The current technology M&A market in India is thriving. There were close to 500 deals in the first half of 2021, amounting to a deal value of about USD17.3 billion.
The COVID-19 pandemic has accelerated the use and adoption of various technologies. Companies in online payments, online education and food delivery have seen a substantial increase in their users. This in turn has resulted in increased M&A activity in the technology sector.
The world’s largest ed-tech deal of USD1 billion was recently concluded between two Indian entities.
M&A activity has been at an all-time high. Deals worth USD90 billion were closed in the first nine months of 2021. Several of these deals exceeded USD1 billion in value.
Several sectors, such as financial services, technology and energy, saw significant M&A activity.
Several companies also undertook initial public offerings and many more IPOs are in the pipeline.
Led by significant investment from US investors, 16 new Indian companies became unicorns.
Large industrial houses, such as Reliance and Adani, were also very active in making acquisitions.
If the entrepreneurs/founders of the start-up company are Indian residents and plan to manage and operate the company themselves from India, then to avoid any adverse tax issues, start-ups are typically advised to incorporate in India.
It takes about three to four working days to incorporate, if all the documents are in order and a trade mark search has been conducted upfront to ensure that the name and business of the proposed company do not conflict with any other company which has a trade mark registered in its name.
The initial capital requirement is nominal, as low as INR1 for a one-person company, INR2 for a private limited company, and INR7 for a public limited company. A private limited company must have at least two shareholders, whereas a public limited company must have at least seven shareholders.
Entrepreneurs are typically advised to choose a private limited company or a limited liability partnership since these are the corporate vehicles which are well understood within the financial and technology community, making it easier to close financing transactions and undertake mergers and acquisitions with such entities.
There is adequate jurisprudence regarding the functioning of such entities, and this provides certainty to investors. Plus, of course, these entities provide limitation of liability for the shareholders.
Early-stage financing is usually provided by family and friends or domestic angel funds/networks. This is documented by way of a share subscription cum shareholders’ agreement. In addition, the articles of association are usually amended to incorporate the key provisions so as to avoid any ambiguity regarding the said agreements being binding on the company.
A typical source of venture capital is foreign venture capital funds which are registered with the Indian securities regulator. There are also domestic funds that provide such financing. Venture capital is easily available in India. The government of India has also launched a start-up initiative, whereby financing is made available to start-ups. Several state governments have also launched their own venture capital funds to invest in start-ups.
Over the past two decades there has been substantial standardisation of venture capital documentation, such as term sheets and shareholders’ agreements. Several provisions, such as anti-dilution, tag and drag-along rights, right of first refusal, deadlock resolution etc, are now well understood and there are basic rules of thumb for these. Of course, based on due diligence on the part of promoters and the company and any facts peculiar to the situation, including any specific intellectual property rights on the basis of which a party may be investing, certain specific clauses would be included in the documentation.
Start-ups may change the form from a private limited company to a public limited company if they plan to list or otherwise raise monies from the public at large. Jurisdiction would change if the key investors wish to relocate the start-up company or if the founders believe they would get a better valuation in another jurisdiction. However, this is not an easy migration since it entails several complex tax and legal issues, including foreign exchange management laws prevalent in India.
Investors always incorporate an exit clause. The exit is either by way of a secondary sale, buy-back of their shares by the company or the founders, or by way of an initial public offering. While an IPO is preferred, very few start-ups reach that stage. However, in the recent past several start-ups have successfully listed in India.
Under the current regulations, Indian companies cannot directly list on overseas exchanges. They need to first list in India or simultaneously list in India and overseas. Although in May 2020 the government announced that Indian companies may list overseas directly, the necessary amendments to the law are still awaited. In the past, some Indian companies used the American Depository Receipts and Global Depository Receipts route to raise capital directly from overseas and enable the listing and trading of depository receipts overseas.
Even under Indian law, there are provisions to squeeze out minority shareholders. Depending on the foreign exchange on which a company decides to list, the squeeze-out option may or may not be available in that jurisdiction.
The form a sale process takes is decided on a case-by-case basis. Usually, bilateral negotiations are held for smaller to mid-sized targets, while auctions are used for larger companies.
The transaction structure depends on the acquirer. Some acquirers, especially strategic ones, prefer to acquire the entire company and control the company. In some cases, the acquirer may be willing to continue with a few minority shareholders with very few rights.
Most transactions are cash transactions. Very few are a combination of stock and cash.
The founders, especially if they are also actively involved in running and managing the company, are expected to stand behind the representations, warranties and certain liabilities such as for any non-compliance with the law, tax demands etc. The VC investors are generally expected to only represent and warrant their clear title to their shareholding in the company and their authority to enter into the transaction.
Spin-offs are not customary in the technology sector but are used at times. Also, due to recent changes in the tax laws, spin-offs have lost many of the erstwhile advantages that they offered. Based on a recent amendment in April 2021, spin-offs must now be done at a fair market value of the assets being transferred by way of sale, exchange or otherwise. Previously, the same could be done at the book value of the assets.
Given the recent changes to the tax laws, tax-free spin-offs have now become difficult. Depending on the fair market value of the assets being transferred, it may or may not be possible to structure spin-offs as tax-free transactions.
There is no legal prohibition and there are no key requirements in the case of a spin-off that is followed immediately by a business combination. However, due to recent amendments in the tax laws, the spin-offs or "slump sales", as they are known in India, have lost many of their tax advantages. For example, a spin-off now needs to be undertaken at the fair market value of the assets, as compared to the earlier book value.
The typical timing for a spin-off would depend on the readiness of the parties involved and the availability of certain reports, such as valuation reports. There is no mandatory requirement to obtain any ruling from any tax authority prior to completion of the spin-off.
It is customary to acquire a stake in a public listed company prior to making an open offer. The reporting threshold for acquisition of shares of a public listed company is 5% or more. This needs to be reported within two working days of the acquisition.
Certain exemptions apply, for example, if the shares are listed on the Innovators Growth Platform (IGP) and/or if the buyer is a housing finance company etc. The IGP is a specialised platform for listing of companies with an information technology, intellectual property, bio or nano technology focus. In the case of such a company, the threshold is 10%.
The buyer does not need to state the purpose of the acquisition or the buyer’s intentions with respect to the public listed company.
The mandatory threshold for having to make a public offer is 25% or more, subject to certain exceptions. For example, if the shares of a company listed on the IGP are involved, the threshold is 49% or more.
The typical transaction structure for the acquisition of a public company is acquisition of shares from the stock exchange, up to the permissible threshold specified in 6.2 Mandatory Offer, followed by an open offer.
On a case-by-case basis, certain companies may also adopt the merger route. On a separate note, recent mergers between unlisted and listed companies have also been permitted subject to certain conditions, such as, the listed company being on a stock exchange that has nationwide trading terminals.
Typically, acquisitions are structured as cash transactions and at times, mergers may also be structured like this. On a case-by-case basis, such transactions may be structured as part cash and part stock.
Payment for acquisitions can be made by issue, exchange or transfer of listed equity shares or listed secured debt instruments or convertible debt instruments of the acquirer or any person acting in concert with the acquirer, subject to certain conditions. These include that the listed shares should be frequently traded and should have been listed for a period of at least two years prior to the public announcement, etc. However, where shares constituting more than 10% of the voting rights of the target have been acquired by one acquirer in the 52 weeks immediately preceding the date of a public announcement and have been paid in cash, then the open offer must provide the shareholders to require payment of the offer price in cash.
Minimum Price Requirement
There is a minimum price requirement which is prescribed by the Securities and Exchange Board of India (SEBI), under the SEBI (Acquisition of Shares and Takeovers) Regulations, 2011 (the “Takeover Regulations”). In the case of direct or deemed direct acquisition of shares or voting rights in, or control over, the target company, the offer price shall be the highest of:
A similar minimum price is to be paid for indirect acquisitions, with some variations regarding the highest price paid being linked to 52 weeks prior to the earlier of the primary acquisition being contracted and the date of the public announcement.
The minimum price is also prescribed where the price cannot be determined under the prescribed scenarios and is the fair price of the shares to be determined by the acquirer and the manager to the open offer, taking into account valuation parameters, such as book value, comparable trading multiples, etc.
Deferred or Contingent Payments
As far as deferred or contingent payments are concerned, these are used at times for bridging any value gaps. However, in the case of cross-border transactions, not more than 25% of the total consideration can be paid by a buyer on a deferred payment basis and this, too, should not exceed a time frame of 18 months from the date of the agreement to transfer shares.
There are several conditions which are common for takeover/tender offers and these are prescribed under the Takeover Regulations. For example, the minimum percentage of shares to be acquired (26%); the minimum price to be offered, as discussed in 6.4 Consideration; Minimum Price; the requirement to appoint a merchant banker who will manage the offer, etc. There are, however, exemptions in certain cases where the acquisition is between relatives or promoters/founders, and/or in cases where the acquisition is pursuant to the invocation of a pledge by a Scheduled Commercial Bank or a Public Financial Institution, etc.
It is not customary to enter into a transaction agreement in connection with the takeover offer. However, for business combinations it is customary to do so. Whether or not there is a transaction agreement, the Takeover Regulations impose mandatory obligations on a target company and on the acquirer. For example, during the offer period, the business of the target company is to be conducted as usual, consistent with past practice. Furthermore, without the consent of a special majority (75%) of shareholders of the target company, neither the board of the target company nor any of its subsidiaries may alienate any material assets; effect any material borrowings outside of the ordinary course; issue or allot any authorised but unissued securities having voting rights; implement any share buy-backs or change the capital structure of the company; enter into, amend or terminate any material contracts, etc.
It is not customary for a public listed company to provide representations and warranties since all the price-sensitive information is already in the public domain. However, certain limited representations and warranties may be negotiated on a case-by-case basis by such companies. On the other hand, an unlisted public company may be asked to provide various representations and warranties, and may also provide the same.
If an acquirer acquires 25% or more of the voting rights or shares in a target company and/or acquires "control" over a target company, then the acquirer is required to make an open offer to acquire at least another 26% of the total equity shares of the target company. The term "control", as defined in the Takeover Regulations, includes the right to appoint the majority of the directors, or to control the management or policy decisions of the target directly or indirectly in any manner.
Where the holders of at least 90% in value of the shares of the target company have approved a scheme or contract involving the transfer of their shares to an acquirer, then the acquirer has the power to acquire the shares of the dissenting shareholders, subject to the National Company Law Tribunal disallowing the same on the basis of an application made by any of the dissenting shareholders.
In order to launch the offer, certain funds need to be deposited in an escrow account for the performance of an acquirer’s obligations under the Takeover Regulations. If the consideration payable under the open offer is less than approximately USD66 million, then the escrow amount must be equal to 25% of the consideration. If the consideration payable exceeds USD66 million, then the escrow amount must be an additional 10% of the consideration exceeding USD66 million. The escrow amount can be in various forms such as cash deposited with any scheduled commercial bank, bank guarantees, a deposit of frequently traded and freely transferable equity shares, subject to certain conditions.
A target company can agree to deal protection measures, such as, reasonable break fees, non-solicitation, matching rights, etc. However, a force-the-vote provision would be in violation of the directors’ duties under the Companies Act, 2013 and would not be legal or enforceable.
At the outset, listed companies – subject to a few exceptions – must have at least 25% of their shares held by public shareholders. Thus, it would not be possible for a bidder to acquire 100% ownership and continue to keep the target listed. If 100% of the shareholders were to tender their shares, then the target would compulsorily have to be delisted from the stock exchanges.
Generally speaking, domination and profit-sharing arrangements would not work between two listed companies, since the boards of the companies have a duty to their respective shareholders, and compromising the interest of their company in favour of another would be in violation of the law. This would also be in violation of the corporate governance norms prescribed by the listing agreements between the target and the stock exchanges, and would also thereby be in violation of the securities laws of India.
It is not common for irrevocable commitments to be given in the case of a takeover of a public listed company. However, these may be used in the case of mergers or amalgamations which are subject to the approval of the National Company Law Tribunal or court. An "out" is usually negotiated for a better offer.
Before a letter of offer goes to the public shareholders, the acquirer needs to send it to SEBI. Within 15 working days of the receipt of such letter, SEBI reverts with its comments or observations and may also ask for certain changes to be made. SEBI may also seek clarifications from the manager on certain issues and this process may take additional time. SEBI’s comments or observations are not treated as approval of the offer letter. However, the offer cannot be in violation of the terms prescribed under the Takeover Regulations. SEBI may also call for a revised letter of offer.
All timelines are established by SEBI.
If any competing offer is received, then SEBI is to provide its comments on the draft letter of offer in respect of each competing offer on the same day.
The takeover/tender offer can be extended if statutory approvals were not obtained, but this is at the discretion of SEBI, which must be satisfied that the non-receipt of approvals was not attributable to any wilful default, failure or neglect on the part of the acquirer.
If SEBI is of the view that such delay was due to reasons beyond the control of the acquirer, then SEBI may grant an extension subject to payment of interest by the acquirer.
Typically, parties obtain, or at least apply for, statutory approvals prior to making the public announcement.
Setting up and starting to operate a new company in certain sectors of the technology industry are subject to specific approvals and regulations by specific regulators. For example, a technology company in the fintech space would require the approval of the Reserve Bank of India (RBI). Similarly, a technology company in the payments sector would also require the approval of the RBI, and would need to comply with the Payments and Settlement Systems Act.
A technology company in the education-tech sector would be subject to the approval and regulations prescribed by the University Grants Commission and the All India Council for Technical Education.
Also, under the recently amended Consumer Protection Act, a separate regulatory regime has been specified for e-commerce operators.
The primary securities market regulator for M&A transactions is the Securities and Exchange Board of India (SEBI). Also, the National Company Law Tribunal constituted under the Companies Act, 2013 has the powers to sanction merger and acquisition transactions.
Most sectors are open to 100% foreign investment. However, there are certain limited restrictions on foreign investment in sectors such as atomic energy, gambling and betting, railway operations, real estate business (with some exceptions, relating to specified construction activities).
There is a national security review of acquisitions and investments in certain sectors such as the defence sector. Investments in the defence sector need the security clearance of the Ministry of Home Affairs and as per the guidelines of the Ministry of Defence. Similarly, in the broadcasting sector, it is mandatory to have security clearance of a company’s key personnel, key shareholders, etc. The telecom sector and ground-handling sectors are also subject to similar clearances.
There are also specific restrictions for countries which share land borders with India, for example, China, Pakistan, etc.
There are export control regulations in India. These are both product and country-specific and are prescribed under the Foreign Trade Policy.
The basic antitrust filing requirement applicable to takeover offers/business combinations which exceed the thresholds prescribed under the law, ie, approximately USD46 million in assets or USD133 million in turnover, are filing of Form I with payment of the prescribed fees.
Recently, all old labour law legislations have been consolidated into four labour codes. However, while the codes have been notified, the rules for their implementation have not as yet been notified. Also, some of the old labour laws have not yet been repealed. Thus, in the current situation, the primary labour law regulations that an acquirer should be concerned with are the Industrial Relations Code, 2020; the Industrial Disputes Act, 1947 (ID Act); the Trade Unions Act, 1926; the Industrial Employment (Standing Orders) Act, 1946; the Code on Social Security, 2020; the Code on Wages, 2019; and the Occupational Safety, Health and Working Conditions Code, 2020. While the aforementioned codes will repeal most of the old laws, such as the ID Act, the notification repealing some of such acts is still awaited. Thus, currently, the applicable labour laws are a combination of the new and the old laws.
Furthermore, as per a Supreme Court judgment which interpreted the provisions of the ID Act, which is not yet repealed, workmen currently cannot be forced to work under different management or owners, and thus their consent is mandatory. If they do not consent to this, then they are entitled to retirement/retrenchment compensation in terms of the ID Act.
It should be noted that this does not apply to non-workmen whose transfers would be governed by their respective employment contracts.
India does have a currency control regulation in the form of the Foreign Exchange Management Act, 1999 and the rules and regulations issued thereunder. In some cases, the approval of the RBI is required for an M&A transaction. These are cases where foreign investment in a particular sector does not fall within what is known as the "automatic route" of foreign investment and may be a result of deviation from pricing guidelines, or where the investment pertains to a particular, sensitive sector.
The RBI has also notified specific rules for cross-border M&A, called the Foreign Exchange Management (Cross-Border Merger) Regulations, 2018.
Some of the significant legal developments and court decisions relating to technology M&A are as follows.
The due diligence information that may be provided is subject to the contract between the bidders and the public company. However, as far as unpublished price-sensitive information is concerned, the same may be shared with a bidder under a confidentiality and non-disclosure agreement, provided it is in connection with a transaction that would entail an obligation to make an open offer under the said Takeover Regulations, and where the board of directors of the public company is of the informed opinion that such disclosure is in the best interest of the company.
Even where a transaction does not attract an open-offer obligation under the Takeover Regulations, unpublished price-sensitive information may be shared where the board of directors is of the informed opinion that such disclosure is in the best interest of the company and such information is disseminated to be made generally available, at least two trading days prior to the proposed transaction being effected, in such form as the board of directors may determine to be adequate and fair to cover all relevant material facts.
There are data privacy regulations in India, however, these would not limit the due diligence of a technology company, provided the technology company has procured the consent of its users for sharing any personal information, which is wide enough to cover the sharing of such information for the purposes of an M&A transaction.
Once the triggering event takes place, a public announcement is made and thereafter a detailed public statement is published in the newspapers and is also provided to SEBI. Thereafter, within five working days from the date of the said statement being published, the acquirer is to file a draft letter of offer with SEBI (through the manager to the offer) and simultaneously send a copy of the said letter to the target company and to all stock exchanges where the target company is listed.
The letter of offer is dispatched to the shareholders of the target company no later than seven days from the receipt of SEBI's comments or, where no such comments are received, within seven days from the expiry of 15 days of the submission of the said draft to SEBI.
Additionally, the acquirer is required to advertise in the newspapers one working day before the commencement of the tendering period announcing the schedule of activities for the open offer and related matters.
Where there is issuance of listed equity shares or the issue of debt securities convertible into listed equity shares, there is no need to issue a prospectus, provided that the shares are frequently traded at the time of the public announcement and have been listed for at least two years prior. The acquirer is also required to have been in compliance with the listing agreement for at least two years prior and have redressed at least 95% of the complaints received from the investors by the end of the calendar quarter immediately preceding the calendar month in which the public announcement is made.
Where the acquirer is a corporate entity, financials based on the latest audited consolidated financials, where applicable, are required to be disclosed in the specified format. The financials are to be presented in the GAAP format. And any financials not in Indian rupees are to be presented in the original currency, then converted into Indian rupees.
In the case of an individual acquirer, a net worth certificate certified by a chartered accountant is to be provided.
The transaction documents that triggered the open offer have to be made available for public inspection. Such documents do not need to be filed, but the details of the transaction type, ie, whether share purchase, share subscription, indirect acquisition or open market, and its details, are to be disclosed in the detailed public statement.
Directors' duties are prescribed under the Companies Act, 2013. A director is required to act in accordance with the articles of association of the company and is required to act in good faith to promote the objectives of the company for the benefit of its members as a whole and in the best interests of the company, its employees, all shareholders, the community and the protection of the environment. A director is required to take decisions with due and reasonable care, skill and diligence and is to exercise independent judgment. These duties would apply to a business combination as well.
With regard to open offers for acquisition of listed public companies, additional specific obligations such as facilitating the acquirer in the verification of shares tendered in acceptance of the open offer, etc, are prescribed.
Whether directors establish special or ad hoc committees in business combinations depends on the company. Directors are not to involve themselves where they have a conflict of interest or even the possibility of a conflict of interest. Special or ad hoc committees are not necessarily created in such situations. However, in the case of takeovers of listed companies, upon receipt of the detailed public statement, the board of directors of the target company is required to constitute a committee of independent directors to provide reasoned written recommendations on the open offer to the shareholders, and such recommendations are to be published at least two days prior to the commencement of the tendering period.
Most takeovers of listed companies are a result of negotiated transactions and thus the board is actively involved. It is not common to have shareholder litigation challenging the board’s decision recommending an M&A transaction.
Legal and financial advice is procured from independent outside advisers. It is customary for a financial adviser to provide a fairness opinion. In fact, in certain cases where a scheme of merger is to be presented for approval by the National Company Law Tribunal, it is mandatory to get a fairness opinion from a SEBI-registered merchant banker.