Private Equity

Private equity investors in the Indian context can broadly be categorised into two buckets:

• those that are domiciled or registered in India; and
• those that are domiciled or registered outside India.

The general legislative framework for both may not always overlap.

For instance, managers of private equity investors domiciled in India are governed by:

• the Companies Act, 2013;
• the Securities Exchange Board of India (SEBI) Act, 1992; and
• the rules and regulations framed under these statutes.

On the other hand, Indian portfolio companies of foreign domiciled private equity funds will likely be governed by the Companies Act – although the investment vehicle itself, and by extension the fund, may not. Similarly, the listing status of the portfolio company at the time of a proposed investment will determine whether the foreign domiciled private equity investor must be registered with SEBI as a ‘foreign portfolio investor’ and will therefore be subject to the SEBI Act.

In general, in addition to the Companies Act and the SEBI Act, the following statutes assume significance in the private equity context in India:

• the Foreign Exchange Management Act, 1999;
• the Consolidated Foreign Direct Investment (FDI) Policy of the government of India;
• the Income Tax Act, 1961; and
• the Competition Act, 2002.

The private equity market in India has become larger and more organised over the years, with several small, medium-sized and large Indian players entering the fray. Given India’s demographic and growth opportunities, a wide range of investment opportunities exist across sectors. The following factors are likely to appeal to private equity investors.

Political stability and ease of doing business: India’s general elections recently concluded and the incumbent government, together with alliance partners, won a third consecutive mandate. This is expected to foster greater confidence in India’s political stability for the next five years. The government’s general approach towards facilitating a business-friendly environment has been proactive, encompassing measures such as:

• improvements in infrastructure;
• promotion of digital transactions; and
• streamlining of regulatory frameworks.

Recent policy reforms aimed at improving the business climate have also reduced compliance burdens. These include the following:

• Goods and services tax (GST): GST was introduced in India to simplify the indirect tax structure and compliance obligations of taxpayers.
• Insolvency and Bankruptcy Code (IBC): The IBC was introduced to:
• • strengthen the resolution framework for distressed assets; and
  • increase opportunities for acquirers (including private equity firms).

Exit opportunities: Exit options available to private equity investors – especially considering India’s currently healthy capital markets – are significant. Initial public offerings, strategic sales and secondary sales to other strategic/private equity firms are the usual exit opportunities.

Entrepreneurship opportunities: There is a growing culture of entrepreneurship in India, with many innovative startups emerging across sectors. This entrepreneurial spirit is supported by a robust ecosystem of incubators, accelerators and venture capital, providing private equity firms with several investment opportunities in early-stage companies with high growth potential.

Protection provisions: There are investor-protection linked provisions in statutes. For instance, Foreign Exchange Management Act, 1999 and rules framed thereunder (‘Exchange Control Regulations’) mandate that all primary issuances of securities to a non-resident and secondary transfers of securities to/with a non-resident, the issuance/transfer must be completed within 30 calendar days of receipt of the funds. If a foreign investor does not receive the securities within this timeframe, the investee company/seller is liable to return the funds in their entirety. A similar provision exists in the Companies Act, whereby fresh issuances must be completed within 60 calendar days of receipt of the funds.

Indian judiciary: Historically, litigation in India was viewed as an extremely slow and time-consuming process. However, in the last few years, this has changed: the Indian courts largely tend to follow the black letter of contract unless there are statutory or regulatory restrictions with respect to enforcement. Courts have increasingly become more commercial and sophisticated. Alternative dispute resolution mechanisms such as arbitration, mediation and conciliation have also played a key role in ensuring timely relief.

Private equity transactions have several facets, depending on the nature of the transaction, including:

• the nature of the investment (primary or secondary);
• the types of entities involved (eg, whether by resident or non-resident investors; whether the investee is an Indian listed entity); and
• the sector concerned (investments in specified sectors require prior government or regulatory approval).

While one or all of the above dictate the regulatory authorities that could have jurisdiction, the following regulatory authorities are relevant in a general context.

Ministry of Corporate Affairs (MCA) and Registrar of Companies (RoC): The MCA has relevance in some shape or form in virtually all private equity/venture capital transactions. Corporate entities in India (ie, companies and limited liability partnerships) are set up under the authority of the MCA. The MCA, via the RoC, administers the implementation of the Companies Act. The RoC functions as the registry of records for companies registered with the MCA. The Companies Act mandates companies to make filings with the MCA for specific matters, including:

• changes in issued capital;
• changes in directors; and
• amendments to constitution documents.

SEBI: Private equity investors seeking an India domicile must register with SEBI as alternative investment funds (AIFs), by virtue of being pooled investment vehicles, before they can accept commitments from investors. AIFs:

• must have defined investment policies; and
• depending on the type of registration obtained, can participate in both equity and debt transactions.

SEBI regulations authorise SEBI, in defined circumstances, to:

• conduct searches and seizures of AIFs; and
• issue orders against AIFs (including imposition of penalties in specific situations).

Reserve Bank of India (RBI): All fund inflows into India from overseas and to overseas jurisdictions from India are regulated by the RBI through the Exchange Control Regulations. The Exchange Control Regulations authorise the RBI to administer and regulate cross-border issuances and transfers of securities (both debt and equity). Any foreign investment transaction must be reported to the RBI through scheduled commercial banks, irrespective of whether it is:

• a fresh issuance of securities to a non-resident; or
• a secondary transfer of securities by a resident to a non-resident or vice versa.

Non-compliance with the reporting requirements could potentially pose a ‘title’ risk for investors, since scheduled banks do not permit transfers of funds unless documentation underlying these reports is submitted to them at the time a remittance is to be undertaken (especially in exit scenarios). The RBI has general powers of investigation and is authorised to impose penalties stipulated under the Exchange Control Regulations and/or compound offences.

Read with the Foreign Direct Investment (FDI) Policy, the Exchange Control Regulations also stipulate sectoral caps on foreign investment. For instance, there are sectors in which:

• foreign investment is permitted under the automatic route (where no prior government approval/permission is required) up to a certain threshold but government approval is required beyond those thresholds (eg, in pharmaceuticals, where the threshold is 74%); and
• foreign investment is restricted beyond a certain threshold (eg, in insurance, where foreign investment beyond 74% is not permitted).

The RBI is also the nodal regulator for:

• banks;
• non-banking financial institutions; and
• housing finance companies.

Regulations stipulate that if a transaction breaches certain prescribed thresholds (whether linked to quantum of shareholding or change in control), the RBI’s prior approval is required before a sale/issuance transaction can be closed.

Depending on the industry sector of the investee, private equity transactions may also be regulated by other regulatory authorities such as:

• the Pension Fund Regulatory and Development Authority of India;
• the Airports Authority of India; or
• the Telecom Regulatory Authority of India.

Sector of investment: At the outset, foreign investors (including private equity investors) should carry out an assessment of the statutory and regulatory framework relevant to the sector in which an investment is being contemplated. The sector usually determines:

• the cap on foreign shareholding;
• the availability of the automatic route; and
• incremental conditions or stipulations relevant to investments or operations in that sector.

In most sectors, 100% foreign investment is allowed under the automatic route. However, the government of India has prohibited FDI in certain sectors, such as:

• the lottery business;
• tobacco manufacturing; and
• real estate (not including development of townships, construction of residential/commercial premises, roads or bridges and real estate investment trusts).

Jurisdiction of investment: Press Note 3 (2020 Series), issued by the government on 17 April 2020, stipulates that prior government approval should be sought before investing in India if:

• the investor is situated in a country that shares a land border with India; or
• the beneficial owner of an investment into India is situated in or a citizen of any such country.

Accordingly, any investment into India from Afghanistan, Bangladesh, Bhutan, China (including Taiwan and Hong Kong), Myanmar, Nepal and Pakistan can be done only through the government approval route.

Valuation: The Exchange Control Regulations regulate the pricing of securities involving cross-border share sale/subscription transactions. These:

• are usually linked to internationally accepted pricing methodologies for arm’s-length transactions; and
• must be certified by chartered accountants or merchant bankers.

The Exchange Control Regulations also restrict foreign investors from having ‘agreed return’ commitments from residents, whether internal rate of return linked or time linked.

Procedural compliance under the Companies Act and the Exchange Control Regulations: Several process-linked compliances may need to be undertaken depending on the nature and structure of the investment, including in connection with:

• the fresh issuance of securities;
• secondary transfers of securities;
• the appointment or removal of directors; and
• on-market purchases or sell-downs.

Private equity transactions in India are typically structured as:

• a primary issuance of securities; or
• a secondary transfer of securities.

Other than funds established for undertaking venture debt, the subscription or acquisition is usually of underlying equity or equity linked instruments. For non-Indian domiciled private equity investors, the only capital instruments in which they are permitted to invest are equity shares and instruments convertible to equity (see below).

Investment route:

Primary issuance: A private equity investor can subscribe to the securities of an Indian company by directly infusing capital. Most private equity investments in India occur in closely held unlisted companies, since they offer higher growth potential, including at the time of listing. Private equity investors invest at different stages of a company’s lifecycle (eg, seed capital, venture capital, growth capital, buyouts).

The primary issuance of shares is permitted under the Companies Act through the following modes:

• a private placement or preferential allotment process; or
• a rights issue, being a proportionate subscription offer to existing shareholders.

Most private equity transactions follow the private placement route.

Secondary transfers: Private equity investors often acquire issued shares from existing shareholders, rather than a subscription via private placement. These are usually undertaken to allow an existing shareholder (founders, employees or other early-stage backers) to monetise their investment. In some situations, companies with significant cash flows may not necessarily require additional capital, but given their growth stage, existing shareholders may be looking for an exit.

Types of instruments: Private equity transactions involve investments by subscribing or purchasing either equity shares or instruments convertible into equity. The Exchange Control Regulations recognise only equity shares and compulsorily convertible securities (eg, compulsorily convertible preference shares, compulsorily convertible debentures, warrants) as permitted capital instruments. All other instruments that are optionally or not convertible into equity are considered debt.

Convertible preference shares are typically preferred over equity. Preference shares, as the name goes, are issued with preferential rights in terms of dividend and repayment in the event of liquidation. The Companies Act provides that preference shares should be either redeemed or converted within 20 years of the date of issue, so these are thus typically structured as being mandatorily convertible within a certain timeframe. No such timeframe is provided for convertible debt instruments.

Primary issuance versus secondary transfer: A primary transaction is usually undertaken where the investee company requires additional capital, whether for business/expansion or otherwise to meet regulatorily prescribed capital adequacy requirements (eg, for financial services entities such as banks).

Unlike a secondary transfer of shares, which could involve shares that are subject to multiple transfers pre-acquisition, encumbrances such as pledges and transfer restrictions, a primary transaction ensures that the title to shares is usually unencumbered.

From an enforceability perspective, in case of a primary issuance, investors tend to have recourse with respect to their shares and their investment against, among others, a company which is a direct stakeholder of the investor at the relevant time. On the other hand, in case of secondary acquisitions, recourse lies primarily against a seller of the shares which may or may not continue to remain a stakeholder with respect to the investee at that point in time.

Equity versus convertible instruments: The terms of instruments convertible into equity often present private equity investors with valuation adjustment or ‘ratchet’ mechanisms. As a result, in early-stage investments, private equity investors prefer convertible instruments given the potential for higher returns.

Convertible instruments in private limited companies also do not dilute the element of control that is otherwise afforded by equity shares. For instance, investors holding convertible instruments are ordinarily entitled to receive dividends prior to equity shareholders. Similarly, preference shareholders sit higher in the distribution waterfall compared to equity shareholders in the event that the investee company is liquidated.

Offshore fund: Private equity investors often invest via entities situated in offshore jurisdictions that either:

• have relaxed taxation norms; or
• have executed favourable double taxation treaties with India.

Such offshore funding structures enable investors to invest into India without registering the investment vehicle in India.

Alternative investment funds (AIFs): Domestic private equity investors are mandated to set up AIFs under the SEBI regulations after pooling investment funds onshore in India. AIFs are funds established in India as privately pooled investment vehicles which collect funds from investors, whether Indian or foreign, for investment in accordance with a defined investment policy. Every AIF must be registered with SEBI. SEBI categorises AIFs based on their investment strategy as follows:

• Category I: These AIFs focus on investments in startups, early-stage ventures, social ventures, small and medium-sized enterprises or infrastructure projects.
• Category II: These AIFs do not fall under Category I or III and avoid leverage or borrowing beyond day-to-day operational needs.
• Category III: These AIFs employ complex or diverse trading strategies and may utilise leverage, including investments in listed or unlisted derivatives.

All foreign investments are subject to pricing guidelines and reporting requirements. Non-resident investors are also subject to pricing guidelines at the time of repatriation of funds during exits from an Indian entity.

On the other hand, AIFs must be registered with SEBI and are subject to various reporting requirements. However, domestically controlled and managed AIFs benefit from flexibility with respect to pricing (subject only to tax implications), since pricing guidelines applicable to foreign investors do not apply.

All cross-border private equity transactions are regulated by the RBI through the Exchange Control Regulations.

Investments from land bordering nations of India: Pursuant to Press Note 3 (see question 2.2), prior government approval should be sought before investing in India where:

• the investor is situated in a country that shares a land border with India; or
• the beneficial owner of an investment into India is situated in or a citizen of any such country.

The press note also extends to:

• any direct or indirect transfer of ownership of any existing or future FDI; and
• any such subsequent change in beneficial ownership.

Pricing guidelines and assured returns: As per the Exchange Control Regulations, the price of equity instruments of an unlisted Indian company issued by such company or transferred from a resident shareholder to a non-resident may not be less than the fair market value according to internationally accepted pricing methodology on an arm’s-length basis, as determined by a chartered accountant/merchant banker/cost accountant (‘fair market value’). On the other hand, where equity instruments are being transferred from a non-resident shareholder to a resident in India, the price of these shares cannot exceed fair market value.

Equity instruments with optionality clauses allow investors to exercise their right to buy (call option) or sell (put option) securities at pre-determined prices (also referred to as ‘strike price’). However, the Exchange Control Regulations also prescribe that a non-resident shareholder of an Indian company which is exercising an optionality clause may exit without any assured returns subject to the pricing guidelines, subject to a minimum lock-in period of one year. This means that a non-resident shareholder cannot be guaranteed any assured exit price at the time of making an investment. Instead, such exit price will depend only on the fair market value at the time of exit.

Keeping this in mind, when the transaction documents are being drafted for a cross-border transaction, the exit mechanisms should be carefully drafted in line with the Exchange Control Regulations.

Deferred consideration and capped indemnity: As per the Exchange Control Regulations, in case of a transfer of equity instruments of an Indian company between a resident shareholder and a non-resident, up to 25% of the total consideration may be paid by the non-resident transferee or may be settled through an escrow arrangement within 18 months of the date of the transfer agreement. The clock starts to run from the date of the transfer agreement and not from the date of closing. This means that there cannot be a gap of more than 18 months between the date of signing the transfer agreement and the date of closing.

With respect to indemnity under an agreement between a resident and a non-resident for transfer of equity instruments of an Indian company, the Exchange Control Regulations permit a maximum indemnity payment of 25% of the purchase consideration, up to a maximum of 18 months from the date of payment of the full consideration without prior RBI approval. A higher indemnity payment or payment after the expiry of the 18 months would require the prior approval of the RBI. As a general matter, it is understood that enforcement of such contractually agreed indemnities is likely to require prior approval of the RBI.

As a general principle, the rights of the investors depend on the value (and timing) of their respective investments. Most companies execute shareholders’ agreement with their investors to clearly lay down their rights associated with their securities.

Most favoured investor (MFI): MFI provisions assure investors that the rights provided to existing or future investors are not more favourable than the rights currently being provided to them. In case certain additional rights are granted to investors in the future, the beneficiaries of the MFI clause will be automatically entitled to these additional rights as well. In this way, MFI provisions ensure consistency across investor groups.

Liquidation preference: Liquidation preference determines the order in which investors receive proceeds during a liquidity event (eg, sale or acquisition/merger of the investee company). Where a liquidation event occurs before an investor receives an exit, it becomes crucial to protect the investor’s interests. The inclusion of a liquidation preference clause in the investment agreement ensures that the investor receives a return on its investment. As a result, where there are multiple investors, the liquidation preference clause is usually negotiated extensively.

Board representation and governance: Board seats influence strategic decisions. Therefore, balancing board representation and governance among investors ensures diverse perspectives and prevents dominance by any single group. In this regard, it is important to negotiate which of the multiple investors will receive board seats or observer seats. Often, board/observer seats are negotiated and given to investors based on the percentage of investment made by them.

Private equity transactions in India typically unfold through the following key milestones:

Term sheet: A term sheet summarising key terms on which the investor is prepared to effect the investment is usually executed with the counterparties. This covers the key commercial terms, such as:

• pricing;
• valuation;
• transaction structure;
• types of instruments; and
• key rights.

Term sheets are generally non-binding in nature, except clauses pertaining to matters such as:

• the exclusivity period;
• confidentiality;
• jurisdiction; and
• dispute resolution.

Due diligence: Post term sheet, investors usually conduct due diligence (legal, financial, tax and business) on the investee company to:

• examine the target’s operations, financial position and compliance status;
• confirm the information presented to them about the target; and
• mitigate any discovered risks.

Findings and issues highlighted during due diligence exercises are sought to be covered in transaction documents either as conditions precedent/conditions subsequent or specific indemnity items, depending on:

• the nature of the underlying issue; and
• the timelines for completion.

Definitive documentation: Definitive agreements are usually negotiated in parallel to the due diligence exercise. The form of definitive agreements:

• depends on the nature of the transaction; and
• can include:
• • share subscription agreements for primary transactions;
  • share purchase agreements for secondary transactions;
  • shareholders’ agreements to govern inter-se rights and obligations; and
  • employment agreements (executed with the promoter/founders/ key personnel).

In some cases, share subscription or share purchase agreements are clubbed with shareholders’ agreements into a single investment agreement.

Specifically, in an Indian context, share purchase transactions must be characterised as ‘spot delivery contracts’. Therefore, for investments in unlisted companies, share subscription/purchase agreements are usually structured as ‘contingent contracts’, where the obligation to invest and acquire the shares is contingent on specified conditions having been met.

Transaction closing: Closing is usually subject to:

• the completion of contractual conditions precedent; and
• the receipt of applicable regulatory/government approvals.

All actions relating to the share acquisition or sale, including transfer of purchase consideration, take place simultaneously. Under Indian law, the allotment of new shares is permitted only after the investee company has received the requisite funds. Similarly, for secondary transactions, depository participants insist on the ‘unique transaction reference’ number, which is relevant for the purchase consideration paid to a seller. As a result, the investor must usually go out of pocket to the extent of the purchase consideration and the share allotment/transfer only takes place subsequently. Investors usually prefer to have escrow arrangements in place to ensure that timing of cash flow and share issuances/transfer can be managed as close to each other as possible. Closing actions also generally include corporate procedural compliances, including:

• board and shareholder resolutions; and
• the appointment/resignation of directors.

Conditions subsequent: Often, issues highlighted during the diligence process could require extensive efforts from the investee company. Such issues could become operationally challenging for the investee company from both a time and cost perspective, and hence private equity investors often allow the investee company to make regularisation of such issues as condition subsequent. That said, these are rarely implemented, since the recourse of unwinding a transaction if a condition subsequent is not satisfied is not available.

Exit: Private equity investments successfully conclude with the exit of the investor from the investee company. There are several avenues to achieve exits and definitive agreements usually detail the timelines as mechanisms by way of which the exit is required to be provided. The choice of exit depends on several factors, such as:

• the stage of growth of the target;
• market conditions;
• investor preference; and
• macro-level factors.

Private equity investors usually conduct extensive due diligence. The scope, materiality and timeframe vary, depending on:

• the size and sector of the investee;
• the mode of acquisition;
• the transaction timetable; and
• the approvals required.

Generally, the scope of the legal diligence includes:

• corporate matters;
• licences;
• contracts;
• indebtedness;
• labour;
• litigation;
• real and intellectual property; and
• insurance.

Additionally, due diligence conducted of the target includes:

• financial and taxation due diligence;
• business/commercial or operational due diligence; and
• other aspects, including:
• • information technology;
  • human resources; and
  • intellectual property.

Target: Disclosure requirements for an unlisted target are not statutorily prescribed, barring statutory reporting obligations post-investment and otherwise (including periodic disclosures regarding shareholdings and beneficial ownership of shares). Investors usually rely on their advisers and prepare requisition lists requesting data and information, which are usually populated in electronic data rooms. The representations and warranties sought by investors in an Indian context are usually higher than those sought in more evolved markets.

Listed companies in India are subject to fairly strict disclosure requirements to the stock exchanges, which include:

• prior intimation for holding a board/shareholders’ meeting to consider raising funds by issuing securities;
• disclosure of acquisitions (including agreements to acquire)/sales/issuance of any securities by the listed target;
• disclosure of a shareholders’ agreement (including rescission, amendment or alteration of a shareholders’ agreement);
• disclosure of a change in directors;
• disclosure of the resignation of key managerial personnel; and
• disclosure of amendments to the constitution documents.

In certain instances, prior intimation to regulators and the public in general must also be made regarding the potential transaction. For example, Reserve Bank of India regulations applicable to housing finance companies oblige a housing finance company (investee) and the investor to publish a prior public notice in the newspaper disclosing the intention behind the proposed transaction and so on if the proposed transaction results in a change in shareholding of more than 25%. These steps are usually implemented as conditions precedent to closing.

Investor: At the time of remitting funds, non-resident investors must complete ‘know your customer’ checks. Investors must also give an undertaking to the effect that they are not:

• situated in a country that shares a land border with India; or
• the beneficial owner of the investment situated in, or is a citizen of, any such country.

All parties to a private equity transaction will typically have internal and external legal advisers, financial and tax advisers, and in several instances investment banks, to:

• guide them through the process; and
• assess the fairness of the terms of the transaction.

In specific cases – for instance, where environmental due diligence or technical due diligence review is required – the services of experts in the relevant disciplines are also sought.

Directors and shareholders/promoters play a crucial role in approving and managing a transaction. Debt arrangements that any target may have executed often include certain events which require the prior written consent of the lenders. These events typically include matters such as:

• changes in management;
• acquisitions; and
• changes in shareholdings.

In sensitive sectors – such as defence, airports and financial services – regulatory oversight of transactions is also fairly strong.

Two main pricing mechanisms have evolved and are now widely accepted:

• closing accounts; and
• locked box.

Closing accounts: An initial per share price is:

• determined based on the financial performance of the business as of a particular date; and
• recorded in the transaction documents.

The accounts are then trued-up prior to closing for any variations between the accounts date and the true-up date, to reflect the most recent per share price. The mechanisms for true-ups (ie, via management accounts, audits/inspections by investors or audits by third-party experts) and items that are permitted to be adjusted (current assets and current liabilities at the very least) are also provided for in the transaction documents.

Closing accounts are usually preferred in price-sensitive sectors where:

• costs and revenues tend to fluctuate (eg, infrastructure, including highways, cement, power); and
• there could be significant time gaps between signing and closing after accounting for substantial conditions precedent or regulatory approvals.

Pricing-wise, the key for a private equity investor is to ensure:

• minimal value leakage between signing and closing; and
• that the projections on which the price per share is based are as close as possible to the then-current numbers.

Locked box: Locked boxes are typical in acquisitions relating to:

• services companies;
• technology companies; and
• financial services providers.

In an Indian context, locked boxes do not get usually get called out as such. However, the pricing for a transaction is arrived at as of a particular date based on an agreed valuation methodology, without any pre-closing or post-closing adjustments. Locked boxes are usually backed by more extensive set of pre-completion standstills, representations, warranties and indemnities when compared to transactions that deploy closing account adjustments.

Indian laws do not explicitly recognise ‘break fees’ as a commercial construct, leaving their validity to be determined by specific terms of the contract.

Break fees are typically predetermined and are payable if the transaction does not close owing to specific reasons cited in the contract. These circumstances usually cover one or more of the following:

• a seller/investee backing out without legitimate reason;
• failure to:
• • procure identified consents/approvals (contractual or regulatory) which are crucial for investor comfort; or
  • satisfy a specific operational condition precedent; or
• any incorrect information being furnished to the investor by the investee pre-signing (including as part of the during due diligence exercise).

While enforceable in domestic transactions as a contractual matter, payment of break fees to a non-resident requires prior RBI approval. However, the Indian courts have not, as yet, been required to opine on the enforceability of break fees.

For foreign investors, it is also advisable to structure break fees as liquidated damages which constitute a genuine pre-estimate of losses that an investor would incur in the event that a deal does not go through. Liquidated damages have lower enforcement risk and the thresholds for establishing actual loss are significantly lower than those for simpliciter damages. Payment of liquidated damages will also require prior RBI approval.

The risks to an investment can typically be categorised as pre-investment or post-investment. Pre-investment risks are associated with operational or statutory liabilities which arise for the period prior to the investment. Post-investment risks cover:

• post-closing operational and statutory risks; and
• risks associated with any exits.

Pre-investment: Even with a comprehensive due diligence exercise, there always remains a risk that unforeseen liabilities may surface in the period prior to closing. These can include:

• potential liabilities from lawsuits, product warranties or other unforeseen circumstances; and
• inaccurate or misleading financial statements.

Post-investment:

• To mitigate post-investment risks, investors often employ a multi-pronged approach by negotiating robust warranties and indemnities in the transaction documents. The aim is to build in sufficient financial protection against breaches by the seller/investee.
• Founders/promoters’ activities post their investments may be subject to certain restrictions such as:
• • exclusivity;
  • non-compete obligations;
  • limitations on investing in competing entities; and
  • non-solicitation obligations.
• Additionally, vetoes on reserved matter rights (see question 7.3) and participation in the investee company’s management through nominee non-executive director on the board:
• • provide better oversight over the affairs of the investee company; and
  • may help investors to minimise operational risks.
• Acceleration of exit is typically sought by foreign investors as a post-closing remedy in case of the occurrence of any event of default or material adverse effect that impacts on their interests.

While the specific representations and warranties included in private equity deals may vary depending on factors such as investment size and industry, some key areas are typically covered in most private equity transaction documents, including the following:

• Investee company’s existence: To confirm the company’s incorporation in accordance with applicable law and authority to enter into the transaction.
• Authority to issue/transfer: To confirm the investee company’s right to issue or the transferor’s right to transfer the shares.
• Ownership: To ensure that the seller:
• • has clear ownership of the shares in question; and
  • has not created any encumbrances on the same.
• Legal compliance: To ensure the compliance of the investee company with the relevant applicable laws.
• Essential licences and approvals: To confirm whether the investee company holds the necessary licences and approvals to operate and conduct its business legally.

The investors tend to safeguard their investment by seeking indemnification from the investee company (or sometimes its promoters) for any loss that they may face because of misrepresentations by the investee company. In some cases, the investors may also demand the investee company to compensate via specific performance instead of just paying monetary compensation.

Warranty and indemnity (W&I) insurance is also gaining traction among private equity investors in Indian deals. The W&I insurance acts as a financial safety net, protecting private equity investors if the investee company breaches its warranties or makes misrepresentations. This protection extends beyond the investee company’s own financial capacity, ensuring compensation even if the investee company does not have the financial ability to afford it.

Companies in India tend to offer incentive schemes to key personnel to ensure that their financial goals align with those of the company. The following structures for incentive schemes are preferred in India.

Employee stock options (ESOPs): The Companies Act defines an ‘ESOP’ as an option given to directors, officers or employees of a company or of its holding/subsidiary company, giving them the right to purchase or subscribe at a future date securities offered by the company at pre-determined price. This is usually done under a board and shareholder-approved ESOP scheme which lays down, among other things:

• the vesting period;
• the determined price; and
• the size of the ESOP pool.

ESOPs can be issued to:

• any permanent employee who has been working inside or outside India; and
• all directors (excluding independent directors).

Companies are prohibited from issuing ESOPs to:

• any employee who is a promoter or who belongs to the promoter group; and
• any director who directly or indirectly holds more than 10% of the share capital in the company.

However, a registered startup – that is, a company with an annual turnover of less than INR 1 billion – is exempt from the above restrictions for the first five years following registration.

Sweat equity: Sweat equity shares are issued by a company to its directors or employees at a discount, or for consideration other than cash, for:

• providing their know-how; or
• making available rights in the nature of IP rights or value additions.

Sweat equity shares can be granted to:

• any permanent employee who has been working in or outside the country;
• any full-time or non-full time director; and
• any employee or director of the company’s subsidiary/holding company.

However, a company is prohibited from:

• issuing sweat equity shares for more than 15% of the existing paid-up equity share capital in a year; or
• issuing sweat equity shares of more than the value of INR 50 million, whichever is higher.

Further, the issuance of sweat equity shares in the company must not exceed 25% of the paid-up equity capital of the company at any time. Just like ESOPs, the aforementioned thresholds of maximum issuable sweat equity are not applicable to registered startups for five years following their registration.

Stock appreciation rights (SARs): SARs are performance-based incentives that are:

• linked to the performance of the company; and
• assessed in terms of the company’ share value.

At the time of exercising the option, the company may issue shares or cash equivalent of the shares and SARs can thus be structured as ‘cash-settled’ or ‘equity-settled’. Akin to ESOPs, SARs are granted on the basis of a board-approved SARs scheme which sets out the manner in which SARs will operate and implemented. Moreover, employees holding SARs are:

• absolved from receiving any dividend; and
• prohibited from voting or in any manner enjoying benefits awarded to a shareholder.

For unlisted companies, SARs remain unregulated and therefore become a function of contract between the employee and the company. The SAR structure is also beneficial for the company, as:

• there is no dilution of shareholdings; and
• the bonus is paid subject to the company’s performance.

Phantom stock options: Phantom stock options or virtual stock options are equity incentive plans that provides employees with a cash payment equal to the appreciation in the company’s stock price over a specific period, without actually owning any shares in the company. In other words, they are cash-settled equity awards that mirror the value of the company’s actual shares. They usually form part of the bonus component in the remuneration packages offered to employees.

The legal concept of phantom stock options is still developing in India; however, unlisted companies in India have been offering such options-based incentives to their employees. Phantom stock options may be offered as either:

• full-value SARs; or
• appreciation-only SARs.

While full-value SARs can bring in cash worth the full value of the stock at the time of computation of consideration, appreciation-only SARs entitle an employee to receive only the difference between the value at which such option was granted and the current ongoing value of the stock of company at the time of computation for consideration in cash or cash equivalent.

While conventionally ESOPs and sweat equity shares have been the preferred forms of incentives for management, SARs such as phantom stock options have garnered a lot of traction lately due to:

• their flexibility absent regulatory oversight;
• the protection that they offer to the promoters of the company from early dilution in the equity of the promoters; and
• the fact that there is virtually no transfer of ownership in terms of the stock to the employees.

Also, unlike in the case of ESOPs, employees need not invest capital in the company upfront to exercise phantom stock options, which makes them an attractive incentive for management. However, since phantom stock options largely remain unregulated in India, the wording of the phantom stock option scheme must be carefully drafted in order to avoid any adverse tax implications.

The tax treatment of the management incentive structures broadly depends on the kinds of assets (ie, shares or cash) that are received by employees.

ESOPs and sweat equity: Both ESOPs and sweat equity attract similar tax treatment and are taxed at two stages:

• at the time of share allotment pursuant to the exercise of options (in case of ESOPs)/at the time of the allotment of shares (in case of sweat equity); and
• at the time of sale of shares (whether acquired via ESOPs or as sweat equity).

No tax is levied at the time of grant or vesting of the options.

Both ESOP shares and sweat equity shares are treated as perquisites in the hands of the employee and are taxed accordingly as salary. At the time of exercise of ESOPs, the difference between the fair market value of the shares on the day of exercise and the price at which the ESOP is actually exercised is taxed as a perquisite. Income tax rules prescribe valuation methodologies for listed and unlisted shares to ascertain the foregoing.

From a sales perspective, the sale price minus the acquisition price is treated as ‘capital gain’ and taxed accordingly.

SARs: In case of equity-settled SARs, employees become eligible to acquire a proportionate number of shares of the company on the date of redemption. The tax treatment of equity-settled SARs is the same as the tax treatment of ESOPs.

In the case of cash-settled SARs, employees are eligible to receive proportionate cash compensation.

A cash-settled SAR (including ‘phantom’ options) is a revenue receipt in the hands of the employee and is taxed as income under the head ‘Salaries’. In such cases, the employer is obliged to withhold tax at source.

One of the prevalent strategies is to implement a longer schedule for stock options, with the vesting taking place in tranches over this period. By linking the vesting to longer-term milestones, the vesting period increases and, by extension, the tax impact is spread out over multiple tax years, potentially reducing the overall tax burden.

Manager shareholders are usually entitled, up to prescribed thresholds, to freely transfer their shares:

• without any prior consents; and
• without transfer restrictions (other than transfers to competitors etc).

Other than the above, restrictions are imposed on manger shareholders to align commercial interests and ensure stability in business operations, as follows.

Vesting of shares: ‘Vesting’ of shares in this context, as opposed to stock options, refers to a process whereby manager shareholders acquire control of their shares over a predetermined period. This means that initially, a certain portion of the shares is restricted and the shares cannot be sold or transferred. These restricted shares progressively ‘vest’ with the manager at defined intervals – typically on a monthly, quarterly or yearly basis.

Lock-in period: During lock-in periods, manager shareholders are restricted from transferring their shares in excess of specified thresholds. Limited transfers are usually permitted for facilitating:

• liquidity;
• estate planning; or
• inter-se management transfers.

Non-compete and non-solicit: Manager shareholders are usually subject to exclusivity, non-compete and non-solicitation clauses post cessation of employment, subject to a cooling-off period. Non-compete provisions post cessation of employment are not enforceable in India. These are largely included as ‘moral’ obligations to ensure that no confidential information is deployed by managers for competitors.

Confidentiality: Manager shareholders are restricted from sharing information about the company, its shareholders and so on with third parties.

In India, leaver (‘good’/‘bad’ or ‘with cause’/‘without cause’) provisions for manager shareholders are governed by contract. Leaver provisions are typically outlined in employment agreements as well as transaction documents executed with private equity investors (mainly shareholders’ agreements), with consequences for a manager’s departure depending on the underlying circumstances:

• Good leavers: These are typically managers who leave on mutually agreeable terms or pursuant to:
• • retirement;
  • disability; or
  • incapacity due to prolonged illness or similar.
• Bad leavers: These are typically managers who leave under circumstances deemed unfavourable to the company. Bad leaver scenarios may arise due to:
• • gross misconduct, including fraud, misappropriation of funds and so on; or
  • breach of contract, performance issues or disciplinary issues.

The consequences for leavers are as follows:

• Typically, good leavers:
• • are allowed to retain their vested shares; and
  • may even be entitled to accelerate vesting of all or some unvested shares.
• Bad leavers face harsher consequences, such as:
• • forfeiture of unvested shares; and
  • buyback rights at discounts.

More or less in every private equity transaction, potential investors carry out thorough legal due diligence of the target in order to discover legal, compliance and contractual risks. While such risks are invariably mitigated through a combination of conditions precedent, specific representations, warranties and indemnities, the investors also push for a number of negative and positive governance controls over the internal workings of the company which are crystallised into the shareholders’ agreement:

Right of board seat/observer: A very common right that private equity investors negotiate for is to nominate one or more directors to the board of directors of the target. The board meeting will not be quorate without the presence of the board nominee of the private equity investor. Having a nominee on the board enables the investors to:

• actively engage in decision making;
• contribute to the company’s direction; and
• monitor progress to safeguard investments.

However, having a nominee director on the board brings with it potential risks and additional responsibilities, including:

• a fiduciary duty to the investee company; and
• an increased probability of vicarious liability concerning the company’s acts and omissions.

Accordingly, even given this right to nominate a director to the board, investors also negotiate a right to nominate an ‘observer’ to the board who has no voting power.

Reserved matters/affirmative voting rights: Reserved or affirmative voting matters are issues that:

• are of particular importance to an investor; and
• can be implemented only after being specifically approved by such investor.

The affirmative voting rights are specifically negotiated by the private equity investors, which forbids majority shareholders (generally promoters) from unilaterally altering the terms attached to the investor shares.

Information and inspection rights: Investors often negotiate for rights to receive or examine certain financial data or other types of information in the target. The common information rights include the right to receive:

• the audit reports;
• the quarterly and annual financial statements; and
• any modifications to the business plans, management information system (MIS) and so on.

More often than not, investors also ask for rights of inspection or visitation of company premises.

Share transfer restrictions: Considering that private equity investors do not remain in charge of the company’s operations and management, investors typically impose lock-in obligations on the promoters of the company with the objective of promoting the stability and continuity of its business. On a similar note, investors end up holding a ‘right of first refusal’, ‘right of first offer’, drag-along rights and tag-along rights against the promoters.

Appointment of nominee director in a non-executive capacity: It is vital for investors to review the filings (together with the ancillary documents) that must be made to the Registrar of Companies by investee companies regarding the appointment of a nominee director to the board. The nominee director should be appointed in a non-executive capacity so as to reduce the likelihood of him or her being considered as an officer of default of the company. An officer of default may be held vicariously liable for the acts and omissions of the investee company.

In recent times, private equity investors (especially non-resident investors) have become increasingly hesitant to nominate directors to the board of an investee company, on account of the risk of vicarious liabilities being imposed despite the lack of the nominee director’s active participation in the operations of the company.

Conflict of interest between investor and investee company: While the nominee director is nominated by private equity investors to represent the interests of the nominating investor under Indian law, the primary fiduciary duty of all directors remains to the company itself. The potential conflict of interests between the investor as a shareholder and the duties of an investor director towards the company should be examined, as nominee directors cannot make decisions in the exclusive interests of the private equity investor, since this may affect the company.

Review of terms of appointment: The investors and company should also discuss the terms of the appointment of a nominee director, including:

• any indemnification obligations of the company towards such directors; and
• any directors’ and officers’ liability insurance to be procured for such indemnification obligations.

Fit and proper criteria: The nominee director should:

• be of sound mind;
• not be an undischarged insolvent;
• be between the ages of 21 and 70; and
• not have been convicted of any offence or sentenced to imprisonment for more than six months, where a period of five years has not expired from the date of expiry of the sentence.

Disclosures: Additionally, at the time of appointment as a director of the company, the nominee must disclose:

• interests in other corporate entities in accordance with the applicable law to identify related parties; and
• past conduct, including any litigation for certain fraudulent or other related activities.

Private equity investors prefer the management of the investee company to enjoy the autonomy to run the business on a day-to-day basis. However, some degree of control over key decisions of the investee company, through reserved matter rights, is reserved for the private equity investors. These matters can be implemented only after being specifically approved by the investor. While the list of such reserved matter rights may vary depending on the size and stage of investment, reserved matters typically cover:

• any change in the share capital structure of the company;
• any change in the charter documents of the company;
• any matter concerning the dilution of a shareholding of an investor;
• matter(s) on the suspension of business activities;
• the issuance of debt above a pre-agreed amount; and
• the appointment or removal of key personnel to the company.

The reserved matters are contractually agreed and are incorporated into the articles of association of the company to ensure that all shareholders’ rights and obligations are appropriately captured in the governing charter document. In the event of any conflict or inconsistency between a contract and the articles, the latter will prevail.

Some, if not all, of the tools and strategies covered under questions 7.1 and 7.2 remain consistent in most private equity transactions. In certain instances, the private equity investors have insisted on the formulation of a strategy agreement within the framework of the board observer agreement to be executed with the investee company, which may specify:

• the terms and conditions of periodical observation of the performance of the company; and
• certain rights that allow private equity investors to control and influence such performance to their benefit.

Additionally, private equity investors may oblige investee companies to execute non-compete and non-solicitation agreements with employees, directors and/or other shareholders which prohibit them from engaging in any competing business activities or soliciting employees of the company after exiting the company.

It is also not uncommon for private equity investors to execute non-disclosure agreements to protect the investee company’s confidential information from anyone who is not supposed to have access to such information.

Exits are usually subject to extensive negotiations. Detailed exit clauses are included in definitive agreements, including:

• timelines;
• methods/modes of exit;
• pricing; and
• obligations of investee companies and promoters in this context.

Initial public offering (IPO): An IPO is a private equity investor’s preferred exit option, as it grants access to:

• international capital;
• the potential for a higher valuation; and
• most importantly, liquidity post listing.

The successful conclusion of an IPO depends on:

• macro-economic factors; and
• prevailing market conditions.

Strategic and/or free sale: A strategic sale requires the investee company and/or its promoters to sell the entire share capital of the company to an acquirer. A strategic sale may cause promoters to lose control of the company in favour of an acquirer that may opt to operate the business differently. Private equity investors often prefer strategic sales as a second-level exit when compared to IPOs, since they offer:

• the potential for change in control premiums; and
• quicker exit timelines.

A free sale is usually an unencumbered sale of the investor’s shares without being subjected to share transfer restrictions. The fall away of share transfer restrictions is usually negotiated to trigger when the primary exit option has not materialised. Usually, depending on the growth pattern of an investee, private equity investors acquire shares from other private equity and venture capital investors as part of free sale processes.

Put option: Put options provide an investor with the right to demand a buyout of its shares by the promoters/founders:

• at a fixed price within a specified time; or
• upon the occurrence of defined events (eg, failure to receive exit through IPO; a material breach of obligations).

Regulatorily, put options face the ‘agreed return’ hurdle and can also be negotiated as fair value exits, with the investor controlling the manner in which the company is valued via the appointment of valuers and so on.

Tag/drag-along rights: Tag-alongs are usually negotiated to provide partial exits in case of a founder/promoter sale. In an Indian context, these have seldom been a preferred mode of exits.

Drag-alongs are usually triggered only where other preferred exit options have not materialised. They:

• are intended to make the private equity investor’s shares more attractive, since a buyer will have access to a larger block of other ‘dragged’ shares; and
• could potentially result in a change in control premium being negotiated as part of the price.

There have been no instances of drag-along rights being exercised by private equity investors in India.

Buyback of securities: Investors also negotiate for a forced company buyback clause at a pre-determined price – usually as the last option in an exit waterfall. A company buyback necessitates compliance with complex regulatory requirements prior to implementation. For instance, while buybacks up to 10% of an investee’s equity share capital can be undertaken with board approval, buybacks in excess of 10% require shareholder approval.

Further:

• not more than 25% of an investee’s equity capital can be bought back in a given financial year; and
• there must be at least a one-year gap between consecutive buyback exercises.

There are also enforceability issues with respect to buybacks, since partial buybacks (or buybacks from select shareholders) are not permitted.

Classification as ‘promoter’ in case of an IPO: Promoters must provide extensive and specific disclosures and undertakings as part of the IPO process. Persons identified as ‘promoters’ post listing are also subject to a lock-in for a prescribed period post listing. Private equity investors typically negotiate specific provisions in definitive agreements to clarify that they will not be, or be deemed to be, a ‘promoter’ of the company.

Untested enforceability of drag-along right: The enforceability of drag-along rights remains untested under Indian jurisprudence. However, drag-along rights are not per se unenforceable. As it is contractually governed, the remedy whereby dragged shareholders refuse to tender their shares is limited to ‘specific performance’.

No assured returns for foreign investors pursuant to put option: While there seem to be few concerns regarding the enforceability of put options in the context of private unlisted companies, a put option for non-resident investors can be made enforceable only if no guarantee of assured returns has been provided to those investors. The guiding principle for an enforceable put option is that a non-resident investor:

• may not be guaranteed an assured exit price at the time of making the investment; and
• must exit at the price prevailing at the time of exit.

As in several jurisdictions, the income tax framework in India is expansive. The primary legislation governing income tax is the Income Tax Act, 1961. All categories of equity transactions are subject to income tax with specific stipulations, including:

• issuances and transfers having to be undertaken at fair market value;
• tax deduction at source in specific instances; and
• tax collection at source in specific instances.

In this question, we outline some of the key tax implications in a private equity transaction (at the time of investment and exit).

Primary issuance:

Investee: Income tax is levied on private companies in case of an issuance of shares where the consideration received by the investee is more than the face value of such shares – in which case the difference between the consideration received and the fair market value of such shares is taxed in the hands of the investee (under the head ‘Other Income’). The rules framed under the IT Act provide for valuation methodologies relevant to this assessment.

There are exemptions from this principle if the consideration is received by venture capital undertakings from venture capital companies or venture capital funds.

Investor: A similar principle applies to investors, as follows:

• Where an investor receives securities (with a fair market value exceeding INR 50,000) without paying any consideration, tax is leviable on the entire fair market value of such securities in the investor’s hands (under the head ‘Other Income’); and
• Where an investor receives securities for consideration which is less than the fair market value of the securities (by an amount exceeding INR 50,000), the difference between the fair market value and the actual consideration paid is taxable in the investor’s hands under the head ‘Other Income’.

Secondary transfers: Capital gains arising on transfer of shares of an Indian company are taxable in the hands of the transferor. Capital gains are computed as the difference between the full value of the consideration received for the transfer less the cost of acquisition of the shares. If the transfer of unlisted shares is completed at a price per share which is lower than the fair market value of the shares, the fair market value of such shares is deemed as the full value of consideration for the purposes of computing capital gains in the hands of the transferor.

Under the Income Tax Act, any person paying a sum of money that would be taxable under the Income Tax Act to a non-resident should, at the time of payment, withhold or deduct tax accordingly. Only the net amount is to be remitted to the non-resident seller with the tax withheld being required to be paid to the credit of the government on behalf of the non-resident. Also, complete information regarding payments being made to non-residents must be furnished to the income tax authorities in India via various forms. Accordingly, in cases where secondary transfers are being made by non-residents, it is important to include relevant representations and warranties in the transaction documents regarding compliance with the withholding tax requirements. Tax insurance is also a popular product which private equity investors rely on at the time of exit – largely:

• in cases where benefits of no withholding are proposed to be availed of under any double taxation avoidance agreements (DTAAs) executed by India with other countries; and
• considering that the investment vehicle may not, on a going forward basis, retain the requisite funds to backstop any indemnity obligations or discharge any tax obligations arising as a result of the sale transaction.

There have been deliberations in the past as to whether the indirect transfer of shares – that is, the transfer of interest in an intermediate entity resulting in the transfer of control over the shares of an Indian entity – is taxable in India. In Vodafone International Holdings BV v Union of India, the Supreme Court of India ruled that the indirect transfer of shares among non-residents was not taxable in India, even where the underlying asset in such transaction was Indian. Post the Vodafone judgment, the Income Tax Act was amended to make indirect transfers taxable in India if the entity being transferred derives substantial value from assets located in India – that is, if more than 50% of the transferor’s global assets are located in India (with an additional threshold condition that the value of these Indian assets should exceed INR 100 million).

Indirect transfers can potentially be structured if there are specific exemptions available under an applicable DTAA. If DTAA provisions are beneficial, this could act as a tax planning strategy.

That said, DTAA benefits remain subject to the General-Anti Avoidance Rule, which allows tax authorities to disregard the legal form of the transactions and look into their substance instead. If the tax authorities of India are of the view that an indirect transfer has been undertaken through an entity incorporated with the mere aim of obtaining treaty benefits, they could potentially deny treaty benefits.

Typically, cross-border private equity transactions are structured such that the place of effective management and domicile of the investing entity is in a country with which India has a DTAA. For instance, the DTAA signed with the Netherlands sets out favourable tax rates for the payment of dividends flowing between the two countries. If the recipient is the beneficial owner of the dividends, the tax chargeable is capped at 10% of the gross amount of the dividends, subject to certain conditions.

Even in instances involving multiple sources of income, tax assessees are entitled to adopt the Income Tax Act for one source of income and provisions of DTAA for another source. One example is Indium IV (Mauritius) Holdings Ltd v DCIT, in which the Income Tax Appellate Tribunal allowed the taxpayer to claim beneficial provisions of the India-Mauritius tax treaty in respect of short-term capital gains and, at the same time, carry forward long-term capital loss as per the Income Tax Act. The rationale for this decision was that transactions constituting the short-term and long-term assets are different sources of income, because of which short-term capital gains/losses and long-term capital gains/losses are considered to be distinct and separate streams of income.

In recent times, India has seen significant private equity/venture capital activity in the Asia-Pacific region. In 2023, India accounted for ~20% of all private equity/venture capital investments in the Asia-Pacific region, up from approximately 15% in 2018. From 2010 to 2023, the number of control/buyout deals has increased four times.

That said, India’s overall deal activity dropped from ~$62 billion in 2022 to ~$39 billion in 2023. There are several global and macro-economic reasons for this trend. Investor sentiments due to higher interest rates and geopolitical tensions – whether Russia’s invasion of Ukraine or tensions between the United States and China – have resulted in decreased economic activity.

This notwithstanding, India remains a more attractive market than its peers. India has been performing better than other developed and developing economies and has seen increased domestic investor participation across sectors. Similarly, domestic private equity funds have become a key part of India’s private equity/venture capital landscape, leading to a more self-reliant economy. Simultaneously, India has announced policy decisions that are aimed at creating a more conducive environment for foreign investors, including liberalisation in various sectors.

Combined with the incumbent government’s re-election for a third five-year term, which has resulted in significant political stability, the continued execution of policies such as ‘Make in India’ and the transformation of India into a global manufacturing hub have created the necessary impetus for private equity investors to consider investments into India.

There are several initiatives underway in India to enhance the regulatory framework and make it easier to do business.

The Digital Personal Data Protection (DPDP) Act, 2023 received presidential assent on 11 August 2023 and will come into force as and when announced by the government. The DPDP Act is a comprehensive statute that is intended to apply to the processing of digital personal data:

• within the territory of India; and
• outside the territory of India if the data being processed belongs to individuals in India and to whom goods or services are being offered.

While the DPDP Act is similar to the EU General Data Protection Regulation in many respects, the law seeks to cater to India’s unique technological and demographic requirements.

On 27 October 2023, the Ministry of Corporate Affairs (MCA) notified the Companies (Prospectus and Allotment of Securities) Second Amendment Rules, 2023, requiring all private companies (other than small or government companies) to:

• dematerialise all their securities on or before 30 September 2024; and
• effect new issuances of securities only in dematerialised form from 1 October 2024.

The new rules aim to improve transparency and optimise efficiencies, and should help to cure several issues that market participants face with respect to physical share certificates, such as:

• non-stamping;
• loss of share certificates;
• failure of companies to maintain certificates in the prescribed format; and
• errors in numbering.

The government of India has also introduced four new labour codes, which will replace over 29 existing national-level labour laws upon their full implementation:

• the Code on Wages, 2019;
• the Industrial Relations Code, 2020;
• the Social Security Code, 2020; and
• the Occupational Safety, Health and Working Conditions Code, 2020

The labour codes aim to simplify the law and make it more accessible but are yet to take effect.

Implementation of these codes will:

• ensure suitable protections for workers;
• improve operational efficiency;
• create a more business-friendly environment; and
• facilitate investments in the long term.

Improved corporate governance: More often than not, private equity investors are involved in the growth and development of their investee companies, with a focus on governance, including:

• ethical conduct and integrity of management;
• resolution of conflicts;
• board composition and its independence in decision making; and
• environment, social and governance practices.

Private equity investors often deploy best practices when it comes to governance, including with respect to:

• internal controls/audits;
• decision-making matrices on key matters; and
• monitoring/escalation procedures.

Early alignment with exit strategies: Targets are not solely driven by funding requirements while looking for a private equity investor. These companies also focus on global operating experiences to which investors can contribute. However, since private equity investors largely (other than in control deals) view portfolio companies as financial investments, targets and promoters usually negotiate very heavily on exit options to ensure that the consequences of not achieving an exit are not onerous to the promoters/companies. It is therefore advisable at the outset to discuss and agree on exit strategies to align interests.

Lack of innovative customised instruments: Private equity deals in India generally involve traditional investment instruments (eg, equity shares, preference shares, convertible debentures). The use of customised investment instruments is limited and, even where permitted, could be subject to government approvals.

Contributors: Rishika Raghuwanshi, S. S. Shri Lakshmi, Rohan Tyagi and Vaishnavi Kanchan