This article is written by Anupam Bhaduri pursuing a Diploma in Mergers and Acquisitions, Institutional Finance and Investment Laws (PE and VC Transactions) from LawSikho.

Introduction

The pandemic has brought forward that despite the existence of giant conglomerates in almost every field, the one and true goliath is the healthcare industry. When we talk of investment opportunities in different segments of the market, we generally fail to discuss the market size of the healthcare industry. This happens because ‘industry’ is not the word that we generally associate with healthcare. And yet, India is one of the biggest markets to target since healthcare as an industry is in a process of rapid expansion, now more than ever. The healthcare industry can be broadly divided into:

1. Hospitals,
2. Diagnostic products and services,
3. Medical services, devices and technology,
4. Trial and research centres. 

As stated by CAGR, the entire healthcare industry will be worth USD 372 billion dollars by 2022. However, after the pandemic, investors will be flocking in to invest in the healthcare sector, increasing this estimated budget manifold, and with an industry size that happens to be dominated by 80% private organisations, foreign investors around the world will be eyeing to invest into it. 

Government’s plans for the healthcare sector

At present, the government aims to increase funding to the healthcare sector to match 3% of the GDP. 2020-2021 saw a budget allocation of INR 94000 crore. After battling pandemic and being forced to confront the disadvantage of the healthcare sector due to being underfunded, the government in its 2021-22 budget allocated INR 2.23 lakh crore to the healthcare industry. This marks an increase of 137% in terms of funding, a further testament to the opportunities that lie hidden within the depths of the industry.

FDI in the healthcare sector

The Indian stance on an FDI regime is what can be called at best to be neo-liberal. It is not entirely keen on loosening the regulatory framework but also understands the need of foreign investments to pour in. Presently, the available limit for FDI through the automatic route is 100%. However, this does not stand true for all segments of the healthcare industry. The brownfield projects are restricted to a 74% upper limit, with an allowance of 100% for greenfield projects. These generally include the pharmaceutical sector, construction companies for hospitals and manufacturers of medical devices. 

FVCI in the healthcare sector 

A large part of the investment received in the healthcare sector, especially the manufacturers of surgical appliances and medical devices, comes from venture capital firms. These VC firms are foreign firms registered with the Securities Exchange Board of India (SEBI) and are regulated by the FVCI regulations. The Foreign Venture Capital Investor Regulations provide significant advantages to the private equity investors, namely:

1. Relief from complying with pricing guidelines as stipulated under the NDI Rules for the acquisition of securities. The exemption holds true at the time of entry and also for the sale of securities during exit if such act is carried out provisions of Schedule VII of the NDI Rules. 
2. No open offer is to be made by the promoters (Regulation 10 of the Securities Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 2011) if they buy back the securities from a registered foreign venture capital investor (FVCI).

However, it would be wise to note that the FVCI is allowed to only invest in the SEBI regulated segments of the healthcare industry. The options which are thus available for the FVCIs lie in SEBI registered alternate investment funds (AIF) and venture capital funds (VCF). Given the limitations imposed, the FVCIs have been observed to heavily invest in the R&D of the pharmaceutical sector. A significant amount of investment also flows to the infrastructure segment that is actively involved in the constriction of hospitals, diagnostic sectors, para-medical institutes and medical colleges. 

Investment structuring of the healthcare sector

Foreign entities often look forward to setting up their Indian subsidiary for outsourcing functions. This can prove to be tax-efficient if the foreign investor, instead of directly investing in the target company, uses a tax neutral jurisdiction that has signed a jurisdiction treaty with India. The foreign investor could now incorporate a company or any entity that enjoys the benefits of hee tax treaties between the jurisdictions and use this entity to invest in the target company in India. 

However, the choice for the appropriate jurisdiction should be made considering the following factors:

1. The political stability and the company friendly political regime

The political stability of the country plays a big role when it comes to incorporating an entity. The actions of a government in terms of fiscal policies or administrative policies may cause problems for the operating entity in the form of trading patterns, often resulting in international restrictions.

2. Availability of industry experts for the relevant field in that jurisdiction 

Although setting up an entity on an island for tax incentives may sound like a great idea, finding industry experts to lead the entity from the front in that jurisdiction is an issue that all foreign investors must pay heed to.  

3. Foreign exchange regulatory framework of the country

Setting up an entity meant for the purpose of the overseas investment must do proper due diligence. The due diligence thus conducted must account for an analysis of the foreign exchange policies and determine the red flags that the company would face in the near future and the ramifications of such.

4. Ease of winding up

Last but not least, foreign investors should take into consideration the ease of winding up their entity. In a business proposition, there are sudden mishaps and most of them have the potential of disrupting the entire setup, forcing the investor to back out. At this point, continuing the entity is no longer a viable option and ending up the company is the only option, forcing investors to confront the regulatory framework for the same. An easy wind-up policy in this case would save the investor a lot of hassles.

Transactional issues

Given the pandemic scenario, and the only industry to turn to in order to combat the pandemic, the healthcare industry is going to be eye candy for all investors. However, no matter how vast the opportunities are available for an investor, some key issues need to be taken into consideration before the negotiations take off. They are:

1. The primary thing to be cautious of is the representations, warranties, covenants and indemnification measures. The healthcare industry has a long list of compliance requirements and hence proper due diligence becomes an utmost necessity when dealing with the same. Non-compliance issues could lead to serious repercussions, both in the form of public reputation and monetarily. Non-compliance repercussions may finally lead to the shutting down of hospitals and diagnostic centres in certain cases. The healthcare sector by and large are expected to follow the standards prescribed by the Bio-Medical Waste Management and Handling Rules, 2016, Air (Prevention and Control of Pollution) Act, 1981 and Water (Prevention and Control of Pollution) Act, 1974. The diagnostic centres must additionally adhere to clinical trial policies that are transparent and robust. 
2. Real-estate due diligence is of the utmost importance. Before the investment, the investor needs to ascertain what type of land the hospital is set upon. Title tracing plays an important part here as leasing government land makes it binding upon the hospital to render service to the economically weaker section on a compulsory basis. This further brings in compliance issues that are required to be met by the investee company. 
3. Employment contracts whether they be on a contractual basis or permanent employees must be accounted for in the due diligence. The terms of engagement entered into by the hospital determine the applicability of various labour-centric legislations like Employee Provident Fund and Miscellaneous Provisions Act, 1952, Contract Labour (Regulation & Abolition) Act, 1970 etc.

Emerging trends to capitalise on the healthcare sector

1. Hospital consolidations

The population of today is dotted with lifestyle-related diseases. The increasing population in the subcontinent makes the healthcare industry services a booming sector. The Indian healthcare industry, so far, has failed to keep pace with the growing demand for quality and affordable healthcare. Foreign investors would find plenty of investment opportunities in India given the immediate need to scale businesses to meet the growing demand.

2. Migratory trends giving rise to townships

The ever-growing urban population has given rise to a dense ppm in the townships. This has furthered the need to provide services in these tier 2 and 3 cities. Investors could find a plethora of opportunities in these market dynamics owing to the increase in the per capita income of these cities as well as the market saturation in tier 1 cities. The third opportunity for investors is that doctors who have been practising in these geographical areas are willing to open hospitals themselves. 

3. Debt funding in the healthcare industry

The healthcare industry generally relies on debt funding as a source for building up capital. The loan structuring requires the borrower to submit a primary and collateral security in order to secure the loan. This is a massive pain point for the promoters of small and medium scale hospitals as they fall short on personal guarantees for collateral securities. As of present, the NBFCs play an important role in the loan segment owing to their non-insistence of collateral security. 

Conclusion

Venture capital and private equity firms were taken aback by the onset of the pandemic. However, with the passage of a year, the firms have witnessed first-hand the boom of the healthcare sector. From the view of an investor, the main issue that needs to be properly accounted for is the approvals and licenses required to operate in this market segment. Two major issues that are directly detrimental to the functionality of the hospital is compliance Pre-conception and Prenatal Diagnostic Techniques Act, 2003, Medical Termination of Pregnancy Act, 1971, Biomedical Waste Disposal, Drugs and Cosmetic Acts for pharmacy, and Atomic Energy Regulatory Board. In addition to these, proper approvals must be obtained with regard to environmental laws. 

Another major takeaway for any foreign investor is proper compliance with the New Drugs and Clinical Trial Rules, 2019 with respect to participation in clinical trials. The new rules place numerous obligations on the hospitals that participate in clinical trials with respect to reporting anomalies and adverse test results by participating hospitals.

Last but not the least, the operating model of the hospitals also plays a big role in determining the management cost-efficiency from an investor’s perspective. 

Reference

• Investment-in-Healthcare-A5-1.pdf (nishithdesai.com)
• www.ijhssi.org/papers/v2(5)/version-3/G253740.pdf
• FDI in Health Sector | FDI in Healthcare Sector – FDI India
• Can FDI improve the resilience of health systems? (oecd.org)

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