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

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:

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.

a. 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”.

b.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?

a.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.

b. 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.