Exits via buybacks hit regulatory hurdles, deals down by 90%

Making exits with decent returns remains a concern among private equity (PE) investors in India. While investors keep trying their luck with alternative exit routes, the buyback route remains the least popular owing to regulatory hurdles.

The changed rules in tax payments as well as the Reserve Bank of India's (RBI) decision to invalidate the pre-determined put-options made a heavy impact on buybacks. According to data, there were just five buybacks worth $33 million between January and July 2014 against 33 buybacks worth $343 million during the same period in 2013, a decline of more than 90 per cent in value.

Among the recent key regulatory developments that hit buybacks are the introduction of 20 per cent distribution tax on buybacks and the restriction on the number of buybacks a company can do in a year.

According to taxation on buyback scheme introduced in Finance Act 2013, any income distributed by an unlisted company on buyback of shares shall be taxed at 20 per cent. The distributed income would be calculated as the difference between the price at which shares were sold and the price at which shares were bought back. Such buyback is tax-exempt in the hands of the shareholder.

Aakash Choubey, partner, Khaitan & Co, said: "The tax provision is even more onerous where buy-back is proposed for secondary shares that PEs may have acquired from promoters, as the target company has to pay the 'buy-back tax' on the original investment made by the promoter and the gain made by the PE on the buy-back. Primarily for these reasons, companies are now reluctant to undertake buy-backs. Also, there was a brief pre-election (April-May 2014) period, where we saw 'suspension' of new transactions as funds were eager to wait till government formation in the hope of revival of stable and pro-business sentiment."

Mayank Rastogi, partner (private equity) at EY India, said: "Under the new Companies Act, the number of buybacks was restricted to one per year with a cooling-off period of 12 months between two buybacks, plugging an earlier interpretation whereby multiple buybacks could have been done in a period of 12 months. These changes have had an adverse impact on buybacks."

According to a recent RBI notification, the companies cannot give guaranteed returns, but can have put options based on internationally accepted valuation norms. "Buybacks were mostly being used when companies did not perform. In those cases, discounted cash flow (DCF) will never get them the returns they expected as per earlier buybacks (at 18 per cent) and that also will have an adverse impact on buybacks," said Rastogi.

Among all exit routes, mergers and acquisitions remains the popular route with the size of deals increasing to $287 million (33 deals) in 2014 (January-July period) against $133 million (27 deals) in the year-ago period. The number of open market exits also increased to 46 from 33 deals, although the size declined to $1.2 billion in 2014 from $1.3 billion during the same period in 2013.

Sanjeev Krishan, leader (private equity and transaction services) at PricewaterhouseCoopers, said: "I would expect secondary transactions to continue to contribute significantly to exit activity - over a period of time. While the IPO (initial public offering) exits are likely to increase over a period of time, owing to revival in the markets, strategic sales would hopefully contribute to exit numbers in due course as foreign strategic investors feel more comfortable about India."

The number of secondary transactions (selling to another PEs) increased to 17 in 2014 ($236 million) from 16 deals ($591) during the January-July period in 2013.