Sebi move to stiffen reverse mergers may hit PE exits

A new rule stipulates that apart from court and stock exchange approvals, Sebi's nod is also required for a reverse merger

Private equity (PE) investors in India struggling to exit their portfolios have found another impasse. One more exit route is likely to get blocked, as the Securities and Exchange Board of India (Sebi) is putting a clamp on reverse mergers.

Earlier, companies were able to do reverse mergers (unlisted entities merging with their listed group companies) easily, with approvals from court and stock exchanges. However, the new regulation where Sebi’s approval is a must could hit PEs that look for reverse merger as an option for exits.

According to a new Sebi circular, the listed company shall send the documents concerned to the stock exchanges, upon sanction of the scheme by the high court.

“The designated stock exchange shall forward its recommendations to Sebi on the documents submitted by the listed company. Sebi shall endeavour to offer its comments or approval, wherever applicable, to the designated stock exchange in 30 days,” the circular said.

Although not many PE funds opt for reverse merger as a preferred exit route, it is typically regarded as one of these. P R Ramesh, senior consultant at Economic Laws Practice, said the circular might remove the advantage the route presented.

“There is the possibility that PE players would need to be classified as promoters, based on the rights they enjoy in the company being absorbed into the listed entity. This could result in the need for a lock-in for their investment.”

In the recent past, Sebi has received applications, seeking exemption, from certain entities containing inadequate disclosures, convoluted schemes of arrangement, and exaggerated valuations. “Sebi is of the view that granting listing permission or exemption on such applications may not be in the interest of minority shareholders. At the same time, if listing permission or such an exemption is delayed or denied, it would add to the uncertainty and would deprive shareholders of an exit opportunity,” Sebi noted in the circular.

Sapna Seth, vice-president, Singhi Advisors Pvt Ltd, said, “While reverse merger has not been a significant choice for PE exits in India so far, it could emerge as one of the preferred choices for exits by PE funds, who are likely to be categorised as promoters (majority ownership by PE funds) as per the new rules of Sebi.”

She added the new rules make the process tougher for the PEs and promoters, making exit very difficult.

According to data from VCCEdge, merger and acquisition was the most preferred route for PE exits in 2012, followed by open market transactions. Initial public offer (IPO) was the least opted route for PE exits in 2012, which witnessed 55 M&A exits worth $486 million and 50 open market deals worth $2.4 billion. Only five exits worth $361 million took place through IPO.

According to PE investors, very few exits took place through reverse merger and the new regulations might not affect investors much.

Mahendra Swarup, president, Indian Venture Capital and Private Equity Association, said, “Its not a preferred exit route for PEs, as it is not common that PE-backed unlisted entities have another listed entity with which it can be merged.”

In a tough market where floating an IPO is not viable, firms are opting the reverse merger routes.

In December, Hardcastle Restaurants, the master franchisee of American fast-food chain McDonald’s, has announced its merger plans with the listed group company Westlife Development. This will make Hardcastle a 100 per cent subsidiary of Westlife, which is listed on the Bombay Stock Exchange.
REVERSE ROUTE

• In a reverse merger, unlisted entities are merged with a listed group entity
• Earlier, only court and exchange approval was required
• Now, Sebi will look into each case
• PEs see reverse merger as another exit route
• Sebi’s tough stance could hit PEs’ plan to liquidate shares