India’s New Global M&A Flavour: Cash-free M&A, SPACs, Roll-ups now possible? - Resolut Partners

India’s New Global M&A Flavour: Cash-free M&A, SPACs, Roll-ups now possible?

Key Takeaways

  • Foreign expansion of Indian companies gets a boost – offshore acquisitions now allowed by share swaps
  • SPACs and roll-ups greenlit – foreign investors can now acquire Indian companies by a share swap
  • Indian listed companies may still have to wait for change in SEBI regulations to achieve a primary swap
  • Indian individuals cannot directly swap shares in most cases – so, for SPACs/ roll-ups which involve individuals, LLP structures, which have been historically used, could be considered
  • Tax laws still need to catch up – share swaps, only an exchange of notional value, continue to be taxable

India’s historically strict restrictions on capital inflows and outflows have been taking on new flavours. Until now, both foreign and Indian dealmakers were rather restricted in their ability to structure cash-free cross-border deals.

Now, that should change, as foreign investors can more freely use the shares they own to pay for their India investments and resident Indians can more freely use shares they own to pay for their foreign investments. That allows both sets of investors to free up cash and leverage the value of the equities they hold.

In this analysis, we identify what’s changed in India’s exchange control regime and its impact from a legal, structuring, dealmaking and tax lens.

What stopped investors from paying with shares previously?

All acquisitions financed by shares are essentially share swaps. That means a foreign investor is investing in India and simultaneously an Indian investor is investing abroad. India’s exchange control regime regulates those two legs in two separate rules: the OI Rules (for Indians investing offshore) and the NDI Rules (for foreign investors investing in India).

Since a swap involves both legs transacting at the same time, both the OI Rules and the NDI Rules had to expressly allow investors to pay for their investments using shares. Fortunately, the OI Rules have in some form always allowed Indian companies to pay for offshore investments using shares. But, the challenge until now was that the NDI Rules did not allow foreign investors to invest into India by swapping their foreign shares (they could only swap using the Indian shares they held, which Indian targets rarely sought). Similarly, foreign investors could not invest into India against swap of shares held by Indians.

What’s changed now?

Two key changes are relevant for dealmakers:

  1. First, as noted above, foreign investors were not allowed to pay for Indian shares1 using foreign shares.2 That has now been permitted.

  2. Second, as noted above, Indian investors were not allowed to pay for the swap using the Indian shares they owned (i.e., a ‘secondary swap’). Indian investors were only allowed to swap if the Indian investor issued fresh shares and paid for the foreign investment using those freshly issued shares (i.e., a ‘primary swap’). Now, both secondary and primary swaps are permitted.

So, what does this mean for deal structuring?

Global dealmakers should see several key structures for M&A opening up, such as direct company acquisitions, SPACs and roll-ups. Before arriving at the most relevant innovative deal structures, we’ve set out some scenarios to help you understand what’s now possible from a structuring lens:

Relevant Scenario
Prior to this Amendment
Post this Amendment
Indian company acquiring a foreign company by way of a share swap

(such that the foreign company becomes a subsidiary of the Indian company, and the shareholders of the foreign company become shareholders of the Indian company)

Not allowed

While the Indian company could pay foreign shareholders with freshly issued shares, it could not receive foreign shares held by the shareholders of the foreign company

Allowed

Indian companies can acquire foreign companies by:

  1. a primary swap (i.e., by issuing fresh shares); and
  2. a secondary swap (i.e., by way of exchanging existing shares it holds in other companies)
Foreign company acquiring an Indian company by way of a share swap

(such that the Indian company becomes a subsidiary of the foreign company, and the shareholders of the Indian company become shareholders of the foreign company)

Not allowed

The foreign company could not issue Indian shareholders foreign shares in exchange for Indian shares.

The only way was for the foreign companies to actually cash out Indian shareholders

Allowed

Foreign companies can finance acquisitions by paying Indian shareholders using foreign equity shares

The following illustrations depict how a primary and secondary swap can take place:

a. Primary Swap:

Now, it is possible for “E” (in Figure 1 above) to acquire shares of “B” from “A” by issuing its shares to “A” as consideration.

b. Secondary Swap:

In Figure 2 above, “A” can now acquire “D” by transferring its shares in “B” to “E”, and as consideration, “E” will transfer its shares in “D” to “A”.

Innovative cross-border deals unlocked?

Two key global M&A structures have now been practically enabled in the Indian context. These are ‘SPAC’ transactions and ‘Holdco roll-up’ structures.

  1. SPAC transactions

    SPACs (i.e., special purpose acquisition vehicles) raise money from investors with the sole aim of acquiring an operating company. Usually, the companies being acquired have a higher value than the amount that the SPACs have raised. Therefore, existing shareholders of the target are paid in the form of shareholding in the SPAC (while a part consideration may also be paid in cash). In some cases, the existing shareholders may prefer to acquire a stake in the SPAC to stay involved in the company and exit at a higher valuation in the future.

    For instance,

    i. A “SPAC”, identifies an Indian target “A”.

    ii. “B” which is the sole shareholder of “A” agrees that the business may be better valued in the US (where “SPAC” is listed).

    iii. Therefore, “SPAC” acquires 100% of “A” by allocating “B” certain shareholding in “SPAC”.

  1. Roll-up transactions with a global Holdco/ platform

    Globally, a common tactic for private equity firms is the roll-up trade. This involves a private equity firm acquiring several companies operating in the same field and setting up a foreign platform to unlock greater value.

    The owners of the target companies are usually given some equity in the platform company as consideration (with a portion also paid out in cash). This equity incentivizes them to optimize the operations of the consolidated entity and may also help bridge any valuation mismatches.

    For instance,

    i. A private equity fund “A” sets up a platform “B” for software outsourcing firms.

    ii. “B” acquires a software outsourcing firm “C” from “D”.

    iii. “B” also acquires another software outsourcing firm “E” from “F”.

    iv. In both instances, the existing shareholders “D” and “F” are paid via a 15% stake to each in “B”.

What remains restricted?

  1. Primary share swaps by Indian listed companies barred

    Listing regulations in Indian only allow listed companies to undertake a preferential issue for non-cash consideration if such consideration is Indian shares.3

    That means listed companies effectively remain restricted when trying to acquire offshore companies (since the listed company cannot offer foreign shareholders freshly issued shares as payment for the foreign shareholders’ shareholding in such offshore company).

    What will be required is a change in SEBI’s regulations to allow foreign shares as consideration for preferential issues. That change may be well-warranted as Indian listed companies will want to leverage their growing valuations to undertake global acquisitions without taking a significant cash hit.
  1. Share swaps effectively barred for Indian individual shareholders

    Under Indian exchange control rules, Indian individuals are only allowed to swap shares they hold in select cases, i.e., mergers, demergers, and amalgamation, which are court-facilitated processes (and then individuals are further subject to a limit of USD 250,000 on the total amount they can invest offshore).

    As a result, some of the structures which involve foreign companies purchasing shares from, or issuing shares to, Indian individual shareholders in exchange for the shares held by such Indians in the target company, should not be possible.

    Individuals have historically resolved the issue of limit restrictions on overseas investments using an LLP structure, where the above restrictions on swap do not apply, and where the limits, though existing, are much higher.

Are offshore share swaps taxable?

Yes, if an Indian shareholder is transferring shares held in India (in exchange for foreign shares), then the Indian shareholder will have to pay capital gains tax based on the notional value of the foreign shares received, at a rate of ~12.5% (LTCG). That taxation may be misplaced from a policy perspective considering that the Indian shareholder receives only notional value in exchange (i.e., in the form of foreign shares) and no actual cash. To that extent, policymakers would do well to also harmonize the intent of exchange control laws with taxation laws.

Conclusion

The policy gradient of the Indian government in the past decade is clear: deregulation. And the recent changes around swap of shares are a step in that direction. For foreign investors, the benefit of structures like SPACs and roll-ups, and a host of other structures should significantly enhance smoother dealmaking.

Indian shareholders will pointedly benefit because they can now leverage the value of Indian companies (which are at their highest ever historically) to effectively undertake M&A offshore, as will foreign companies looking to tap into India’s growth. It also provides an avenue for Indian cos which want to list abroad or whose business may do better as part of a larger global group.

There are a few features which remain to be included, namely, with respect to listed Indian companies and resident individuals. The trend, however, seems to indicate that these may come sooner rather than later

1 Note. This includes shares, share warrants, and preference shares.

2 Note. Foreign shares also includes equity shares, perpetual capital, irredeemable instruments, and contribution to non-debt capital in the form of compulsorily convertible instruments issued by foreign companies.

3 Regulation163(3), Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2018.

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SEBI is slowly re-defining InvITs: What’s at risk for the product and its institutional audience?

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  • Strong minority unitholder protections introduced – for both public and private InvITs
  • Private InvITs originally designed to attract large institutional capital – light touch re- gulations allowed flexibility to parties to manage their arrangements…
Investing into Infrastructure Holding Companies: What if you become a core investment company?

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  • Infrastructure companies are mandated to execute concessions through SPVs, which often results in qualification of the holding company as a core investment company (CIC)
  • CIC risk is often avoided by structuring EPC and O&M revenues through the hol- ding company and swelling …
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  • Public shareholders will need to brace for impact and be proactive – else risk getting the short end of the stick
  • Legal sanctity of the ‘theory of attribution’ possibly misplaced in the Fortis context…
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  • No express framework exists for nominee directors to share UPSI with nominating shareholders
  • Natural expectation that nominee directors should represent their nominators’ interests – not permitted under law
  • Since nominee directors’ fiduciary duty remains towards the company and stakeholders, nominee directors are paradoxically placed and exposed to significant…
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Decoding Boardroom Dilemmas – Hiving Off to Fundraise Through Subsidiaries – Commercial Wisdom or Short-Changing Public Shareholders?

  • Transferring a majority-revenue generating business into a private subsidiary (hiving off) and raising funds at the subsidiary level is increasingly seen as a preferred alternative to direct listed acquisitions or slump sales
  • Hiving off may result in a ‘holding company discount’ and public shareholders lose out on value…
Threat of valuation litigation in Public M&A – Carlyle-PNB Effect! 

Threat of valuation litigation in Public M&A – Carlyle-PNB Effect! 

  • SEBI floor price prescription in case of fund raises should not automatically dislodge directors’ duty to exercise independent judgment and maximise shareholder value
  • Target boards to proactively consider appointing an independent banker and running a robust auction process for capital raises…

Research Paper

Public M&A: Do List Cos Really Need Omnibus RPT Approvals?

Public M&A: Do List Cos Really Need Omnibus RPT Approvals?

  • There seems to be an overlap between regular RPT approvals and omnibus approval routecreating ambiguity on what type of approvals must be procured for long term related partycontracts?
  • Listed companies often enter into long term contracts with…
Should Offshore Funds Appoint Directors?

Should Offshore Funds Appoint Directors?

The issue of director duties and attendant liabilities has been a subject of immense debate as the role of directors evolves in the Indian context. India is perhaps a decade behind the west in this evolution process, though rapidly catching up driven by increasingly proactive proxy advisory firms and institutional capital taking significant positions in Indian companies, though activist funds are still a rarity. Transcendence from ‘complying with their obligations’ to ‘performing their duties’ has probably been most transformational and manifested only in the past couple of years…

Tax Structuring & Litigation

Analysis

Ambiguity with thin cap norms: Private credit players risk significant tax leakage

Ambiguity with thin cap norms: Private credit players risk significant tax leakage

  • Accurate reading of thin capitalization norms is highly relevant to maximize IRRs, especially in asset heavy sectors
  • Currently, norms interpreted such that sometimes the entire interest paid to foreign related parties is disallowed for the target (as expense)…
Private Credit: Interest on NCDs recharacterized as dividends 

Private Credit: Interest on NCDs recharacterized as dividends 

  • Tax authorities recharacterized interest income on NCDs as dividends
  • Interest recharacterization has not taken place under GAAR
  • Investors can prevent such mischaracterization by demonstrating the nature of the underlying instrument, periodicity of payments, maturity date, management rights,
    etc….
Denial of tax treaty benefits: Blueprinting defence strategies for PE funds – A tax litigation perspective

Denial of tax treaty benefits: Blueprinting defence strategies for PE funds – A tax litigation perspective

  • Revenue has issued reassessment orders to several global PE/VC funds denying
    tax treaty benefits to grandfathered investments alleging treaty shopping through Mauritius and Singapore between AY 2013-14 and 2015-16

  • Substantial tax, interest, and penalty has been levied invoking judicial anti-avoidance principles based on a supposed lack of commercial substance in these jurisdictions…
Top 5 Tax Considerations When Structuring Debt Investments in India

Top 5 Tax Considerations When Structuring Debt Investments in India

  • Recent developments in the Indian tax regime have brought India closer to global
    norms though hybrid instruments that have come under increased scrutiny

  • GAAR provisions have enabled tax authorities to examine the commercial substance of transactions, underscoring the importance of purpose, pooling, and people…

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