Private Equity funds face 'associate' googly

Funds having influence will be subject to provisions of associate firms

Private equity (PE) firms picking substantial minority stakes in companies might have to prepare themselves for additional compliance requirements under the new Companies Act. The new law introduces a new concept of associate companies.

Associate companies are identified as related parties and the holding companies of these associates are required to file consolidated accounts. The new law has also provisions restricting persons relating to associate companies from becoming independent directors or being appointed as auditors.

Section 2, Clause 6 of the new Companies Act says: "Associate company, in relation to another company, means a company in which that other company has a significant influence, but which is not a subsidiary company of the company having such influence and includes a joint venture company."

'Significant influence' in this context means control of at least 20 per cent of total share capital, or of business decisions under an agreement.

This section, which has already come into effect, is among the 98 sections of the Act notified by the corporate affairs ministry on September 12.

Accordingly, a company that owns 20 per cent or more of share capital of another firm would be considered an associate. Secondly, even a company with a lesser shareholding could be covered if by virtue of the shareholder agreement it is able to exert 'significant influence' over business decisions.

Further, since the 20 per cent would be calculated on the entire share capital, many PE players who hold their investments in the form of preference shares would also be covered by the new provision even though their equity holding is less than that number.

"The associate company will be identified as a related party and the annual accounts will be consolidated. This could lead to significant changes in the way private equity investors deal with their investee companies. They may be looking for some exemptions," said Pavan Kumar Vijay, managing director, Corporate Professionals.

Vijay said an exemption on the lines given to qualified institutional bidders in the definition to private placement can be included in the Act. He added, "As of now, there is no exemption for private equity investors."

Amish Shah, transaction tax leader, EY, said the impact for funds based abroad would depend on the requirements of law in their home jurisdiction. However, funds based in India, which are fewer in number, would have to comply with requirements. "We have to wait for the rules to be notified. There is no specific exemption for PEs," he added.