Recent Trends in PE and M&A Activities

As per publicly available reports, the value of private equity transactions was at USD29.7 billion, which declined by 38% in 2023 compared to the record of USD47.6 billion investments in 2022. In 2023, the investment value dropped by 38% and the volume of investments was 44.5% lower compared to 2022. Having said this, 2023 witnessed historic opportunities when it comes to public M&A, both in terms of the quantum of control deals as well as initiatives of SEBI. The public M&A market witnessed a total of 85 open offers in 2023, where the aggregate deal value was approximately INR105 billion, with an open offer by Proximus group to acquire Route Mobile Limited for INR26 billion being one of the largest cross-border control deals in the communication platform space in India.

Despite the slowdown in 2023, domestic deal volume gained momentum in 2024, as private equity firms invested over USD6.2 billion in Indian companies during the first quarter of 2024. Although investment value in Q1 2024 was lower as compared to the same quarter in 2023, overall disclosed deal volume as per public information, in the first quarter of 2024, was marginally higher.

The first quarter of 2024 saw a staggering 354.5% increase in PE exits compared to Q1 2023. As per publicly available information, this translates to a jump from just 11 exits in the previous year’s first quarter to a robust 50 exits in Q1 2024. There was also a sizeable increase in the overall exit value of deals in this period.

Overall inbound investment activity in India remained positive in the first half of 2024, and in the view of the authors, given the market trend, it is expected that the second half of the year will witness resurgence in deal activity (which of course is subject to any downturn for geopolitical issues which may impact the overall economy).

Sectors Dominating the PE and M&A Landscape

The technology sector continued to be a prominent player in private equity and M&A deals in India, with highest deal volume and deal value in 2023. Tech companies topped the industry chart with some notable investments such as infusion of USD500 million each in Quest Global by Carlyle and Lenskart by Abu Dhabi Investment Authority. Other noteworthy deals included the USD450 million investment in IBS Software by General Atlantic.

In 2024, TMT has also seen a significant rise in deal activity, particularly in areas like digitalisation and streaming services, with the high-profile Reliance-Disney merger. Telecoms emerged as the top industry for Q1 2024, led by the USD2 billion acquisition of ATC-Brookfield. Having said this, traction for funding of technology companies continued in Q1 2024, which was led by the USD150 million funding in Indo-US contact centre software maker Kore.ai. The second quarter witnessed IT companies attracting investments worth USD3.6 billion, with notable investments in Altimetrik and Zepto.

The healthcare and pharma sectors also witnessed the largest investment in 2023 in Manipal Hospitals by Temasek and TPG Capital of USD2.4 billion. This was followed by the USD732 million buyout of Indira IVF by Baring Asia and USD700 million buyout of Care Hospitals by Blackstone. Strong traction in this sector continued in 2024, with investments worth USD2.1 billion in the second quarter of 2024, led by the USD840 million acquisition of medical devices firm Healthium Medtech.

Financial services witnessed a 45% decline in deal value in 2023, however, deal volume rose by 23%. The finance industry attracted investments worth USD3.4 billion, led by the USD1.3 billion buyout of education loans provider HDFC Credila Financial Services by Baring Asia and ChrysCapital. Further, 2023 saw the highest number of open offers being made in the financial services sector, with a total number of 19 open offers made in target companies involved in the financial services sector. The financial sector remained strong in Q2 2024 with deals such as the USD554 million acquisition of Shriram Housing Finance by Warburg Pincus.

Factors Impacting PE/M&A Activities

Technology has seen the highest growth in cross-border M&A activity owing to increasing supply and demand, with Artificial intelligence (AI) emerging as a popular target for deal-makers around the world.

While higher interest rates and macro-economic factors have presented challenges, the first quarter of 2024 suggests that PE firms are finding solutions to navigate the new environment. The authors have observed continued focus on growth opportunities, selectivity in investments and a rise in smaller and mid-sized deals.

The key developments which have brought changes to the regulatory landscape and influenced investment decisions are set out below. 

Reserve Bank of India (RBI)

Scale-based regulations

On 19 October 2023, RBI released the Master Direction – Reserve Bank of India (Non-Banking Financial Company – Scale Based Regulation) Directions, 2023, consolidating the Master Directions governing systemically important and non-systemically important NBFCs, as well as relevant provisions from the Scale Based Regulatory (SBR) Framework and periodic circulars of RBI, into a single master direction. This new framework has replaced the previous distinction between systemically important and non-systemically important NBFCs, now categorisng all NBFCs into four distinct categories.

• base layer (NBFC-BL), which includes non-deposit taking NBFCs with an asset size of less than INR1,000 crore, NBFC P2P, NOFHCs, NBFCs not availing public funds and not having any customer interface;
• middle layer (NBFC-ML), which includes all deposit-taking NBFCs, non-deposit taking NBFCs with asset size of INR1,000 crore and more, HFCs, IDF NBFCs;
• upper layer (NBFC-UL), which includes NBFCs which are specifically identified by the RBI; and
• top layer (NBFC-TL), which will include NBFCs which the RBI shifts from the upper layer to the top layer if such NBFCs have potential systemic risk.

The SBR framework focuses on improving risk management, governance, and transparency across the sector.

Restrictions on investments in AIFs

On 19 December 2023, the Reserve Bank of India issued a circular prohibiting all regulated banks, financial institutions, and non-banking financial companies (collectively referred to as “Regulated Entities” or “REs”) from investing in Alternative Investment Funds (AIFs) that have downstream investments in a “debtor company” of these RE.

The RBI’s clarification to the 19 December 2023 circular, issued on 27 March 2024, states that the restriction does not apply to investments in the equity shares of debtor companies. However, other investment types, such as hybrid instruments, remain restricted. According to the 19 December 2023 circular, regulated entities unable to divest their investments within the specified timeframe must allocate funds to cover 100% of the investment’s value. The recent clarification adjusts this provision to apply only to the portion of the investment directly related to the debtor company, not the entire investment. Additionally, it clarifies that investments made by regulated entities in AIFs through intermediaries, such as fund of funds or mutual funds, are not subject to these restrictions.

Companies Act, 2013

On 27 October 2023, the Ministry of Corporate Affairs (MCA) vide notification came up with the two major amendments in relation to limited liability partnership (LLP) and companies.

• Declaration regarding beneficial interest in LLP – the concept of registered partner and beneficial partner has been introduced vide the aforesaid notification and registered partners and beneficial partners are required to disclose their interest in Form 4B and Form 4C within 30 days of acquiring such control in the LLP.
• Identification of designated person of the company – under Companies Act, 2013, beneficial owners were liable to disclose the beneficial interest; however, as per the amendment, companies are required to appoint a designated person of the company who shall be responsible for disclosures made by beneficial owners for such company. Such designated person could be either a company secretary or key managerial personnel or a director.

Digital Personal Protection Act, 2023 (DPDPA)

The DPDPA, 2023, which aims to amend India’s current data protection laws, received presidential assent on 11 August 2023. However, its effective date has not yet been announced. This new law broadens the scope of protection from “sensitive personal data” under the previous Information Technology (Reasonable Security Practices and Procedures and Sensitive Personal Data or Information) Rules, 2011, to include “personal data”.

Competition law

On 6 March 2024, CCI enacted the CCI (Settlement) Regulations on August 24 (the “Settlement Regulations”). Section 48A of the Competition (Amendment) Act, 2023 allows an enterprise under investigation to seek settlement with CCI. The Settlement Regulations outline the process for settlement proceedings by providing a quicker resolution of competition-related disputes, thereby reducing the legal uncertainties and risks.

In addition to the foregoing, the Ministry of Corporate Affairs revised the asset and turnover thresholds for transactions requiring CCI approval. Prior to the amendment, transactions were exempted from CCI approval, if the asset threshold was INR350 crore and turnover is INR1,000 crore. After the amendment, the revised thresholds are INR450 crore for assets and INR1,250 crore for turnover.

These CCI amendments have been poised to simplify regulatory requirements for private equity investments in India by potentially exempting more transactions from CCI scrutiny, making India a more attractive destination for private equity investments.

Abolition of Angel Tax

In the budget presented by the finance minister for financial year (FY) 2024–25 on 23 July 2024, the government abolished Angel Tax – ie, tax on consideration received by Indian companies for issuance of equity shares above fair market value. This is a significant move in the right direction for companies raising capital, as the abolition of this tax alleviates the ability for the company to be taxed when it is issuing securities to investors at a premium to the fair value.

Securities Exchange Board of India (SEBI)

SEBI AML amendments

As per the SEBI circular issued on 31 July 2023, an AIF, at the time of onboarding a foreign investor, is required to ensure that such foreign investor or its underlying investors contributing 25% or more in the corpus of the investor or identified on the basis of control, is not a person(s) mentioned in the Sanctions List notified from time to time by the United Nations Security Council and is not a resident in the country identified in the public statement of Financial Action Task Force.

On 11 January 2024, SEBI issued a circular revising the aforementioned threshold from 25% ownership to beneficial owner as defined under sub-rule (3) of Rule 9 of the Prevention of Money-laundering (Maintenance of Records) Rules, 2005 (the “AML Rules”). The threshold under the AML Rules for determining beneficial owners of (i) companies is 10% of the shares, capital, or profits; (ii) partnership firms is 10% of the capital or profits; and (iii) trusts is 10% of the interest in the trust.

The regulatory environment for private equity funds and transactions in India is overseen by various key regulators, each playing a crucial role in ensuring compliance and investor protection. In recent times, there have been notable developments in M&A regulations and a growing emphasis on investing in AI, environmental, social, and governance (ESG) compliance. 

Primary Regulators for Private Equity Funds

The Reserve Bank of India (RBI) is the key regulatory authority for foreign direct investment (FDI) in India. The Foreign Exchange Management Act, 1999 (FEMA), consolidated FDI Policy Circular of 2020, and FEMA (Non-Debt Instruments) Rules, 2019, govern foreign investment transactions. The foreign exchange regulations also distinguish FDI investments from foreign portfolio investments (FPIs). FPI investors are from offshore entities, hold an FPI registration, and invest in India through equity instruments where such investment is less than 10% of a listed Indian company.

SEBI is the primary regulatory body governing private equity funds in India. SEBI’s oversight extends to venture capital, private equity funds, and pooling vehicles operating as Alternative Investment Funds (AIFs). The SEBI (Alternative Investment Funds) Regulations, 2012, as amended, lay down the regulatory framework for AIFs, prescribing investment restrictions and conditions for different categories of funds to safeguard investors and manage risks.

Some of the relevant provisions for FDI include the following.

• Automatic route and approval route. Approval requirements for foreign investments in India depend upon the sector in which the company is conducting business. Most sectors, including information technology and manufacturing, fall under the automatic route, where no government approval is required. Certain sensitive sectors continue to require governmental approval such as retail trading, broadcasting, and sensitive defence and energy sectors. 
• Sector-specific restrictions. Under the automatic route, different business sectors have varying investment thresholds and conditions for foreign investment. Therefore, any deviation from such thresholds or conditions would trigger an approval requirement.
• Pricing guidelines and reporting requirements. Foreign investors must comply with the pricing guidelines, valuation norms and reporting obligations such as inward remittances, KYC, and providing investment details to RBI under FEMA Laws.

Obtaining regulatory approvals and navigating lengthy disclosure requirements may present challenges.

Regulatory Issues in M&A Laws

Mergers and acquisitions in India are governed by a framework that includes the Companies Act, 2013, Competition Act, 2002, FEMA laws, and SEBI Act, 1992, along with rules and regulations.

Key regulators for a merger differ based on the type of company involved. For private and unlisted public companies, the National Company Law Tribunal (NCLT) serves as the primary regulator. For public listed companies, in addition to the NCLT, SEBI acts as a regulatory authority.

Noteworthy provisions in merger control include the following.

• Merger approval. Companies seeking to merge must apply to the NCLT. Among other conditions and requirements, a majority in number, representing three-quarters in value of the creditors or shareholders present and voting, need to agree to the merger. Thereafter, once sanctioned by the NCLT, it is binding on all the creditors and shareholders of the company.
• Fast-track mergers. Small companies and holdings, or wholly-owned subsidiary companies, may utilise this route, streamlining the approval process. This merger doesn’t require approval of the NCLT, unless central government directs the NCLT to take up this merger.
• Cross-border mergers. Mergers between Indian and foreign entities have been facilitated subject to satisfaction of certain conditions set out under the Companies Act, 2013 and FEMA regulations.
• Listed company mergers. SEBI’s Takeover Code may apply, requiring an open offer to acquire at least 26% voting capital. Further, under Listing Regulations, any listed company involved in the scheme of the merger must seek a no objection certificate from the stock exchange prior to filing with the NCLT.

Regulatory Issues in ESG Compliance

In recent years, ESG considerations have gained prominence in private equity investors’ value creation and exit plans. India does not have a specific regulatory framework for ESG; instead, the regulatory framework related to ESG comes under various pieces of legislation, including: the Factories Act, 1948; Environment Protection Act, 1986; Air (Prevention and Control of Pollution) Act, 1981; Water (Prevention and Control of Pollution) Act, 1974; Hazardous Waste (Management, Handling and Transboundary Movement) Rules, 2016; Companies Act, 2013; SEBI Act; Prevention of Money Laundering Act, 2002; Prevention of Corruption Act, 1988; and laws with respect to the payment of minimum wage, bonus, gratuity, welfare activities, health and safety, etc. Various aspects of ESG are covered under these pieces of legislation in a fragmented manner.

Some of the recent developments include the following.

• SEBI – from FY 2024–25 onwards, disclosures as per BRSR core in the annual report are required for value chain partners of the top 250 listed entities by market capitalisation on a comply-or-explain basis.
• Cybersecurity and data privacy – mandatory disclosure of data breaches and compliance with the Digital Personal Data Protection Act, 2023, which includes penalties for data protection failures.
• RBI – RBI published a draft disclosure framework on Climate-related Financial Risks, 2024, to improve the consistency and comparability of climate-related disclosures in India. The framework mandates the Indian financial institutions to incorporate climate-related assessments into their mainstream compliance.

The diligence exercise plays a crucial role in private equity transactions by providing a comprehensive assessment of a company’s legal standing, identifying potential risks, liabilities, and other pertinent issues that may impact the deal. A legal due diligence is the foundational step of any investment decision in PE and M&A transactions. The level of legal due diligence may vary based on the nature of each transaction and the intricacies involved.

Typically, a detailed legal due diligence questionnaire is prepared to ensure a meticulous investigation of the target company. This largely involves a thorough examination of relevant legal documents, understanding the corporate structure of the entities involved, assessing compliance with various regulatory requirements and identifying any pending or potential claims involved.

Key Areas of Focus for a Legal Due Diligence in Private Equity Transactions

The legal due diligence process in private equity transactions centres on reviewing the following key aspects.

• Directorship and shareholding. Examination of the terms and conditions attached to issued securities, directorship details, and the shareholding structure and analysis of corporate governance practices.
• Statutory and regulatory compliance. Delving into licences, permits, approvals, and industry-specific statutory compliance undertaken by the target company.
• Affiliates. Scrutinisation of the details of group companies, holding entities, subsidiaries, and associate companies to assess potential implications on the transaction.
• Inward and outward remittance. Inquiries are made into FDI or outward direct investments (ODI) related to the target company.
• Intellectual property rights. Verification of ownership of patents, trade marks, copyrights, industrial designs, and other proprietary rights owned or used by the company, as well as rights granted to third parties.
• Books of accounts. Examination of financial statements, loan details (both availed and provided), and open charges on the target company to understand its financial health.
• Ongoing litigation. Identification of pending and threatened litigation, arbitration, or regulatory actions involving directors or promoters that may impact the target company as well as assessment of potential liabilities and litigation risks.
• Contracts, commercial agreements. A careful review of contracts and commercial agreements is undertaken to assess contractual obligations, including change in control provisions and key contractual terms such as termination clauses, indemnities, and warranties.
• Employment. Labour law compliances as well as agreement with employees are reviewed as a part of the diligence exercise. 
• Data Protection. Evaluation of compliance with data protection laws and assessment of data security measures.

Generally, the following issues, if they arise, are material for a private equity investor to focus on. 

• Legal proceedings with substantial risks against the target company or its promoters.
• Statutory restrictions that may hinder the execution of the proposed transaction.
• Statutory non-compliance which may result in material risks to the company or its business model.
• Matters related to the core management, control, or ownership of the target company.
• Hidden contingencies or undisclosed commitments that may pertain to trade secrets or intellectual capital.
• Corporate governance issues that need to be addressed.

Recent Trends and Lessons From Start-Ups

Recent years have witnessed various start-ups making headlines due to corporate misgovernance and financial discrepancies. These instances have raised questions on the adequacy of information or scrutiny for such governance issues. 

In order to address such pitfalls, founders and investors have placed increased emphasis on corporate governance in their due diligence process. Furthermore, robust internal controls, transparent financial reporting, and adherence to regulatory guidelines are being adopted, thereby ensuring a more secure investment landscape for private equity transactions.

The use of a vendor due diligence (VDD) is a significant feature in certain company-driven or competitive deals. VDD involves the target company providing essential information to potential buyers, including details about its business, financial condition and legal standing. It aligns with the goal of maximising value for investors as this information is analysed by prospective buyers to assess the associated risks and safeguard their interests post-closing.

Scope and Documents in VDD

In VDD, the target company’s representatives are required to prepare a comprehensive VDD report, which serves as the primary source of information for potential buyers. The report highlights key aspects of the target company, enabling buyers to make informed decisions regarding the transaction. Alongside the VDD report, buyers are also provided with key documents to supplement the findings stated therein. The scope of these documents is typically limited to additional information requested by buyers to gain clarity on the issues highlighted in the VDD report.

Reliance on VDD Reports

Unlike some other jurisdictions, in India, sell-side advisers or target companies do not typically provide reliance on the VDD reports. While they can serve as a helpful resource for buyers, it is essential for investors to independently request material diligence documents and have discussions with the target company to address any key issues referenced in the VDD report. 

Access to UPSI vis-à-vis VDD

In the case of listed entities, disclosure of unpublished price sensitive information is restricted unless:

• the transaction triggers an open offer and the board of the target company is of the informed opinion that sharing such information is in the best interests of such target company; and
• the transaction does not trigger an open offer, the board of the target company is of the informed opinion that sharing such information is in the best interests of such target company, and the information that constitutes unpublished price sensitive information is disclosed at least two trading days prior to the proposed transaction.

Private equity investments as well as acquisitions are predominantly structured through the primary or the secondary route, or a combination of both. Private equity funds typically enter into share subscription or share purchase agreements for subscribing into new shares or purchasing the existing shares of the target company, in the form of equity or preferred stocks or a mix of equity and preferred capital, for cash or non-cash considerations paid on an immediate or deferred basis. With respect to foreign private equity funds, hybrid instruments are not customarily contemplated as an investment instrument for FDI in India. FDI in India is permissible through equity shares, compulsorily convertible shares, compulsorily convertible debentures and share warrants, as opposed to instruments which are optionally convertible or are non-convertible, which are considered as external commercial borrowings and are governed by separate regulations. 

Further, a court-approved scheme is preferred in scenarios for a merger of companies or where a company opts for reconstruction of its capital and its assets with the approval of the court and its shareholders prior to the sale/acquisition.

In India, private equity-backed buyers conventionally acquire the target directly rather than establishing a separate SPV for pooling of funds. Having said this, it would be more customary for offshore acquisitions by Indian companies to establish an offshore SPV to pool funds or raise debt. 

Financing of PE Acquisitions

Private equity transactions are traditionally financed through a combination of debt and equity. The details of such a fusion of equity and debt depends on a number of factors such as the size of the deal, stage of the target company and risk profile of the investment. The equity component is infused by institutional investors and a pool of private capital deposited in the private equity fund, which is used to pay for the equity investment. There is also an increasing tendency towards infusion of capital by high net worth individuals in acquisition transactions involving private equity funds in India, where high net worth individuals invest directly in the target companies, invest through private equity funds or co-invest with a private equity fund. 

Debt Financing

The debt component is conventionally provided by financial institutions or private debt funds. However, acquisition financing is generally not permitted by Indian banks, except in certain limited circumstances. Non-banking finance companies (NBFC), alternate investment funds and mutual funds may provide financing for acquisition of shares in India, provided they meet prudential and concentration norms. Non-convertible debentures (NCDs) are another method of debt financing, however, the extent of regulation of NCDs depends on their being listed, unlisted, publicly or privately placed. Privately placed unlisted NCDs are a popular form of debt financing for foreign private equity investors. NCDs are offered and sold directly to a select group of investors and have a pre-determined short-term tenure. Furthermore, in case of an investment by a foreign owned and controlled Indian company, such Indian entity is not permitted to use borrowed funds for the purpose of making downstream investment in India, which is considered as an indirect foreign investment.

There is an emerging trend within private equity consortium culture that India has witnessed in recent years. Private equity funds typically collaborate with other private equity funds or corporates to invest in target companies as a consortium. Co-investments involving the acquisition of passive stakes by limited partners along with the private equity funds that are already investors in the target companies are also significantly evidenced in the private equity landscape. In some deals, high net worth individuals may also collaborate with each other in a similar manner and invest as a consortium. The consortium brings to the table the complementary skills, expertise, resources and networks of different private equity funds and investors, which in turn are instrumental in supporting upcoming business and help to yield maximum profits on their investment.

Private equity transactions employ various consideration mechanisms, each tailored to meet the specific needs of the parties involved. These mechanisms include fixed price with or without locked-box, completion accounts, and share swaps. Additionally, while deferred consideration structures feature in private equity deals, transactions involving non-resident or foreign parties must comply with foreign exchange regulations when incorporating deferred consideration.

Consideration Mechanisms in Private Equity Transactions

• Fixed price – in this structure, the parties agree upon a fixed consideration amount that remains unchanged throughout the transaction.
• Completion accounts – under this mechanism, the consideration is determined based on the financial statements of the target company as of a specified date. This provides flexibility for adjustments based on the audited or verified value of the target, ensuring a fair and accurate valuation.
• Share swaps – in a share swap, the acquirer purchases the shares of the target company in exchange for allotting its own shares to the shareholders of the target company. This mechanism enables an exchange of ownership and alignment of interests between the acquirer and the target company’s shareholders.

In the event non-resident or foreign parties are involved, the parties must further comply with foreign exchange regulations, including the pricing norms thereunder.

Deferred Consideration in Private Equity Transactions

If non-resident or foreign parties are involved, these transactions must adhere to specific foreign exchange regulations.

• Limitation on deferred consideration – for secondary transactions with non-resident parties, the deferred consideration component should not exceed 25% of the total consideration.
• Timeframe for payment – the payment of deferred consideration for a secondary transaction must occur within a period of 18 months from the execution date of the transfer/secondary agreement.
• Pricing guidelines – the deferred consideration must comply with the pricing guidelines on fair market value prescribed under the foreign exchange regulations. 

In addition, the parties involved in private equity transactions take various protective measures to safeguard their interests. These protections may include indemnity holdbacks and escrow arrangements, which are further subject to certain limitations prescribed under the foreign exchange regulations in cases involving non-resident/foreign parties. The impact of private equity fund involvement on these protections may differ compared to a corporate seller or buyer.

Under certain cases, reverse charge interest may be charged on any leakage that may occur during the locked-box period. Typically, leakages can be in the form of transfer/disposal of assets, write off of any receivables, dividends. Having said this, there are certain leakages which are permitted, such as remuneration to the employees in the ordinary course of business and general administrative and management costs and any other leakages agreed between the parties. 

The majority of private equity transactions have institutional form of arbitration as the preferred mode of dispute resolution. The choice of dispute resolution does not really vary based on the consideration structure used under the transaction. However, the computation of the consideration amount which is in dispute among the parties is typically ascertained by an expert customarily from amongst the Big Four accounting firms. 

Furthermore, there has been a general tread of parties adopting arbitration administered by the Singapore International Arbitration Centre with the seat of law being in India or Singapore (which is a negotiated point based on each party’s preference). 

Private equity transactions are typically subject to:

• completion of all pre-closing conditions to the satisfaction of the purchaser(s);
• consent or intimation requirement from the lenders or financial institutions;
• third-party consents under any contractual arrangements which a company may have;
• any change of control intimation or consent requirement under any material contracts; and 
• board as well as shareholders’ approval as arising or set out under the applicable law, existing shareholders’ agreement or any agreement governing the rights and obligations of a company’s shareholders and the charter documents. In addition, documentation will include key diligence findings as conditions precedent to closing the transaction, in order to ensure that the target company addresses material issues highlighted by the investor. 

Furthermore, the concept of “material adverse change” (MAC) is quite common under private equity transactions in India. MAC accords the contractual protection to the acquirer to terminate the agreement or not proceed towards funding for events which effect the validity of the transaction documents or which have an adverse impact on the financials or business of the company. The concept as well as the definition is similar to that as adopted in the UK or Singapore.

Hell or high water conditions typically depend on a case-by-case basis in private equity transactions in India. There are certain sectors under foreign investment conditions wherein foreign investment above a certain threshold requires regulatory approvals and certain conditions to be followed. Similarly, there are certain monetary thresholds prescribed under the merger control regime in India for which parties are required to take regulatory approvals. 

Therefore, depending upon the sectors under foreign investment and the monetary thresholds under the merger control, hell or high water undertaking is negotiated under a transaction. However, as a general rule, depending upon the applicable rules and regulations, the hell or high water conditions are commonly undertaken on a “reasonable” or “best efforts” basis by the parties involved.

In India, break fees as well as reverse break fees are not common and typically depend contractually on a deal-to-deal basis.

From a legal perspective, there are no specific laws which govern the trigger and volume of such break fees and it contractually depends upon the parties involved. However, an overarching principle is that such break fees should not be punitive in nature and are captured as “liquidated damages”. Having said this, remittance of break fees from an Indian counterparty to an offshore party may require regulatory approvals. 

Under an acquisition agreement, both the buyer as well as the seller are provided with the right to mutually terminate the agreement, if so decided and agreed and in case the transaction is not consummated and closed within the long-stop date. 

However, there are certain additional protections accorded to the buyer wherein buyer can unilaterally terminate the agreement in case of:

• breach of representations and warranties or of any material covenants provided by the seller;
• fraud, wilful misconduct or gross negligence;
• occurrence of MAC; and
• failure to complete any conditions precedent (whether regulatory, contractual or diligence related) to the transaction on or prior to a long-stop date. 

Typically, a long-stop date is negotiated between the parties depending upon the time required for the completion of pre-funding obligations by both the parties. However, subject to the nature of conditions precedent, a period of 45–60 days from the signing of the documents can be considered a reasonable timeline for the same. If any specific governmental or anti-trust approvals are required, then this time period will need to be adjusted.

The overall allocation of risk differs in a deal where the seller or buyer is a corporate or an institutional fund. In instances where institutional funds are sellers, the representations and warranties provided to the counter party are limited and primarily restricted to authority, title, tax and capacity. Furthermore, the indemnity obligation is also limited (capped in amount and time) as opposed to an open-end liability in case of company and promoters or founders.

Private equity sellers customarily provide only fundamental warranties limited to title to shares, tax, authority and capacity. Furthermore, depending upon the fund life and the nature of the transaction:

• the indemnity monetary limitation can typically vary from 50% of the consideration amount or up to 100% of the consideration; and
• the indemnity time period can vary from the fund life of the private equity seller up to seven years.

Buyers also negotiate for carve-outs from fraud on the part of the seller. 

Furthermore, under an exit, management as well as the company may also provide additional business warranties to the buyer and the corresponding indemnity. Customarily, monetary limitation on such warranties can vary from 100% of the consideration to uncapped in relation to breach of fundamental warranties and occurrence of fraud. In certain deals, the parties may also agree on carve-outs in relation to the personal assets of the promoters or founders.

In addition, while a generic disclosure against the data room is not accepted against the warranties, the seller can have a disclosure against the specific warranties. Having said this, disclosure against fundamental warranties is not usually accepted by the buyer. 

Apart from the protections mentioned in6.9 Warranty and Indemnity Protection, warranty and indemnity insurance may also be explored by the buyer or the seller. Warranty and indemnity insurance is, typically, prevalent in cases where there is an indemnity time limitation on the seller on account of its fund life or if the management of the seller is not founder driven. Having said this, the costs for business warranties are typically covered by the target company or split pro-rata among the selling shareholders, and tax insurance is obtained independently by the offshore sellers participating in the sale of securities. In cases where the fund life of the seller is expiring before the completion of the indemnity time limitations, the buyer may even require the general partners of the fund to undertake that the obligations of the seller fund will be satisfied by such general partners post winding-up of such seller fund.

In addition, parties also consider an escrow or retention mechanism wherein a certain percentage of the consideration, to be paid to the seller, is held in escrow to back the indemnity obligations towards the buyer for the breach of the warranties. If the transaction involves a non-resident, then the escrow mechanism is to be in compliance with foreign exchange regulations.

In terms of recent commonly litigated provisions, allegations of fraud, siphoning of company’s funds by the founders/promoters, non-arm’s length related-party transactions, breach of business-related representations or misstatement in the accounts of the company have been a feature. Another key aspect or area of contention are breaches of exit-related clauses by the company or founders. 

Customarily, the shareholders’ agreement will address the manner for assessment as well as the consequences of these breaches. The consequences for founder breaches will also include a termination of the employment on the account of the fraud as well as a claw-back of securities and resignation from all positions in the company, including automatic resignation of all directors nominated by such founder. However, the authors have seen that such actions initiated are challenged by the founders/promoters and are subject to protracted negotiations or an arbitration process.

There are instances of public-to-private transactions, however, they are not as prevalent as transactions involving private companies going public by way of listing. 

SEBI (Delisting of Equity Shares) Regulations, 2021, regulates public-to-private transactions in India. The number of such transactions have been relatively low due to the limited effectiveness of purchasing the residual shareholding and the reverse book-built price mechanism prescribed under the above-mentioned regulations. 

However, in order to protect the interest of investors and to provide flexibility in the voluntary delisting framework, SEBI has inter alia approved the following measures:

• a fixed-price process as an alternative to a Reverse Book Building process (RBB) for delisting of companies whose shares are frequently traded;
• introduction of an alternate delisting framework for listed Investment Holding Companies (IHC) through a scheme of arrangement by way of selective capital reduction;
• reduction in the threshold for making a counter-offer under the RBB process from existing 90% to 75%, provided that at least 50% of public shareholdings have been tendered;
• introduction of adjusted book value as an additional parameter for determining floor price for frequently and infrequently traded shares of the companies under the delisting framework, except for the public sector undertakings; and
• modification of the reference date for computing floor price from the existing requirement of approval of the board to the date of initial public announcement for voluntary delisting as in the case of Takeover Regulations.

Under the terms of SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (the “Takeover Regulations”):

• any acquirer (together with persons acting in concert (PAC)) holding shares equivalent to or more than 5% in the target company is required to disclose its shareholding; and
• any change in the shareholding of the acquirer of 2% or more is also required to be disclosed. 

Further, an acquirer, together with PAC, holding shares or voting rights equivalent to or more than 25% of such listed company shareholding is required to make annual disclosures under the Takeover Regulations. 

In addition to this, SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015, mandates a quarterly shareholding pattern disclosed by listed entities in India. The shareholding pattern is required to be disclosed across three broad categories:

• promoter and promoter group;
• the public; and
• non-promoter-non-public.

Furthermore, pursuant to the amendment in 2022 under the Listing and Disclosure Regulations, listed companies are now required to provide shareholding details on more categories of shareholders (eg, sovereign wealth funds, foreign portfolio investors, FDI, foreign companies, foreign nationals and non-resident Indians) which are now required to be separately disclosed categories. 

The takeover regulations require a mandatory open offer under the following circumstances. 

• An acquirer acquiring shares, together with its existing shareholding and along with the shareholding of the PACs, entitles its shareholding to be 25% or more.
• An acquirer holding at least 25% or more shares (together with their PACs) intends to acquire 5% or more shares in the target company.
• Any direct or indirect acquisition of “control” of the target company. Furthermore, the definition of “control” includes the right to appoint the majority of the directors or to control the management or policy decisions of the target company. 

Along with the above-mentioned thresholds, if the acquirer already holds a stake that is 25% or more but less than 75% of the target company, in the event it acquires 5% or more of the shares/voting rights in the target company within a financial year then an open offer has to be made.

That being said, the above thresholds are subject to exemptions outlined in the Takeover Regulations. For instance, exemptions may apply in cases of acquisitions following a scheme of arrangement approved by the NCLT or during insolvency resolution proceedings.

In investment transactions, cash is typically the predominant form of consideration. However, in M&A transactions, consideration often involves a combination of shares and cash.

Additionally, all non-resident individuals must adhere to RBI pricing guidelines regarding “fair market value”. This ensures that no shares are sold or transferred to non-residents at a price below the fair market value of those shares.

In addition to the mandatory open offer requirements as set out in 7.3 Mandatory Offer Thresholds, the takeover regulations also prescribe conditions for an acquirer for voluntary open offer, offer size, mode of payment under the offer and withdrawal of offer. 

The financing documents by and between the acquirer and the target are entered and executed prior to the opening of the tender offer so that, in addition to the regulatory requirements under the securities law, the rights and obligations of the acquirer as well as the target are documented contractually. 

The Takeover Regulations require that at least 25% of the share capital of a public listed company should be held by the public at all points in time. 

In the event that the public shareholding falls below 25% during an open offer then the acquirer is required to dilute its shareholding to an extent such that the public’s shareholding in the listed entity is at least 25%. Alternatively, the acquirer can delist as well at the time of making the open offer in such a situation. 

Subject to the above, the Indian Companies Act, 2013, also includes provisions for “squeeze outs”. However, minority shareholders can object to such squeeze-out mechanisms on the grounds that it is not is fair and reasonable to the minority shareholders and can block expeditious methods of minority buy out.

Typically, negotiations usually precede the trigger of an open offer by the acquirer to buy the shares in the listed company. The acquirer as well as the promoters and management negotiate the transaction and enter into definitive documents to crystalise the rights and obligations which would flow upon the trigger of the open offer. 

Equity incentivisation of management-level personnel is a common practice in private equity transactions in India. Companies often utilise mechanisms like employee stock options (including phantom stock options), performance-based payments, bonuses, and stock appreciation rights to ensure alignment with the investor’s objectives and milestones. Furthermore, management teams may be issued shares as non-cash consideration to incentivise achievement of performance targets or facilitate exits for institutional investors or listings of securities.

Companies typically allocate an option pool ranging from 7% to 10% of the share capital for employee stock options (ESOPs). The size and structure of this ESOP pool depend on factors such as the company’s type, industry, and specific commercial policies implemented by the company and its investors to incentivise employees.

The Companies (Share Capital and Debentures) Rules 2014, exclude an employee who is a founder or a director (who either by themselves or through a relative, or body corporate holds more than 10% of the outstanding equity shares of the company) for issuance of shares from the ESOP pool. This rule is not applicable to a start-up company for a period of ten years from the date of its incorporation or registration. 

In private equity transactions the management shareholders’ participation is typically conducted through the following methods:

• management stock options;
• a contractual commitment of sharing the equity upside with the investor over a particular threshold; or
• issuance of warrants.

These options provide both investors and the management team with increased flexibility to structure transactions according to their respective needs and objectives. Having said this, the aforementioned options are in addition to the existing ownership of the management/founder at the time of setting up or incorporation of the company.

In early-stage companies, shares held by founders typically undergo a vesting period of four years. During this period, the shares vest equally on a monthly or quarterly basis, along with a one-year cliff period. Similar to other jurisdictions, this structure ensures alignment of founders’ incentives with the long-term success and growth of the company.

In the event of termination or resignation of a founder’s employment with the company on or before the vesting of all shares, the unvested shares are typically repurchased by the company (or its nominee) or transferred to the ESOP pool/trust of the company at face value. This is subject to certain exceptions built in for “good leaver” scenarios. 

In case of termination of employment on account of “cause” or “bad leaver” events, the vested shares are also bought out or transferred at a discounted value.

Private equity investors often require investee companies to impose restrictive covenants on founders and key employees. These covenants typically include limitations on transferring shares, investing in other companies, maintaining exclusivity, adhering to non-compete agreements, refraining from soliciting employees or customers, and maintaining confidentiality.

In addition, investors may seek to amend the terms of employment agreements for founders and key employees. This ensures that any employee or founder exiting the company is restricted from joining or establishing competing businesses, soliciting employees, and disclosing confidential company information to unauthorised third parties.

Under Indian law, non-compete obligations that are directly linked to the shareholding of a founder and are aimed at safeguarding or transferring goodwill are generally enforceable. However, non-compete obligations that extend beyond the term of a contract are typically considered invalid (except if there is transfer of “goodwill”). Non-solicit covenants are generally enforceable under Indian law.

Management shareholders usually receive governance rights, such as a board seat, along with their equity ownership in the company. Depending on their shareholding and board structure, management or founders for a certain period of time may also have a veto over critical operational or strategic decisions. However, management shareholders generally do not have economic protection in the form of anti-dilution protection or liquidation preference rights (unless in some cases where the management shareholders acquire the same class of securities as the investors, without any discount).

Investors negotiate for a range of control mechanisms over their portfolio companies to actively participate in decision-making and monitor financial performance. These mechanisms vary based on several factors such as the type of shares held (equity or preference), the corporation’s by-laws and specific governance, and applicable laws and regulations in the jurisdiction where such corporation is incorporated. However, customary rights extended to such investors by the Indian portfolio companies include board appointment, observer seats, affirmative voting rights, information/inspection rights, dividend rights, pre-emptive rights, liquidation rights, and involvement in key managerial personnel appointments, empowering private equity fund shareholders to safeguard their investments and contribute to the long-term success of the portfolio companies. Recent trends indicate an increase in shareholders’ activism whereby the institutional investors/shareholders, through consistent interaction with the board, active participation in general meetings and public announcements on transacted matters are strengthening corporate governance policies to bring transparency to the affairs of the company.

In addition to above, the affirmative rights of the shareholders ensure control over management or corporate actions proposed to be undertaken by the company which include matters such as related-party transactions, change in business, alteration of charter documents, corporate restructuring, appointment and removal of key managerial personnel, liquidation, or dissolution of the company, exit-related provisions, litigation, annual budgets and business plans and strategic initiatives. 

In India, the company is seen as a distinct legal entity from the shareholders, and no liability for acts or omissions of the company can be placed on its shareholders. Therefore, the corporate shareholders are typically not liable for the debts or obligations of the company, including legal liability for torts or contractual actions. Separately, there are no statutory duties of shareholders with respect to the corporate entities, except in relation to certain disclosures as per the applicable laws. 

However, a court may disregard the corporate protection granted to such shareholders and hold them personally liable in certain exceptional situations wherein piercing of corporate veil establishes the knowledge or intention of such shareholder in the alleged wrongdoing, fraud, money laundering or tax evasion. 

The exit strategies typically negotiated by private equity firms include private sales to other private investors or corporations and initial public offerings (IPOs). However, other forms of exit include the following.

• Strategic sale/third party sale – The sale of a significant or controlling stake in the company to any third party (not being a competitor of the company) taking control over the operations of the company. The option of a strategic sale is also dependent on the size of the company as well as the exit strategy. More often, early-stage investors are provided liquidity through sale of securities to other financial investors (often linked with a primary fund raise of the company).
• Buyback – In the event that the company is unable to provide an exit to the investors within the exit timeline, then, as an alternative recourse, an option of a company buyback of securities is included in the documents. This is not a preferred exit route, as a buyback is subject to certain restrictions as set out in the (Indian) Companies Act, 2013. Furthermore, the inclusion of this clause in the documents also may result in the auditors of the company recording the same as a contingent liability in the books of accounts.
• Drag-along – This right allows the majority investors/shareholders to require and obligate the other existing shareholders to sell their shares to a third party purchaser at the same price and conditions at which the right-holder proposes to transfer its shares. While the document binds the founders to facilitate the exit in this manner, practically, the exercise of a drag-along right requires transaction assistance from the founders. The pricing and valuation of a drag sale is not different from other modes of sale and is subject to applicable law (for instance, in the case of a non-resident exiting investor, it will be governed by Foreign Exchange Management (Non-Debt Instruments) (Amendment) Rules, 2019).

A dual-track process provides an opportunity for private equity investors to explore the public market while seeking a strategic purchaser or another financial investor. However, it is an expensive procedure for the company and it is difficult for the management to allocate resources to fully commit to evaluating both options in parallel. 

Drag as well as tag rights are a common feature in equity transactions. These are designed to protect the interests of both the minority and majority shareholders in the event of a sale. 

Typically, a drag is initiated post the exit period or in an event of default. Any liquidation event, such as a merger, acquisition, public listing or sale of assets resulting in a change of control of the company could also trigger such provision. This right is triggered by major financial investors aggregating to at least 51–75% (as applicable) of their inter-se shareholding, and exercised by written notice to the company to require the minority shareholder to transfer any of the shares as specified in the drag notice in conjunction with an offer received from a third party on the same terms and at the same price. Furthermore, the participation of the founders in such a drag sale can be made necessary, including providing customary representations, warranties and indemnities as required by the third-party buyer. Lastly, if the drag sale does is not comprised of shares held by investors (other than the dragging investors), then the minority investors negotiate a tag-along right to enable them to participate in such transaction. 

Tag-related transactions are linked to a sale of securities of the founder. The tag-along is customarily on a pro rata basis with the founder(s). However, a full tag is provided to the investors if such a transfer results in a change in control or the founder’s shareholding falling below a negotiated threshold. 

Lastly, the parties may also negotiate to include the concept of a housekeeping tag, whereby transfer of shares by one or more shareholders to the third-party buyer results in a change of control scenario. In such a scenario, each shareholder (other than the selling shareholders) shall have the right to require such a third-party buyer to purchase up to all their shares held in the company on the same terms and price offered to the selling shareholders as part of such sale.

Lock-in restrictions are governed by the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018. As per these regulations, subject to certain exceptions and categories of investors, the entire pre-issue capital held by persons (other than the promoters) is locked-in for six months from the date of allotment in the initial public offer. Founders’ minimum statutory contribution is locked in for 18 months and the amounts in excess of that are locked in for six months.

Under applicable SEBI Regulations, the minimum promoter contribution (MPC) required to be contributed by the promoter in an initial public offering is at least 20% of the post-offer paid-up share capital. However, SEBI has recently relaxed MPC requirements and has permitted non-individual investors holding 5% or more of the post-offer equity share capital of a company, to contribute towards the MPC, without being identified as promoters. This will provide a fillip to entities where significant shareholding is held by institutional PE and VC investors and not the original promoters to undertake exits via the IPO route.