Lexology GTDT Market Intelligence provides a unique perspective on evolving legal and regulatory landscapes. This interview is taken from the Private Equity volume featuring discussion and analysis of emerging trends and hot topics within key jurisdictions worldwide.
1 What trends are you seeing in overall activity levels for private equity buyouts and investments in your jurisdiction during the past year or so?
Over the years, private equity (PE) and venture capital (VC) funds have played a transformational role in the Indian corporate landscape. From being mere financial investors, to strategic advisors, minority stakeholders to taking greater control – they have done it all. This gradual shift in PE mindset resulted in several new themes in the PE deal scape: PE-backed buyouts, consolidation among PE-backed entities, start-ups and e-commerce dominated PE deal activity.
It is interesting to note how technology and technology-enabled sectors continue to drive the Indian economy in recent times, on the back of rising sectoral platform creation by large PE houses, PE-backed cross-border and domestic acquisitions, among others. PE activity has even shaped the regional characteristics of the country, with cities being mapped as specific sector hubs.
PE players in India are at a stage where they have gained significant experience in India and have the wherewithal to deal with governance and regulatory risks and exposure. This has placed PE funds in a favourable position where they are able to apply their expertise from running businesses globally to the Indian context.
Thus, investors continue to be bullish about the Indian market and want to make deals. However, what bothers them is high valuations. Valuations have been fairly high in India and that is true for growth-oriented markets. Growth across sectors – be it banking, financial services and insurance (BFSI) and consumer internet – has been very rapid and these companies have the potential to focus on one line of business today but do much more of something different tomorrow, which adds to incremental value. The other factor is competition. The number of active funds is going up every year and every deal these days sees more competition than five years ago. These are structural factors in a market that is fundamentally attractive. Thus, it seems that the valuations will continue to be fairly hard-hitting and there will be capital chasing those valuations.
2 Looking at types of investments and transactions, are private equity firms primarily pursuing straight buyouts, or are other opportunities, such as minority-stake investments, partnerships or add-on acquisitions, also being explored?
PE firms are not necessarily focused on straight buyouts as an investment strategy vis-à-vis other opportunities such as minority stake investments, partnerships or add-on acquisitions. Looking at the markets, it can be safely said that, currently, it looks like a good mix of all strategies.
The reason for this is India’s continued momentum for dealmaking in 2018. Investment momentum was robust for a second consecutive year, with the total investment of up to US$26.3 billion from approximately 793 deals during the year. While the deal volume was higher than in 2017, the average deal size was flat. The result was a small decline in total investment value, which still was the second-highest in the past decade.
Consumer tech and BFSI remain the largest sectors for investment by value and contributed about 40 per cent of the total deal value in the year. While consumer tech investment was still large at US$7 billion, it shrank from more than US$9 billion in 2017. As a result, over the past few years, there were fewer but higher quality deals in consumer tech, with investors backing winners to scale further.
The other sector to remain dominant was BFSI, which attracted almost US$5 billion of investments in 2018. As in previous years, BFSI investments were fuelled by deals in banks as well as a rising class of non banking financial companies (NBFCs). NBFC business models demand heavy infusions of capital and investors were ready to deploy capital in strong-performing pure play NBFCs, housing finance companies and microfinance institutions. Increased investment activity in consumer and retail, with multiple deals in food and apparel segment has also been witnessed.
Funds focused purely on the consumer segment are seeing heavy traction, driven by the rise in new disruptive brands that are riding the Indian consumption growth story. These investors are betting on new fast-growing consumer brands that are tapping into rising disposable incomes and the country’s large population of millennials.
For example, US$350 million was raised by one of the largest debut funds by an Indian fund manager, highlighting the interest that limited partners (LPs) have in the consumer sector and plans to invest in consumer start-ups in the fields of healthcare, financial services and retail brands.
Buyout funds continued to draw the biggest share of capital, but investor interest during this stretch has been broad and deep, benefiting a variety of funds. The total share of late-stage investments and buyouts have increased, with an increase in majority deals as well. These featured a few large individual buyouts like Star Health and Allied Insurance (US$930 million) and Prayagraj Power Generation Company (US$830 million).
Indian cities like Bengaluru, Hyderabad, Mumbai, New Delhi, Gurugram and Chennai are industry hotspots drawing in investments.
3 What were the recent keynote deals? And what made them stand out?
The recent keynote deals from our perspective would be the Star Health and Allied Insurance Company Limited (Star Health) deal and the Delhivery Private Limited (Delhivery) deal. Samvad Partners represented Sequoia Capital in the Star Health transaction, in relation to the exit of Star Health Investments Private Limited (Star Health Investments), the promoter of India’s first and largest standalone health insurance firm, Star Health and Allied Insurance Company Limited (Star Health Insurance). Sequoia Capital held 43.71 per cent approximately in Star Health Investments. The transaction, apart from being one of the largest in the in the highly regulated insurance sector, involved various legal aspect and complex transaction legs ranging from investments by strategic and financial investors, voluntary liquidation and distribution of shares to the proposed sale of the shareholding held by the existing shareholders of Star Health Insurance (including Sequoia) to a consortium of investors (Safecrop Holdings Pvt Ltd, including WestBridge AIF, Rakesh Jhunjhunwala and Madison Capital).
Samvad Partners acted as the transaction counsel to Delhivery and assisted on all aspects of the Series F funding in Delhivery led by SoftBank Vison Fund (SoftBank). The transaction involved a late stage investment in an e-commerce company engaged in the business of supply chain and logistics. Given the multiple financial investors on board, the transaction involved interesting issues and concerted efforts towards achieving a balance in the interests of the broad spectrum. This was in addition to the common concerns in matured stage multiparty transactions, such as interests of minority investors versus majority investors, and investors versus founders.
In addition to the above and according to what has been reported so far, Brookfield-Reliance Jio’s US$3.7 billion deal is the largest ever PE and VC deal in India, surpassing the US$2.5 billion investment made by Softbank in Flipkart in 2017.
PE and VC investments, too, had a record year in 2018, touching an all-time high of US$35.1 billion. Investments during the year surpassed the previous record of US$26.1 billion in 2017 by 35 per cent, owing to significant growth in large-size deals. Eight deals of over US$1 billion each was also recorded in 2018, compared to 11 such deals in the preceding 12 years combined.
The largest deal during the year saw Singapore’s sovereign fund GIC, private equity giant KKR, PremjiInvest and Canadian pension fund OMERS investing US$1.7 billion in HDFC Ltd for a 3 per cent stake.
Thus, 2018 witnessed a number of significant deals in various sectors. One of them being the investment led by Naspers and Canada Pension Plan Investment Board in an education technology start up Byju’s (Think and Learn Private Limited) of US$540 million. Immediately after, Naspers led another round of investment of US$1 billion for a food delivery application, Swiggy. Other notable deals include the US$250 million investment in Ola Electric Mobility by SoftBank and the US$150 million investment in the online grocery brand BigBasket by Alibaba, CDC Group and Mirae-Asset Growth Fund.
4 Does private equity M&A tend to be cross-border? What are some of the typical challenges legal advisers in your jurisdiction face in a multi-jurisdictional deal? How are those challenges evolving?
Yes, most of the M&A deals are cross-border transactions – though not all M&A transactions in a PE or VC segment are cross-border transactions.
Traditionally, Indian companies have been attractive targets for acquisition by international companies, but a stronger emerging trend is that of Indian corporations scouting for international targets, especially in the US and Europe, in the quest of market share and other efficiencies. This trend is visible primarily in the IT, steel, aluminum, pharma and life sciences and automotive sectors, and is beginning to extend to other sectors as well.
The typical challenges legal advisers face in a multi-jurisdictional M&A deal are cross-border structuring issues, complex legal, tax and exchange control issues peculiar to the particular jurisdiction (either the target or the acquirer) and the creation of innovative structures to address constraints as well as commercial considerations. Generally, the structuring for M&A matters involves various aspects of corporate and securities laws, taxation (and tax efficient structures), antitrust laws, exchange control laws and determining the type of the special purpose vehicle (SPV), jurisdiction of the SPV, the type of instruments to be used, among others.
Getting the right legal structures in place is the key. The focus should be on deal structure and legal entities, competition and sector-specific regulation, considering basic legal and regulatory aspects. Collaborating with lawyers across spectrums, sectors and geographies and drawing additional strength from specialist practice groups and industry expertise is also vital. Approaching transactions with an interdisciplinary team of attorneys handling the various tax, corporate, securities, intellectual property, litigation, employee benefits, tax, environmental, antitrust and other issues inherent in M&As further helps in dealing with cross-border challenges.
5 What are some of the current trends in financing for private equity transactions? Have there been any notable developments in the availability or the terms of debt financing for buyers over the past year or so?
As indicated, the trend continues of investment in BFSI and consumer and retail remains, even though the valuations are still perceived to be high. Healthcare is another sector of rising interest, with funds looking at players across the spectrum – pharmaceuticals, equipment, single-speciality hospitals and clinics, diagnostics and others. Interest in technology and IT will be largely driven by rapidly growing enterprise tech companies that operate out of India and sell globally.
Banks are not permitted to extend loans for funding an acquisition of shares in India except in relation to acquisitions in the infrastructure space subject to certain restrictions. Therefore, PE investors rarely raise debt finance from banks for their investments in India. However, some investors do approach non-banking finance companies for financing acquisitions. Foreign sources such as external commercial borrowings (ECBs), including privately placed non-convertible debentures (which are comparatively less regulated), are emerging as sources for funding.
We understand that non-banking financial companies do extend loans to promoters or their companies during an exit for acquisition financing on the strength of secured assets, to enable the promoters or the companies to buy out venture capital or private equity investors. The Reserve Bank of India is currently considering relaxing restrictions on financial institutions, especially to enable leveraged buyouts of distressed assets. Additionally, public companies are also prevented from providing financial assistance for the purchase of their own shares.
6 How has the legal, regulatory and policy landscape changed during the past few years in your jurisdiction?
The government has eased 87 foreign direct investment (FDI) rules across 21 sectors in the past three years, opening up traditionally conservative sectors like rail infrastructure and defence. One of the fundamental reforms undertaken by the government last year was the abolition of the Foreign Investment Promotion Board (which had been responsible for processing FDI proposals for over 25 years) with the intention of expediting FDI approvals. For the first time, the FDI Policy 2017 makes specific reference to fundraising through convertible instruments by start-ups, which should encourage fundraising by Indian start-ups from foreign venture capital investors and non-residents.
Additionally, the government and regulators have made several transformative policy changes that are helping to reshape the manner in which investments into India are structured. Some of these include the following.
- The resolution of the Mauritius tax conundrum: the amendment to the India-Mauritius Double Tax Avoidance Agreement (DTAA) provided a calibrated phaseout of the capital gain tax exemption, while grandfathering tax benefits to investments made until March 2017, providing certainty on an issue that has persisted for over two decades. The India–Singapore DTAA was also renegotiated on similar lines.
- The introduction of a 10 per cent tax rate on long-term capital gains arising from transfer of equity shares of listed companies which reversed a tax policy that exempted such gains since 2004.
- The introduction of the General Anti-avoidance Rule and the concept of place of effective management for determining the tax residence of foreign companies in India.
- Allowing foreign investment in the Securities and Exchange Board of India (SEBI)-regulated alternate investment fund (AIF) under the automatic route with a liberal policy that allows AIFs, whose sponsor or fund manager are owned and controlled by resident Indian citizens, to make investments in India without attracting exchange control limitations.
- Gradual amendments in the domestic tax law to implement the actions agreed under the Base Erosion and Profit Shifting (BEPS) project to curb tax evasion. India, as part of the BEPS project, has agreed to amend its tax treaties by signing the multilateral instrument along with 78 other jurisdictions.
Overall, the PE and VC industry in India is clearly in transition. The rules for investing in India have been changed to provide foreign investors a sense of certainty and clarity and at the same time ensure that India collects its fair share of tax on the income earned from investments in India. Going forward, this approach may provide a significant impetus to PE and VC activity and capital flow to India, which is sorely needed for growth of the Indian economy at large.
7 What are the current attitudes towards private equity among policymakers and the public? Does shareholder activism play a significant role in your jurisdiction?
There has been a slow rise of shareholder activism in India – though it may be gaining ground, it still has a distance to go. Legislative and regulatory action over the past few years has started to change things for the better. The Companies Act 2013 has empowered minority shareholders, particularly after the notification of clause 245, enabling class action suits in 2016. SEBI’s regulatory changes in 2014 and 2016, meanwhile, mandated greater transparency regarding institutional investors’ voting decisions. The Insurance Regulatory and Development Authority, and the Pension Fund Regulatory and Development Authority, have likewise pushed their industries to vote on portfolio company resolutions.
Almost all relevant corporate laws and regulations in India have been revamped in the past few years and are continually evolving with the needs of the market. This impacts both inbound and outbound investments, yet there has been a ‘positive investment sentiment’ over the past few years, which can be attributed to various economic and political factors combined with structural reforms promoted by the government.
8 What levels of exit activity have you been seeing? Which exit route is the most common? Which exits have caught your eye recently, and why?
One of the primary ways to assess investor confidence in a market is to look at exit momentum and how it is trending. In this context, the Indian PE market performed very well, with the highest exit values in the past decade. Consumer technology, IT and IT-enabled services (ITES) and BFSI drove most of the exit values in 2018. Notably, these are also the sectors in which investments have grown during the past four to five years.
Exits have increased consistently and totalled 265 exits valued at nearly US$33 billion in 2018. Almost half of this exit value resulted from the Flipkart sale to Walmart (US$16billion). However, even excluding the Flipkart exit, 2018 was one of the best years for exits in the past decade.
Exits increased in most sectors, with consumer tech, IT and ITES, and BFSI as the primary contributors to exit values. A few large exits dominated in 2018, with the top 10 exits accounting for 70 per cent of total exit value. Apart from Flipkart, these included Intelenet Global Services Pvt. (Blackstone), GlobalLogic (Apax), Star Health and Allied Insurance (multiple funds) and Vishal Retail (TPG).
The public market remained the most preferred mode for exits – though there was a spike in strategic exits, primarily driven by consumer tech. Over the past five years, funds have made reasonable returns across most sectors, with consumer tech, IT and enterprise-tech and BFSI having the highest multiples on invested capital.
Exit momentum highlights investors’ confidence in the Indian ecosystem and the public markets and signals an overall maturation of the Indian PE landscape.
9 Looking at funds and fundraising, does the market currently favour investors or sponsors? What are fundraising levels like now relative to the past few years?
Foreign institutional investor flows into Indian equities are US$11 billion, surpassing the total annual tally in the previous years and setting 2019 on course for the highest annual inflows since 2012. PE deal activity in India surged to US$19 billion in 2018 and sovereign wealth funds and pension funds made up about two-thirds of that amount. India is also popular with sovereign wealth funds, buying stakes in everything from airports to renewable energy. What makes India attractive is the political stability, a growing middle class and reforms making it more enticing for foreigners to invest.
Regulatory reforms are also bolstering sentiment and drawing in wealth funds. Indian-based fund managers are, from this year, licensed to manage foreigners’ portfolio holdings in the country, where previously such assets had to be managed outside India. This change has helped kick-start the onshore fund management industry for foreign-sourced funds.
10 Talk us through a typical fundraising. What are the timelines, structures and the key contractual points? What are the most significant legal issues specific to your jurisdiction?
A fundraising exercise begins with structuring the fund. Key considerations for ascertaining the best structure include the jurisdictions of target investors, tax efficiency for the fund and the investors. In India, most PE funds are set up as trusts, which are preferred as fund entities over companies or limited liability partnerships because of the simplicity with respect to incorporation and governance, and the rules of taxation applicable to them.
Once the structure is finalised, fund documents are prepared, setting out the investment strategy, investment purpose, its investment methodology, key terms of the fund and also information about the key stakeholders of the fund (ie, sponsor and manager). The fund is then registered with SEBI and once capital commitments have been obtained from the investors, the fund holds the initial closing for receiving contributions from the investors. The entire cycle can vary for each fund depending on the jurisdictions of the investors, the corpus size and the stakeholders involved, but typically takes between six and eight months. Historically, funds have been structured on unified or co-investment models, however, of late, with the liberalisation of FDI norms, unified structures have gained popularity with both domestic and foreign investors and have emerged as the preferred choice for structuring India-focused funds.
Key contractual points in the fund documents will typically include distribution waterfall, management fees, hurdle rate, carried interest, equalisation amount, contributor giveback, tax structuring provisions and provisions relating to transfer and withdrawal of units, co-investment arrangements and allocations of expenses. In unified structures, typically, the Indian law is the governing law. The governing law with respect to offshore documents at the feeder fund and master fund level is usually that of Singapore, Mauritius or New York.
11 How closely are private equity sponsors supervised in your jurisdiction? Does this supervision impact the day-to-day business?
More accountability has been given to the sponsors and managers with increased disclosures and periodical compliances. It is mandatory for the manager’s key investment team to have adequate experience in advising and in the business of buying and selling. It is also imperative for the trustee, sponsor and manager to be fit and proper persons based on the criteria specified by SEBI. Any change in control of the sponsor or manager of the fund requires prior approval from SEBI. However, SEBI supervision does not have an impact on the day-to-day business of the fund and the regulatory environment is generally conducive to business.
12 What effect has the AIFMD had on fundraising in your jurisdiction?
The AIFMD is a European Union regulation that applies to hedge funds, private equity funds, and real estate funds. The AIFMD regulation sets out specific compliances and guidelines that regulates the activities of fund managers, including non-EU fund managers who seek to market or set up a fund within or outside the EU to the investors in the EU. On the recommendations of the standing committee as constituted by SEBI, the SEBI (International Financial Service Center) Guidelines 2015 were published to maintain a single market for alternative investment funds.
13 What are the major tax issues that private equity faces in your jurisdiction? How is carried interest taxed? Do you see the current treatment potentially changing in the near future?
A number of tax issues arise in respect of investments made by PE and VC firms and these could be enumerated as:
- taxation of PE funds – how a PE fund is structured and how it is taxed;
- tax issues on a management buyout – dealing with the tax issues for the target’s management team and the acquisition group;
- tax issues on a secondary buyout – dealing with the tax issues for the target’s management team and the acquisition group; and
- growth capital – the key tax issues that arise for investors when a company is seeking seed, venture or development capital.
Capital gains tax is one of the most significant considerations while exploring sale or roll over of investments into newer acquisition structures. Where an asset is held for less than 36 months (12 months in case of listed securities) before transfer, such transfer is eligible to short-term capital gains (STCG) tax, whereas gains arising from the transfer of assets after 36 months are treated as long-term capital gains (LTCG) and taxed accordingly. LTCG on sale of debt instruments will be taxed at the rate of 20 per cent (both listed and unlisted instruments). Further, LTCG on the sale of equity instruments will be taxed at the rate of 10 per cent (both listed and unlisted instruments). STCG on the sale of equity-linked mutual fund and securities is taxed at the rate of 15 per cent (both listed and unlisted instruments).
However, the aforementioned may not apply in case the seller is an offshore entity in a jurisdiction having a double taxation avoidance treaty with India and entitled to benefits thereunder.
Previously, Indian tax avoidance principles were based on judicial principles, which were crystalised on a case-by-case basis. The government has tried to reign in tax avoidance and on 1 April 2017 implemented the General Anti-avoidance Rules to ensure that complex and multilayered structures cannot be used to obtain illicit tax benefits.
The rules provide that an arrangement whose main purpose is to obtain a tax benefit and which also satisfies at least one of the four specified tests (arrangement is not at arm’s lengt; misuse or abuse of tax laws; lacks or is deemed to lack commercial substance; or not carried out for bona fide purpose) can be deemed to be ‘impermissible avoidance agreements’. Once an arrangement is held to be an impermissible avoidance arrangement, the Indian tax authorities have been given powers to disregard entities in a structure, reallocate income and expenditure between parties to the arrangement, alter the tax residence of such entities and the legal situs of assets involved, treat debt as equity and vice versa, deny DTAA benefits, among others.
There are no separate provisions for taxability of carried interest. The tax levied depends on how the income is structured. However, the Place of Effective Management Guidelines could have an impact on some of the carried interest structures, such as personal holding companies set outside India.
14 Looking ahead, what can we expect? What might be the main themes in the next 12 months for both private equity deal activity and fundraising?
There seems to be sufficient India-focused dry powder with PE and VC funds to ensure high-quality deals do not lack capital. BFSI, consumer and retail, and healthcare appear as attractive investment sectors in the future. Consumer tech will also continue to see investments into scaled players. Going forward, funds believe that cost improvement and capital efficiency will become an even more important driver of returns. Though most of the market reports indicate that returns will remain about the same, what seems as a concern is the valuations and rising interest rates.
The Indian PE and VC market saw a large number of funds close in 2018 compared to previous year with rising allocations, both from existing LPs and fresh investors. Last year also witnessed sector-focused funds as a result of growing willingness on the part of investors to create global sectoral platforms.
This year could be a year of larger ticket investments and buyouts as we see interest from investors looking to buy a score of large companies that are undergoing insolvency proceedings in the Conclusion National Company Law Tribunal, stressed assets in select sectors such as BFSI, among others. Investments are likely to stay healthy given the attractiveness of the Indian economy and relentless effort by the government to improve ease of doing business in the country. The liberalised FDI policy seems to be further encouraging more foreign investors to set foot in India.
The Inside Track
What factors make private equity practice in your jurisdiction unique?
PE deal sizes are getting bigger and there is a surge in control-oriented transactions. Though there is a lower degree of competition intensity, the source of PE capital makes the Indian different from other emerging markets like China. Nearly half the PE capital deployed in China is yuan-denominated, but in India’s case, more than 95 per cent of such funds are dollar-denominated and sourced from overseas investors.
What should a client consider when choosing counsel for a complex private equity transaction in your jurisdiction?
Any counsel who advises on transactional law is required to be meticulous, patient and efficient. It is advisable to choose a firm that has experience in a vast array of deals and is business-savvy. It is crucial that the counsel is able to take a solution-oriented approach, where they not only evaluate the issue from a legal perspective but are also able to address all practical concerns that may arise. Understanding the client’s technology and their market is crucial for the success of these associations.
What interesting or unusual issues have you come across in recent matters?
There have been a lot of unconventional and unique issues in our practice that have required out-of-the-box solutions. We have worked on complicated and creative structures with even more complex documentation and negotiation. Further, after the process of mergers has become more streamlined and brought under the purview of the National Company Law Tribunal rather than the High Courts, there has been an increase in interest in adopting a court-approved arrangement of mergers and demergers to limit the tax and regulatory costs involved in a transaction.
Additionally, an interesting development can be seen in the ways the promoters are wrestling back control in the boardroom. For example, hospitality startup Oyo Hotels & Home founder’s bid to regain a substantial stake in the company is the third such notable attempt by promoters in India recently.