Legal Aspects of Exit Strategies for Private Equity Investments in India

Akshay Nair and Saransh Sharma

Exit strategy forms an integral part of the investment process which helps investors in realizing returns from their investments. In India, there are various exit strategies for private equity investments, each having certain legal implications that the investors and companies need to consider. These primarily include Exit through Initial Public Offerings (IPOs), Secondary Sales, Mergers and Acquisitions (M&A), Exit through Share Buybacks, and Exit through Put Option.

 

An IPO is the first sale of shares by a private company to the public and allows companies to raise capital. Large private companies with strong growth records often use an IPO as an exit strategy. This exit strategy can provide substantial returns for investors but involves extensive regulatory compliance and legal processes. The Securities and Exchange Board of India ( SEBI ) regulates IPOs under the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018. Companies must comply with disclosure norms, submit a draft prospectus, and undergo a rigorous review process. Existing shareholders, including private equity investors, are typically subject to a lock-in period, usually ranging from six months to a year, during which they cannot sell their shares. Accurate and comprehensive disclosure in the prospectus is crucial to avoid legal repercussions. The prospectus must provide detailed information about the company's financials, business operations, and risk factors.

Secondary sales are sales of shares by existing shareholders of a company to other investors. Secondary sales can be used to provide liquidity without going for a public listing. Secondary sales must comply with SEBI regulations and, if the company is unlisted, the Companies Act, of 2013. roper filings with the Registrar of Companies (RoC) and compliance with the Foreign Exchange Management Act (FEMA) have to be followed for foreign investors. Shareholders' Agreement (SHA) should specify the terms and conditions of secondary sales, including pricing mechanisms, transfer restrictions, and right of first refusal (ROFR) provisions. Both the buyer and seller would be subject to tax implications on secondary sale including withholding taxes, and capital gains taxes.

M&A transactions involve the sale of a company or its assets to another entity. This exit strategy can yield high returns but requires solid legal groundwork. M&A transactions often require approval from regulatory bodies such as SEBI (for listed companies), the Competition Commission of India (CCI), and, in some cases, the Foreign Investment Promotion Board (FIPB) if foreign investors are involved. Extensive due diligence must be conducted to uncover any legal or regulatory roadblocks that could curtail the transaction. This includes reviewing contracts, intellectual property rights, and labor law compliance, etc. The exit structure i.e., whether it should be an asset purchase or share purchase should be designed meticulously taking into account tax implications and potential liabilities.

Share buybacks refer to the process of a company buying back its shares from the shareholders. It is a way of providing liquidity and is beneficial when a company has excess cash. In India, Share Buybacks are regulated by the Companies Act, of 2013. The formalities and conditions as mentioned in the Act need to be followed by companies for considering share buybacks i.e. Board approval, compliance with respect to the buyback limits, etc., are required to be adhered to and necessary documents need to be filed with the RoC and if it is a listed company then SEBI regulations also needs to be complied with. Apart from that, Companies are also required to file relevant documents with the RoC and follow SEBI regulations if the company is listed. The buyback may affect the valuation of the company and the interests of the remaining shareholders. Legal advice is crucial to ensure fair treatment of all shareholders.
 

Put options are rights given to investors to sell their shares in the Company or to the other shareholders at a pre-determined price. Put options are regulated by SEBI and FEMA. Previously, put options that provided for an assured return were generally not considered valid, but recent regulatory changes now permit them subject to certain conditions. The terms of the put option, including when it will be triggered and how pricing will be determined, etc., should be clearly set out in the SHA. Enforcement of put options may require litigation if disputes arise. The exercise of put options may have tax implications, including capital gains tax and other applicable taxes.

In Cruz City Mauritius Holdings v. Unitech Ltd  (2017) (3) ARBLR 20 (Delhi) the honorable Delhi High Court held that so long as the put option that offered an assured rate of return was exercisable only in the event of a breach of the contractual assurances, it was not violative of FEMA. Similarly, in the case of NTT Docomo Inc. v Tata Sons Ltd (2017) SCC OnLine Del 8078 a provision was put in place where the unique feature was that the put option had to be exercised in case, Tata Teleservices Limited was unable to achieve certain performance benchmarks. This clause was held to be enforceable because there was no fixed price at which the option holder could exit the SHA making the option more akin to a ‘downside protection’ option as against FEMA’s downright ‘assured return’. Thus, now the general impression has been created in their favor to enforce put option contracts although there are no guarantees of assured returns.

However, there are problems associated with these exit strategies. Some of the problems include Uncertainties in the market that affect the possibility of the exit and the time it is done.

Conclusion and analyses

It has been observed that there has been a considerable increase in PE exits as well as PE investments in India in the first quarter of 2024. PE exits in India rose in Q1 2024, there were 50 exits worth $ 3. 6 billion. These were 11 exits in Q1 2023. This represents a 354. 5% increase in the number of exits and a nearly five-fold increase in the amount of exits values. Open market exits were particularly outstanding, with value increases from $121. Given such facts, it is imperative that Investors look for exit strategies long before they seal an investment deal that touches their desired company so that they leave as smoothly as they got in once the time arises. Contrary to what used to be the case some time time ago, exits are no longer occasioned by the poor performance of a company. It has made them a norm in the investment lifecycle; they are now tangible indices of success.

Akshay Nair and Saransh Sharma are Associates at White & Brief’s Sidebar.