Depending on the nature of the target, the investor and the type of deal, the transaction may be subject to regulatory conditions as detailed in 3.1 Primary Regulators and Regulatory Issues.

Where the agreement between the target and the third party (such as a lender or commercial counterparty) mandates consent for the transaction, that consent is included as a "condition precedent" to the transaction. The requirement for that consent is identified during the due diligence exercise conducted by the investor.

Separately, material adverse change provisions (usually with built-in cure periods) are customary in private equity transactions, and typically trigger termination of the agreement. The COVID-19 pandemic has brought greater focus on the definition of "material adverse change" and parties’ rights in respect thereof in the transaction documentation.

A "hell or high water" undertaking is common where the transaction is subject to regulatory conditions. In these cases, the transaction documents will include conditions requiring the buyer’s co-operation for obtaining any such approvals.

Break fees are usually a matter of contractual agreement and are not common in the Indian private equity context. Indian law does not expressly regulate break fees or the terms or limits thereof. There are, however, several issues when it comes to the payment of break fees. For instance, cross-border payments will require RBI approval, while break fees from listed companies may require SEBI approval.

Break fees, if paid, are restricted to the reimbursement of actual expenses incurred by the receiving party in relation to the transaction.

Agreements for private equity investments may usually be terminated:

  • by mutual consent;
  • by a party on account of the failure of the other party to meet conditions precedent by the long-stop date;
  • by a party if closing does not occur as contemplated; and
  • upon the occurrence of a material adverse change.

Private equity sellers usually assume very limited risk in relation to the target’s business, with warranties being restricted to the seller’s capacity and title to, and encumbrances over, the securities being sold. Liability in the case of a breach of the private equity seller’s warranties is also often limited by time and/or quantum, based on negotiations between the parties. While private equity buyers usually expect robust warranties in relation to the target’s business and operational matters, this is not usually the case where the seller is a private equity investor.       

A private equity seller normally provides "fundamental" warranties regarding the title to the shares and the seller’s ability to execute the transaction to a buyer upon exit. The target and its management separately provide commercial warranties regarding the target and its business.

The commercial warranties may be qualified with the knowledge of the target’s management and disclosures made by the target. In this respect, it is not common for the buyer or investor to be given full disclosure of the data room; the target provides a separate letter with a limited set of disclosures against specific warranties. No such limitations and disclosures are typically accepted against the fundamental warranties.

The position does not differ when a buyer is a private equity fund. Typically, liability on loss for breach of warranties in the case of commercial warranties (ie, other than fundamental warranties) is limited in time and quantum, for which the time period and amount are both heavily negotiated between the parties.

Key protections for a private equity investor include:

  • standstill obligations on the target, preventing it from making any material business decisions without the investor’s consent between the signing of the transaction document and the closing of the transaction; and
  • the private equity investor receiving exclusivity during negotiations from the target for any primary or secondary investments.

Indemnities are usually provided for the various representations and warranties given by the private equity seller and management shareholders. However, as previously mentioned, the liability of a private equity seller is usually restricted to fundamental warranties. The last 24 months have seen an increase in the popularity of warranty and indemnity insurance.

An escrow or retention to back the obligations of the private equity seller is not common in India.

Private equity funds are slow to make claims against the target or its management, and do not typically approach the courts in the case of a dispute. Any disputes that do occur are usually in respect of the investor’s exit rights. Given the considerable backlog in Indian courts, arbitration is the preferred mode of dispute resolution.

Indian law does not contemplate outright public-to-private transactions. Under the Takeover Regulations, an acquirer must first acquire control of a listed company and thereafter commence the delisting process. However, the delisting of listed companies is infrequent on account of regulatory issues arising out of the SEBI (Delisting of Equity Shares) Regulations, 2021, and the unfavourable pricing mechanism mandated therein. SEBI is in the process of evaluating amendments to the Delisting Regulations to address these concerns.

Any person (including an acquirer) who, individually or together with persons acting in concert (PACs) with them, holds shares or voting rights aggregating to 5% or more in the target is required to disclose their holding in accordance with the Takeover Regulations. Thereafter, any change in shareholding of 2% or more must also be disclosed.

In addition, any person who, alone or together with their PACs, holds shares or voting rights that amount to 25% or more of a listed company is required to make annual disclosures of the aggregate shares or voting rights held by them.

Under the Takeover Regulations, a mandatory open offer is triggered if:

  • an acquirer acquires shares or voting rights of a listed company that, together with the existing holding of the acquirer and their PACs, entitle them to 25% or more in a listed company; and
  • a person already holding 25% or more in a listed company (together with their PACs) acquires more than 5% of the listed company in a financial year.

A mandatory open offer is also triggered where there is a direct or indirect acquisition of control of a listed company. The definition of "control" is inclusive and refers to control over management or policy decisions arising from shareholders’ agreements. In the past, SEBI has tried to require that an open offer be made in the event of the acquisition of negative control; this issue has yet to be resolved by SEBI and/or the courts.

Although consideration other than cash (including through a share swap) is permitted in India, most private equity transactions in India have occurred for cash consideration only.

SEBI does not grant acquirers much flexibility and the only conditions that an acquirer may impose on an open offer are:

  • a minimum level of acceptance; and
  • that the relevant regulatory approvals required for the acquisition be obtained.

Financing arrangements need to be made prior to the open offer. Break fees may be negotiated between the parties. However, as discussed in 6.6 Break Fees, there may be regulatory hurdles at the time of payment.

At least 25% of the capital of a public listed company is required to be in the hands of the public. If, pursuant to an open offer, the public shareholding falls below 25%, unless the acquirer had announced an intention to delist at the time of making the open offer, the acquirer is required to dilute its shareholding to increase the public shareholding to 25%. Whilst a target may be delisted from the stock exchange, the promoters of the target cannot compel the public shareholders to surrender their shares.

A squeeze-out of minority shareholders may be undertaken by unlisted targets (including those that have been delisted) in accordance with the Companies Act, 2013. Shareholders of a target holding 75% or more of the capital may squeeze out the minority shareholders through a scheme of arrangement sanctioned by the National Company Law Tribunal. Alternatively, a person who alone or together with their PACs holds 90% or more of the capital of a target may compel the minority shareholders to sell their shares to them.

Except in the case of a hostile takeover, it is common for the promoters to make irrevocable commitments to tender their shares or vote. In such cases, negotiations between the private equity investor and the promoters would generally precede the open offer.

While hostile takeovers are not prohibited by Indian law, they are not often undertaken. Private equity buyers do not usually engage in hostile takeover offers.

Equity incentivisation of the management team within private equity transactions is not common in India. To the extent that such incentivisation is provided as part of the transaction, this is typically done through stock option plans where the option pool size is 5% to 10% of the share capital.

However, Indian law prohibits the issue of such stock options to employees who are also promoters or part of the promoter group of a company that is not a "start-up" registered with the Department for Promotion of Industry and Internal Trade. This prohibition extends to a director who holds more than 10% of equity in the company. In such cases, incentives are often structured as convertible instruments or equity value-linked bonus payments.

Where they participate in the transaction, management shareholders typically subscribe to ordinary shares. Such participation does not extend to management personnel who are not shareholders. The company’s issue of stock options and sweat equity to incentivise those management personnel is independent of the transactions.

Stock options issued to management shareholders are typically granted over a four-year vesting period, with some options vesting each year.

Good and bad leaver clauses are generally the subject of negotiation, especially in early-stage companies where greater reliance is placed on the management of the company. Typically, for good leavers (ie, persons whose employment is terminated other than for cause, death or disability), vesting of their options is accelerated. However, for bad leavers (ie, persons whose employment is terminated for cause), unvested options are terminated and, in certain cases, the company has the right to buy back vested shares.

Private equity investors typically require the re-execution of promoter and key employee employment agreements as a condition subsequent to their investments. These agreements usually contain non-compete and non-solicitation provisions that remain in force for one to two years following their termination.

Non-compete restrictions are enforceable while the employee is with the company. The likelihood of enforcing non-compete restrictions after the employee’s termination is low. Unlike other jurisdictions, India does not have a reasonability threshold to determine the enforceability of non-compete restrictions after the termination of employment as they are deemed to be a restriction on trade, except where the employee has sold their goodwill. Nevertheless, non-compete clauses usually include language clarifying that the employee agrees that the restrictions imposed are reasonable and necessary to protect the company’s business, to deal with any evolution of the law that permits the enforcement of such restrictions.

Minority protection for promoters is typically provided in the form of veto rights, as long as the promoters hold a specific percentage of shares in the company (usually 5% to 10%). A veto in this respect may exist for any change in control of and/or key operational decisions in respect of the company’s business, including termination of material agreements and making material financial commitments. Such rights, however, are not generally available in the case of early-stage companies or start-ups. Furthermore, minority shareholders do not generally enjoy anti-dilution protection other than the option to subscribe to shares pro rata to their shareholding in future funding rounds.

While veto rights give the management shareholders some influence over any change in the company’s share capital, they do not apply to the private equity investor’s exit rights. It is customary for the management shareholders to be obliged to facilitate the private equity investor’s exit.

Other minority protection rights, such as tag-along rights and information rights, will also extend to managing shareholders by virtue of their stake in the company.

Private equity investors nominate directors and/or observers to the board of directors of the target, while the promoters manage the day-to-day affairs of the target. The role of the nominee director(s) is to ensure that the rights of the private equity investor are protected, primarily through the exercise of affirmative voting rights over matters material to the private equity investor. These rights, inter alia, include changes in capital structure, the nature of business, and transactions above a certain threshold. The private equity investor also typically has rights relating to information and inspection, audit control and the appointment of senior management.

The shareholders of a company are not generally responsible for its actions and may only be held liable where the corporate veil is pierced by the courts, which occurs only in exceptional cases. In the past, the corporate veil has been lifted:

  • for fraud;
  • for improper conduct by the officers of the company;
  • for tax evasion;
  • in the case of a sham company; and
  • in the public interest.

Upon lifting the corporate veil, courts are likely to impose liability on those shareholders whose knowledge, consent or connivance have been established.

It is common for private equity investors to require targets to adopt the investors’ internal policies and compliance protocols (including with respect to compliance with ESG parameters). The nature of the policies and protocols so adopted varies, depending on the investor, the size of the investment, the business in which the target is engaged, etc.

A private equity investor usually holds its investments for an average of four to seven years, depending on the sector of investment and the deal size. Usually, the preferred exit routes for private equity investors are IPOs and/or secondary sales to another institutional investor. Dual track processes are also common. The private equity market in India saw a number of exits in 2021 (with an aggregate value of approximately USD36 million – ie, four times the value seen in 2020).

It is not common for private equity investors to reinvest upon exit.

Transaction documentation typically includes a drag-along right for the private equity investor, but this right is rarely exercised. Where there are multiple investors, the drag right lies either with the single largest institutional investor or with a group of investors who have the power to exercise the drag right collectively. The drag right ceases to exist upon the investor’s shareholding falling below a certain negotiated percentage (usually 10%). A drag right is usually available against all shareholders. Where the drag right extends to institutional investors, late-stage investors seek price protection. Where it does not, the non-dragging investors generally have a right to tag along.

Tag-along rights in favour of management shareholders are uncommon, as they could have an adverse impact on the ability of the private equity investor to exit. Tag rights, where granted, are usually triggered if a controlling stake is being sold.

Following an IPO, the shares held by anchor investors are subject to a lock-in period of 90 days, pre-IPO shares held by other investors are subject to a lock-in period of six months, and pre-issue shares of the promoters are subject to an 18-month lock-in.

It is uncommon for a private equity investor to have special rights following an IPO, since this is not viewed favourably by SEBI. Where such rights are granted, they would usually be enshrined in the constitutional documents of the target.

Bharucha & Partners

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Trends and Developments


Authors



Trilegal is a full-service firm for private equity investors, providing legal and strategic counsel throughout the life cycle of the firm's private equity clients from entry to exit, including primary and secondary investments, fund structuring, funds formation, share purchase, offshore funding and exits by way of trade sales and initial public offerings. The firm regularly acts on advisory mandates for general partners (GPs), fund boards and limited partners (LPs) on governance and fund-related regulatory and compliance matters, as well as on fund-related disputes, extensions and restructuring.

Private Equity and Venture Capital in India – Emerging Market Trends

After record levels of private equity/venture capital investments and primary/secondary market exits across sectors during 2021, deal-making activity has sharply decreased in terms of both numbers and volumes since the first quarter of 2022. Investors across jurisdictions have become risk-averse and are increasingly focusing on managing their existing portfolios or down-round/consolidation opportunities. The Indian private equity/venture capital industry has also largely followed these global trends as investors and entrepreneurs face a general slowdown in investing momentum, although India has continued to do very well comparatively. Similarly, several start-ups that were eyeing initial public offers (IPOs) have had to recalibrate their expectations and adopt a wait-and-watch stance, given the global headwinds in public markets.

Despite some sharp corrections in private equity-backed IPOs in 2021, the few good IPOs over the last few months are certainly positive signs for the industry. Furthermore, as a number of companies are ready with IPO diligences, etc, in case the momentum on the investment side continues, the number of exit opportunities is expected to start developing towards the 3rd and 4th quarter of this financial year. The past year also witnessed marquee investors such as pension funds, sovereign wealth funds and family offices supplanting private equity/venture capital investors, in a trend that may continue in the coming months as well.

With the headwinds being faced currently, financial services, pharma, infrastructure and fintech are expected to be the focus sectors of deal activity (similar to 2021). However, there is likely to be a trend of down-rounds and consolidation in the private equity/venture capital industry, with market players focusing on expense shrinking and compliance issues (particularly employment, criminal investigations and governance issues). With this, fundraising and secondary exits may continue to remain difficult in the medium term. Investors can expect more strategic investments and buyout deals rather than minority exits as consolidation within sectors remains an attractive proposition for some of the larger players.

Key Legal and Regulatory Developments

The Indian legal regime continues to evolve in tandem with market needs and commercial developments, and the recent overhaul of the overseas direct investment (ODI) regime is a clear step in that direction. The recently notified Foreign Exchange Management (Overseas Investment) Rules, 2022 (the "ODI Rules") are intended to simplify and bring flexibility to the overall ODI framework, with various ODI transactions allowed under the automatic route (that previously required prior approval). For instance, no prior approval is required for the deferred payment of consideration and the issuance of corporate guarantees to or on behalf of a second or subsequent level step down subsidiary.

Similarly, the Securities and Exchange Board of India (SEBI) has also removed the requirement for investee companies to have an “Indian connection” for overseas investments by alternative investment funds and venture capital funds. While the practical implications of these changes will emerge in the coming months, they are expected to augment the ambitions of Indian investors and entrepreneurs to explore overseas investments.

The Indian government also made several key changes to the foreign direct investment (FDI) regime in 2022, aimed at the IPO of Life Insurance Corporation (LIC) (for which 20% foreign investment has been permitted), which took place in May 2022. For instance, the definition of "Indian company" under the exchange control laws has been expanded to include body corporates established under any central or state act.

Several changes were also aimed at providing flexibility to start-ups. For instance, the specified period for convertible notes issued by start-up companies to be converted into equity shares has been doubled from five years to ten years. Furthermore, Indian companies are now permitted to issue share-based employee benefits in the form of equity instruments to employees or directors who are resident outside India. These changes will have positive trickle-down effects on the larger start-up industry.

The RBI issued a press release on 10 August 2022 ("Press Release") seeking to immediately implement certain recommendations of the Working Group Report on Digital Lending constituted by it ("Report"). The Press Release mandates several changes, such as requiring regulated entities and lending service providers to:

  • have a suitable nodal grievance redressal officer to deal with fintech/digital lending-related complaints;
  • disclose the all-inclusive cost of digital loans to borrowers; and
  • bar lenders from automatically increasing credit limits without the borrower’s consent – aimed at safeguarding customers’ interests.

The Press Release also states that all loan disbursals and repayments are required to be executed only between the bank accounts of the borrower and the regulated entities, without any pass-through/pool account of the lending service providers or any third party. These changes promise to have significant implications for the way fintech businesses function in India.

Furthermore, the government intends to introduce the draft Mediation Bill 2021 in the coming parliamentary session as another step towards ensuring ease of doing business. The Bill aims to be a comprehensive law on mediation, and to incentivise institutional mediation in India. It also seeks to make pre-litigation mediation a mandatory condition prior to filing civil or commercial suit, which should be completed in a time-bound manner.

Sectors and Key Issues in Focus

Corporate governance

With major corporate governance controversies occurring at renowned start-ups, investors are keeping a close eye on corporate governance systems and controls in their existing portfolio and while evaluating potential investee companies. The key aspects upon which investors are taking a keen interest include:

  • minority protections under shareholder documents;
  • board controls over key managerial personnel;
  • checks and balances on executive decisions;
  • regular financial audits;
  • organisational culture, etc.

Investors and entrepreneurs are expected to negotiate closely on such issues in the coming months, as public scrutiny of these items is increasing.

There has also been a rise in investor activism over the last few months, as environmental, social and governance concerns form a key aspect of investors’ philosophy. As overall fundraising and deal making slow down, private equity/venture capital investors can be expected to take a more active role in their investee companies. Factors such as the appointment of their nominees on the board of directors, and their roles, responsibilities and participation in meetings of the board and its committees will gradually assume a greater role in the coming days.

Edtech and fintech

Sectors such as edtech and fintech, which were amongst the biggest recipients of FDI inflows in 2021, will continue to be in investors’ focus due to constant shifts in the regulatory landscape and evolving market opportunities. The government’s focus on digital payments and continuous innovation in the fintech sector has led to several new products and platforms being launched by National Payments Corporation of India (NPCI), which has kept the industry on its toes. The government’s proposal to set up an Open Network for Digital Commerce (ONDC) promises to revamp the existing e-commerce industry in India and harness the potential of micro, small and medium enterprises to cover underserved rural areas in the country. With Microsoft becoming one of the earliest multinationals to join the ONDC, investors are keeping a keen eye on potential investment opportunities here, as several other market players are expected to follow suit.

The edtech sector has been constantly in the news for several major fundraisings by edtech companies, with many unicorns being created in the process and equity valuations reaching new highs. Several companies in the sector also undertook major mergers and acquisitions, with a wave of consolidation as companies sought to create complete K-12 offerings on their platforms. While equity valuations in the sector have rationalised as classroom education again takes centre-stage and customer preferences are shifting, investors are keeping a close watch on their portfolio companies. The coming months may witness deal-making opportunities in edtech companies, many of which are in cash-conservation mode as investors look to reset valuations and focus on profitability and exits.

Future Trends

Another major feature driving deal making in India over the last few years has been a renewed focus by major corporate houses on consolidation across business domains. The Reliance and Tata groups’ string of acquisitions and investments in companies across sectors and domains has given several investors handsome exits on their investments, which can be expected to continue this year as these corporate groups continue to venture into new verticals. The Adani group’s proposed ventures in metals and cements businesses also promise to unlock many investment opportunities in these sectors, as existing market players will look towards fundraising to establish their competitive advantages or seek out competitors.

India has rapidly become a preferred destination for foreign investors looking for value and ease of doing business. Major legal reforms over the past few years have resulted in enhanced efficiency in business operations for companies, and have been a major factor in increasing India’s visibility as a business-friendly destination. With geopolitical conflicts and tensions between several countries, India is fast emerging as a credible investment jurisdiction with a stable and broad-based economy.

India’s economic growth before the pandemic had slowed down as a result of corporate sector deleveraging on business investment. With the deleveraging complete, corporate sector investment coupled with investment-friendly government policies and rapid digitisation of the economy can help in providing support to continued business cycle expansion through several quarters and generate an attractive Indian private equity/venture capital market for venture capitalists.

Trilegal

311 B/C/D
DLF South Court
Saket
New Delhi
Delhi 110017
India

+11 4163 9393

+11 4163 9292

Yogesh.Singh@trilegal.com www.trilegal.com
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Law and Practice

Authors



Bharucha & Partners has offices in three cities, with 15 partners and more than 100 associates, who offer rich experience and creativity. The firm has established a formidable reputation in the private equity space for working on large and complex transactions within very tight timelines, with services covering the entire investment cycle, from fund formation, downstream investment, follow-on transactions and the restructuring of holdings, to exit from the investment. The firm’s lawyers structure transactions across publicly traded and private companies, consortium deals, management buyouts, pre-IPO placements, and private investment in public equity (PIPE) deals covering the financial services, technology, hospitality, media, research and development, telecoms, energy, roads, pharmaceutical and real estate sectors. The firm acts for a variety of financial investors, including private equity and venture capital funds, portfolio investors, angel investors, family offices and foundations, as well as acting for target companies and founders on the full range of transactions.

Trends and Development

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Trilegal is a full-service firm for private equity investors, providing legal and strategic counsel throughout the life cycle of the firm's private equity clients from entry to exit, including primary and secondary investments, fund structuring, funds formation, share purchase, offshore funding and exits by way of trade sales and initial public offerings. The firm regularly acts on advisory mandates for general partners (GPs), fund boards and limited partners (LPs) on governance and fund-related regulatory and compliance matters, as well as on fund-related disputes, extensions and restructuring.

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