If fortune favours the bold, the deal makers of 2020 may just know who to thank for all the business: the bold. The markets last year barely mirrored the other challenges of the year. Our personal experience with deal processes across sectors: lockdowns yes, slowdowns, not really.
Regulatory liberalisation, pragmatic deal parties and decisive negotiators have parts in the momentum. Private equity dry powder and opportunistic movement aside, it was the sheer will to bring investment that inched deals toward a close.
As lawyers there are lessons in it for us. Being at the forefront of M&A and greenfield investments, taking our seats across negotiation tables, we are somewhere responsible for generating economic activity.
Will we ditch some of our traditional process-allegiances in favour of "getting the deal done"? It is our call to take how bold we can be when it comes to choosing what is best for our client.
But all other significant actors seem to be getting on with the program. Take for instance the Reserve Bank of India (RBI), the Department for Promotion of Industry and Internal Trade (DIPPT), the Foreign Investment Promotion Board (FIPB) and then the investors and promoters themselves.
Foreign Direct Investment (FDI) inflows for the preceding fiscal were affirmative of growing foreign investor confidence in India. The government has moved in line with the goal of keeping this confidence on a high and supporting the ease of doing business.
Foreign investment in India is currently governed by the Foreign Exchange Management (Non-debt instruments) Rules, 2019 and the consolidated FDI Policy 2020. These regulations have undergone several relaxations over the years.
If we focus just on payment structures, there is an oft-prevailing market practice in cross-border transactions where investors withhold payment for indemnity. In India, this practice suffered under the old rules where a foreign investor had to pay the purchase consideration upfront to the Indian counterparty, and also seek RBI approval for escrow arrangements.
The RBI relaxed the rules to (1) allow deferred payment of purchase consideration, and (2) to settle payment through an escrow arrangement and/or to adjust it towards any indemnity claim. Investors can defer 25 per cent of the consideration for 18 months from the date of signing the transfer agreement. Deferring the payment of consideration also helps the non-resident investor in structuring their payment in cross border transactions. Earlier, this structuring was subject to RBI approval.
While implementing such structures, it is imperative to comply with the pricing norms: the total consideration finally paid by a foreign investor/buyer must comply with the pricing guidelines.
Another welcome step by the regulator was to allow warrants and partly paid shares (PPS) as eligible capital instruments for FDI purposes. For sectors in which the government allows FDI under the automatic route, Indian companies can issue warrants and PPS to non-residents subject to certain conditions.
Yet another initiative on the DIPPT's part was the Start-up India Scheme. Should a start-up be eligible to register under the scheme, it opens doors to benefits such as tax holidays, simplified compliances via self-certification, their investors exempt from capital gains tax, easy exits and winding up for start-ups, and other shots in the arm.
The Ministry of Corporate Affairs also stepped in vide the Companies (Share Capital and Debentures) Third Amendment Rules 2016 to provide for issuing ESOPs to start-up promoters.
With this amendment, the promoters of start-ups are not only able to maintain respectable shareholding in the company, but they also continue to have skin in the game which acts as a driving force for them to work harder.
The relaxations are a welcome step, albeit, in my opinion, with some potential for finetuning. The period of deferral of payment by foreign investors is not currently achieving the greatest possible ease of business. The period of 18 months starts from the date of transfer agreement. In my view, the clock should start from when the sale transaction concludes. This will provide the non-resident investor ideal time, whereas currently it may reduce in a large way.
The lag between the execution date and the closing date varies case to case, depending on the nature of conditions precedent. In my experience, however, there is usually a large lag.
An area where regulatory perception may have been disadvantaged by defensiveness, where mindful analysis was called for was the Press Note 3.
Amidst border conflicts with the neighbouring countries, the DPIIT introduced press note 3 of 2020 (PN 3). The intent was to be “curbing opportunistic takeovers/acquisitions of Indian companies due to the current COVID-19 pandemic”. PN 3 mandates that any investment from an entity of a country which shares a land border with India or where the beneficial owner of an investment into India is situated in or is a citizen of any such country, requires prior government approval.
PN 3 has posed a lot of challenges for the private equity and venture capital world. There's lack of clarity on what amounts to beneficial ownership. The multitude of its interpretations floating in the market are only causing applications by foreign investors to fall into a blackhole. Clarity and guidance on expected timelines for approval should be on priority now.
Macro-economic factors apart, in my experience deal parties have also entered a new season in their stances. Their approach to several aspects of the transaction documents is far too pragmatic in contrast to what we have witnessed in the past.
Promoters have started recognising basic protections that find favour with the investors. Whereas investors may not be very flexible given their obligations under their fund documents.
In their turn, investors now recognise the importance of incentivising promoters. They see the importance of creating an environment conducive for the promoters, to achieve the desired deal outcome. Issuance of ESOPs has its place as the best incentive to employees. Unfortunately, the Companies Act did not permit this incentive for the promoters. The way around this hurdle was to structure such incentives into each transaction, until the MCA amendment we mentioned above that allowed ESOPs to start-up promoters.
The writing on the wall is clear. All stakeholders are designing ways to ease instead of drag investments. And lawyers have a mandate to act the part as well. For instance, most investors recognise that promoters cannot personally be held responsible for the business not making profits or that they shouldn't be expected to liquidate their personal assets for making indemnity payments to the investors. A common ask from the promoters is that the investors should claim indemnity from the company first and only if the company is unable to pay, should the promoters be asked to pay. This payment too should only be to the extent of the value of their shareholding.
Lawyers are bound by the mandate to accomplish the best for their client. However, in doing so, pragmatism is often lost, and negotiations are unnecessarily dragged thereby affecting the overall deal timelines. I think it is important for a lawyer to also advise their client on what is market practice and whether the ask is reasonable or unreasonable.
Siddharth Mody is a Partner, in Mumbai, in the corporate practice of a leading Indian law firm.