PE firms need to tailor their strategies for PSUs

From the cross border M & A perspective, the single most important phenomenon in recent years, has been the entry and evolution of Private Equity (PE) investment.

The impact is not restricted to the surge in volume of inflows and innovative investment options, but also the change in the deal making process, from the selection of the target, negotiations, tax implications and sale modalities.

When, how and why did this happen? For one, SEBI started clamping down on FII activities, and PE with its flexibility and access to large funds and credit, provided the complete solution to funding issues, without worrying about repayment of debts or working up enough steam to go public and complying with multiple regulations.

The description of PE is self explanatory -- the investments take place in companies not listed on the stock exchange, through the negotiated process, either by acquisition or issue of new shares.

There are various species of PE, Venture Capital being one we are historically familiar with. Venture Capital Funds have been around since the late ’80’s largely run by banks, but there was very little activity. Presently, SEBI Regulations recognise crossborder venture capital activity, under the Foreign Venture Capital Investor (FCVI) Regulations 2000, prescribing certain eligibility criteria with disclosures and conditionalities attached to the investments, such as a dedicated corpus mandatory requirement of 66.67 per cent investment in unlisted stock, with 33 per cent being permitted to be invested in IPOs and preferential allotments of listed companies.

Why would a PE fund voluntarily seek to classify itself as a registered FVCI when the purpose in funding private companies? The reasons are several – for one, share valuation as per RBI pricing guidelines is not mandatory. The tax pass through status is available, though some sectoral restrictions were introduced in 2007. In any event, most funds are located in tax beneficial jurisdictions and can avail of benefits under the double taxation treaties.

For FVCIs investing in capital markets, the SEBI Takeover Code does not apply if the shares are transfer-red back to promoters, or a buy back is made by the investee company or promoters, provided this is agreed to by the parties in a preexisting agreement. Since 2003, FVCIs have enjoyed the “QIB” status enabling participation and permission to invest in NBFCs was accorded in 2004. Press Note 05 of 2005 exempted FVCIs from Press Note 18/98.

But nothing comes without a price – FVCIs are bound to commit investments of at least Rs 5 crore, not less than Rs 5 lakh per investor, before starting operations. There are also restrictions on investments, so not all PE players make the crossover to FVCIs since it is not mandatory. PE firms continue to invest as per FDI guidelines, and with recessionary times and trends behind us, PE is already on an upward swing.

Angel Investment is another specie - the rich man’s benevolent club, where the funds belong to privately owned institutions or individuals, who select entrepreneurs on the basis of comfort level. The Indian Information Technology business in particular, has witnessed several angel funds. Other than finance, angels provide value addition in terms of their experience, contacts and ideas that they bring to the table. The driving factor is not dynastic considerations, but sharing of wealth and knowledge - the desire to give back some of what one has gained over the years.

Did PE in India take off when Oak Hill Capital and Financial Technology Ventures made a bid for Consero’s stake in EXL services? Or when Warburg Pincus sold its 18 per cent share in Bharti? Theses are irrelevant — what matters is that with volumes and numbers of deals on the upswing and disinvestment of PSUs on the anvil, deal making has regained momentum. And deal making strategies and structures have also changed.

M&A advisors and lawyers have seamlessly absorbed and applied the distinctions in advising PE acquirers or target companies. While strategic acquirers look for synergy between their existing business and that of the target, PE firms assess the target as a stand alone business, with growth potential and a time bound predicable profitable exit. If the target is PSUs, then PEs may have to tailor their strategy appropriately.

Kumkum Sen is a Partner at Rajinder Narain & Co., and can be reached at kumkumsen@rnclegal.com