Technology law
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This article is written by Prince Pathak who is pursuing a Diploma in M&A, Institutional Finance and Investment Laws (PE and VC transactions) from LawSikho.

Introduction

Private equity (PE) investment in India hit a new record high of $38 billion in 2020 that is much higher than the $16.27 billion recorded in the entire 2019 and it was only $10 billion in the year 2018. India, despite the pandemic and capital inadequacy, set a new benchmark with a record $80 billion of M&A and Private equity in 2020. The highest PE investment was driven by flows into the Jio platforms at $15.34 billion followed by tower infrastructure at $ 3.4 Billion and Flipkart at $ 1.2 Billion.

Going by the data, it is clear that PE firms want to put more money investment in the Indian business market and help India to become the fastest-growing private equity market. Indian PE/VC investments have achieved another new all-time record in 2019, passing US$ 48 billion, following two consecutive record-setting years. In India, PE/VC investments have risen at a Compound Annual Growth Rate (CAGR) of 44% over the past three years

As with the time private equity has grown and developed, PE market in India has achieved new heights, especially in two decades. Starting from very scratch, this Industry in India has achieved milestones and there are also numerous challenges to deal with it. PE/VC activities were expected to slow down due to the COVID-19 pandemic but various investors took advantage that led to all-time high investment. In this article, the author has tried to explain the changes and impact on the private equity sector due to COVID-19 in India. In conclusion Author has explained the way forward approach for PE firms. 

Equity and private equity 

Private equity means a capital investment made into companies that are not publicly listed or traded, equity is the amount of capital invested or owned by the owner of a company. Usually, it’s an investment when an investor buys a certain stake in a private company with the hope of a substantial increase in the value of that stake. Private Equity is also different from an angel investment where investment is mainly done in start-ups. There are regulatory frameworks governing for private equity funds such as Companies Act, 2013, Prospectus and Allotment of Securities) Rules, 2014 and (Share Capital and Debentures) Rules, 2014. 

From the last five years, the number of PE deals has been increased and let’s look at the number of deals from 2015-20.

Legal developments and emerging trends for PE/VC

India has seen a robust rise in global investment and became the most preferable destination for foreign investment in past few years, sharp rise in the ranking of World Bank’s annual Ease of Doing Business Surveys from 142 in 2014 to 63 in 2019 has also impacted the Indian business. Further, the government’s diplomatic approach and active participation from foreign investors had been a major reason to create impact on PE/VC deals in India. Introduction of Differential voting rights (DVRs), changes in exchange control regime and foreign investors regulation are the legal developments that also impacted the PE/VC deals in India. 

In 2019, The Foreign Exchange Management (Non-Debt Instruments) Regulations, 2019 and the Foreign Exchange Management (Debt Instruments) Regulations, 2019 were notified by the Government of India and the Reserve Bank of India (RBI), India’s central bank, to replace the former regime with the intention of simplifying and bifurcating the regulation of debt and non-debt instruments and facilitating the transaction approval process

The introduction of DVRs (Differential Voting Rights) by SEBI (Securities and exchange board of India), the Indian capital market regulator, again introduced a framework for issuance of shares in the form of Differential Voting Right (DVRs). Those shares can have multiple votes per share and do not follow the common rule of one share-one vote, enables promoter to retain control over the company even after new investors come in, the issuance of DVRs was previously prohibited by the SEBI to protect the interest of small shareholders.

The introduction of DVRs can help the promoters when in any case companies are on the brink of expansion, they also do not have to dilute their shares in such cases. Further, the recent introduction of a new take-over provision will provide the benefit to the PE/VC funds to grow. 

In the past year, the (Indian) exchange control system has also witnessed a major change the former Reserve Bank of India (RBI) regulations have been split into non-debt instruments and debt instruments and separate rules and regulations have been issued for both, aimed at making the entire regime simpler. A different set of rules for the reporting of foreign investment has also been released. 

Following are the recent trends in private equity space in India:

  1. Buyout: Buyout is one of the most popular categories of private equity investments. In relation to leveraged buyouts (LBOs) are not permitted under Indian law, except in limited cases, LBO is a strategy to acquire equity in a target company. The word ‘Leverage’ indicates significant debt against the assets of the target company taken by the investors from the financial institutions. Under Section 67, the Companies Act, 2013 provides for deterrence for LBO. The section forbids public companies for providing financial assistance for the reason of purchasing or subscribing to the shares of the company. Restriction on LBOs is one of the challenges faced by private equity firms in India. 
  2. Large Deals: As the Indian PE sector matures, deals are converting into large and more complex. There has been a progressive increase in the share of large deals (value greater than US$100 million) in the total PE/VC investments in India. The increasing trend of buyout could be one of the reasons of large deals. 
  3. Emergence of pension and sovereign wealth: A major contributor to the Indian PE/VC investment story has been direct investments made by sovereign wealth funds (SWFs) and pension funds. These funds have directly invested around US$32.8 billion in India over the past five years, accounting for 22 percent of the dollar value of investments made over this period. 
  4. Startup Funding: startup funding continues to be in trend, despite the challenges this year, private equity (PE) players, companies, accelerators, angel investors, etc. put together more than $11.4 billion in startups (second-highest annual transaction value in the decade), down from $14.5 billion in 2019. 

Recent reforms due to COVID-19

Nationwide lockdown and travel restrictions have resulted in the ongoing transaction being deferred or breached nevertheless certain sectors have seen huge investment in 2020 such as e-commerce and ed-tech platforms because consumer has relied more heavily on technology and technology-based services. 

There has been a recent reform in Indian laws that have created positive impact in private equity sectors such as changes in FDI (Foreign Direct Investment), FPI (Foreign Portfolio Investment) and development under SEBI regulations. 

Foreign Direct investment 

FDI relaxations in various sectors, relaxation has been provided in terms of threshold and approvals. Foreign Investments in India are regulated through two routes i.e. “automatic route” (no regulatory approval) and “approval route” (require consent from regulators). The government has already introduced the FDI policy, 2017 with 100% FDI under the automatic route in sectors such as contract manufacturing, digital media and insurance intermediaries that has benefited the PE/VC sectors.

Government to combat the negative effects of COVID-19 pandemic, the government has amended the FDI policy in which government approval is required for (direct and indirect) investment into India by persons resident in a country with whom India shares a land border (i.e., China, Afghanistan, Bhutan, Myanmar, Nepal, Pakistan and Bangladesh). These restrictions are implemented with a view to mitigate the chances of hostile takeover of Indian companies. 

Foreign Portfolio Investment

In order to increase the investment in the light of COVID-19, Indian market regulator SEBI eased the threshold for foreign portfolio investor by categorizing them under category-1 consists of inter alia entities which are regulated (banks, insurance companies, investment managers, etc), pension funds and regulated funds from Financial Action Task Force compliant countries. This has been done with the aim to boost investment as category-1 entities have to face fewer compliance requirements.   

Tax Reliefs and changes in trade policies 

Union government has also announced tax relief measures to dispel the gloom caused by COVID-19, government to ease the cash flow it reduced rate of interest on delayed tax payments; waiver of late fees on delayed returns; Government has extended the due dates for filing monthly/annual GST tax returns and other compliance requirements for specified classes of taxpayers.

Further, in regard to relief under foreign trade policy, the government has extended the Foreign Trade Policy (FTP), which was set to expire in March 2020. Some key change has also been done in the Finance Act; it abolished distribution tax, and, as a result of which dividend will now be taxed only in the hands of the recipients at the applicable tax rates.

Conclusion

No doubt, 2020 has seen a major decline in private equity investment due to the outbreak of COVID-19 pandemic even though some sectors have generated investment opportunities such as e-commerce, ed-tech and health care services. Although understanding or forecasting the future is getting increasingly more complicated in these days, PE/VC funds may therefore have to reorganize themselves to the changing times.

Private equity investors have already adopted a “wait and watch” approach as they evaluate market recovery before exercising their exit rights. Despite these challenges, several segments have started to see business activity progressively improving with investment as the economy adapts to the new normal. Nevertheless, In order to promote entrepreneurship and economic growth in India, the government has to come with less stringent laws or regulations for PE/VC investors. 


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