Merger And Acquisitions (M&A) In India's IT Industry

Introduction

In 2024, the mergers and acquisitions (M&A) landscape in India's IT industry reflects both opportunity and caution amidst global and domestic pressures. Deal volume has declined due to economic uncertainties and cautious investor sentiment, but the average deal size has grown as companies focus on fewer, high-value transactions aimed at strengthening technological capabilities and expanding into new markets. Notable transactions this year include Infosys's acquisition of Insemi for $33 million and Wipro's majority stake in Aggne Global, both emphasizing investments in digital transformation and operational consolidation.¹

Key trends in the sector also include an increase in inbound M&A activity, driven by global interest in India's expertise in areas such as artificial intelligence (AI), cloud computing, and cybersecurity. The U.S. leads as one of the active acquirer, and high-value transactions are primarily aimed at gaining access to India's robust tech infrastructure and skilled talent pool. Indian firms have also increased their outbound activity, albeit cautiously, targeting expansion in North America and the UK.²

New regulatory developments, such as relaxed rules for cross-border mergers and liberalized foreign investment policies, are aiding deal fluidity and encouraging cross-border M&A. However, Competition Commission of India (CCI) has also updated its merger control regulations, which now require more extensive compliance checks for deals exceeding certain valuations and impacting domestic market share. These regulatory adjustments, while boosting foreign interest, could lengthen deal timelines due to increased scrutiny, especially for tech companies with significant user bases.³

The Indian IT sector's M&A activity in 2024 reflects both strategic investments in transformative technology and adaptability in navigating regulatory changes, with significant global and domestic partnerships shaping the industry's growth.

M&A in Medium and Small-Scale IT industry

In 2024, mergers and acquisitions (M&A) among medium and small software companies have shown increased activity, driven by several industry trends. Smaller "techquisition" deals are becoming more prevalent, especially as major buyers like private equity (PE) firms and larger tech companies seek specialized, innovative companies in fields like AI, cloud solutions, and SaaS. The focus on these smaller acquisitions is partly due to economic uncertainty, which has made them more appealing than large-scale deals, as well as the challenge of high valuations in the public sector.

Key sectors driving this M&A growth include healthcare, financial services, and government technology, where demand remains resilient due to the mission-critical nature of these services. Vertical SaaS solutions (those aimed at specific industries) and high-demand areas such as security, human capital management, and sales and marketing automation are especially active within the software M&A space. This trend aligns with the broader shift toward companies with proven financial resilience and steady growth potential, which are increasingly preferred over high-growth but less stable firms.

The appetite from private equity (PE) and strategic buyers for smaller, high-value companies suggests an encouraging environment for medium-sized software companies, especially those with proprietary technology or a significant market niche. However, with high demand for high-quality assets, competition is fierce, driving up valuations for companies with strong revenue retention, profitability, and growth profiles.

Reasons for M&A in software industry

Mergers and acquisitions (M&A) in the software industry are primarily driven by strategic, financial, and market-based motivations. Here are key reasons for M&A activity in this sector:

1. Access to Innovative Technology and Talent: The fast-paced nature of the software industry often pushes companies to acquire new technologies rather than develop them in-house. By acquiring smaller companies with specialized technology or intellectual property, large firms can accelerate innovation. This approach is particularly common in fields like artificial intelligence (AI), cybersecurity, and cloud computing, where niche expertise is critical.
2. Expansion of Product and Service Offerings: Many software companies use M&A to broaden their product suites, allowing them to offer end-to-end solutions and meet more comprehensive customer needs. For example, adding SaaS offerings to existing portfolios or incorporating tools that enhance customer experience enables firms to increase customer engagement and build more integrated solutions.
3. Market Share and Geographic Expansion: Acquiring a competitor or a firm with a strong regional presence enables companies to quickly capture a larger share of the market and expand into new geographies. For example, U.S.-based companies may acquire European or Asian firms to access those markets, particularly where local expertise and regulatory compliance are essential.
4. Cost and Operational Efficiencies: M&A can help companies reduce operational redundancies, optimize resource allocation, and achieve economies of scale. By consolidating functions like R&D or customer service, companies can streamline processes and cut costs. This is especially advantageous in highly competitive markets where profit margins can be tight.
5. Strategic Diversification and Risk Management: Diversifying into new but related business areas helps software companies mitigate risks associated with over-reliance on a single product or market. For instance, a cybersecurity company might acquire a data analytics firm to complement its offerings and reduce dependence on one sector, making it more resilient to industry fluctuations.
6. Private Equity (PE) Involvement and Investment Opportunities: PE firms are increasingly active in the software sector, driven by the potential for high returns through operational improvements and resale value. These firms target medium and small companies, aiming to increase their value by improving profitability and growth prospects before reselling them, often at a premium.
7. Meeting Growing Demand for Digital Transformation: As businesses across industries seek digital transformation solutions, demand for cloud-based and automation tools has surged. Acquisitions allow software companies to capitalize on this trend by quickly adding capabilities that cater to digital transformation needs across sectors such as healthcare, finance, and education.

Recent Trends in M&A activity in IT industry⁴

1. Total Number of IT Services M&A Deals: There has been a steady upward trend in IT Services M&A transactions between 2015 and 2021, with an average annual growth rate of 8% during the first seven years. The year 2021 saw a peak in IT Services M&A deals, totaling 1,104 transactions, which then dropped by 16% to 874 in 2022. However, 2023 marked another all-time high for IT Services M&A, and as of September 20, 2024, there have been 852 M&A deals in IT Services.
2. Strategic vs. Financial Acquisitions: Overall, strategic investors were the predominant driving force behind M&A activity in the IT Services market, accounting for 75% of the total deals. Accenture, with 44 deals, being one of the largest player in the IT Services industry. Financial acquisitions accounted for 25% of the M&A transactions in the IT Services sector between 2015 and 2022, with maximum activity from PE firms. PE Firms are expected to continue with the robust M&A acquisitions in coming years driven by high levels of dry powder.
3. EV-to-EBITDA Multiple: As is applicable to most industries not requiring substantial initial investment, EBITDA multiple is the most frequently used multiple in the IT services M&A's. As per Aventis surveys, for 331 deals between 2015 and Q3 2024 the median multiple was stable hovering between 10.0x and 12.5x. After more than doubling during 2021's risk-on environment, it has been observed that it fell sharply in 2022 back to pre-pandemic levels and the median EV/EBITDA multiple of an IT services company is 11.1x as of data from Q3 2024.

Legal Underpinnings of M&A in IT Industry

Due diligence is the most crucial phase of any acquisition or merger, as it plays a pivotal role in identifying potential risks and ensuring the smooth progression of the transaction. The following key areas must be carefully examined during the due diligence process:

1. Intellectual Property: As part of the due diligence process, it is crucial to assess the target entity's intellectual property (IP) portfolio. This includes verifying whether the IP assets—such as trademarks, logos, software programs, and source codes—are properly protected and registered in accordance with applicable laws. Furthermore, if the target entity uses third-party software, it is essential to confirm that the entity holds the appropriate licenses, ensuring compliance with licensing agreements and intellectual property laws. One of the key challenges observed during due diligence is the improper registration of intellectual property, which is often held in the name of an individual—typically one of the promoters—rather than the target entity itself.
   This misalignment of ownership creates several issues. First, it exposes the target entity to potential tax liabilities, as the intellectual property is frequently used without proper consideration or for inadequate consideration, often not determined on an arm's length basis. Additionally, this situation poses commercial risks, as the intellectual property rights technically belong to an individual, not the target entity, complicating the transfer of such assets during the acquisition or merger. The transfer also attracts heavy stamp duty, which is a transaction tax even applicable in related-party transactions. Consequently, this discrepancy may cause delays in the consummation of the transaction and may require renegotiation of terms to resolve the IP ownership issue. This could result in additional legal and financial burdens, which may undermine the value and timing of the deal. In relation to third-party intellectual property used by the target, the contracts need to be closely reviewed to ascertain the continued right to use the assets post-transaction without additional financial implications or third- party consent for changes in ownership or management as a consequence of the transaction.
2. Data Privacy and Cyber Security: Under the existing data privacy and cybersecurity laws, companies operating in India are required to undertake various compliance measures, such as implementing a privacy policy and establishing an information security management system to maintain the integrity of personal data. As part of the due diligence process, the internal company controls and policies must be reviewed in light of the provisions of the Information Technology Act, 2000, the Digital Personal Data Protection Act, 2023, the rules framed thereunder, and the guiding principles enshrined under the General Data Protection Regulation, 2016, and the California Consumer Privacy Act, 2018, among others. The internal controls of the target entity must be examined, keeping in consideration the specific products or services offered by the company. For instance, if the target entity is engaged in offering financial products, in addition to the aforementioned legislation, various guidelines issued by the Reserve Bank of India must also be considered. It is common, however, for many companies to be unaware of these complex regulatory requirements, leading to non-compliance. This lack of awareness exposes the target entity to significant risks, including penalties, fines, and potential litigation. As a result, it is essential for the acquirer to ensure that the target entity's data privacy practices comply with all relevant laws and regulations to avoid significant penalties and legal ramifications post-acquisition.
3. Employment Laws: As part of the due diligence exercise, it is crucial to review the employee-related statutory registrations, licenses, and policies of the target entity, considering the nature of the business activities being conducted. Employee-related compliance is highly scrutinized by statutory authorities, tribunals, and courts, with stringent penalties for non-compliance with applicable labor laws. It is important to note that the specific registrations, licenses, and policies required depend on the nature of the products and services provided by the target entity. As such, the scope of the due diligence will vary depending on the business model and industry sector of the target entity.
   Additionally, in India, employee-related laws are governed not only by central legislation but also by state-specific laws, which can vary significantly across different regions. Therefore, a thorough and sector-specific due diligence exercise is necessary, particularly when the target entity operates across multiple jurisdictions. This review should encompass compliance with all relevant labor laws, including those related to employee benefits, working conditions, wage laws, social security contributions, and any other state-specific employment regulations. Failure to comply with these regulations can expose the acquirer to substantial legal liabilities and operational risks post-acquisition. Hence, it is critical to ensure that all employee-related statutory obligations are fully addressed to avoid any future legal or financial setbacks.
4. Foreign Exchange Laws: Investment by foreign investors in India is primarily governed by the Foreign Exchange Management Act, 2000 ("FEMA"), and the rules framed thereunder, including the Foreign Direct Investment ("FDI") Policy, 2020, as well as the Overseas Direct Investment directions under FEMA. Investments in India can be made under the automatic route, where no prior approval is required, or the government approval route, where prior permission must be obtained from the Reserve Bank of India ("RBI"). Additionally, certain sectors are prohibited from receiving any form of foreign investment. As a first step in structuring any proposed merger and/or acquisition transaction, it is essential to understand the business activity of the target entity in detail, to determine the sector under which the business operates and assess the applicable conditions (if any) under the current foreign exchange laws. In the case of an overseas investment into an Indian target entity, various factors, such as pricing and valuation norms under FEMA, must also be considered to ensure compliance.
   In our professional experience, we have also observed that rather than pursuing an acquisition or direct investment, parties sometimes opt for technological collaborations to penetrate the market, thus bypassing the more cumbersome regulatory requirements. However, even in these instances, the proposed business activity must be thoroughly analysed, as technological collaborations related to certain activities may be prohibited under the FDI Policy. In the event, these regulatory frameworks are not adhered to, there are significant risks that can undermine the transaction, including non- compliance with FEMA which could lead to penalties, retroactive taxation, or even the reversal of the investment. Furthermore, foreign investors may be barred from repatriating profits or capital if the necessary approvals are not obtained or if the investment is made in a restricted sector. Violating sector-specific restrictions could result in the cancellation of the investment or blacklisting of the foreign investor by Indian regulatory authorities. In the worst case, the investment could be considered illegal, leading to severe reputational damage and legal liabilities for all parties involved. It is therefore critical to conduct a comprehensive review of both the business activity and the regulatory landscape to determine the best approach for structuring the transaction, ensuring compliance with all relevant foreign exchange laws, and mitigating any potential risks associated with foreign investment in India.
5. Real Estate: Real estate is often tied directly to business continuity, especially for target entities that have established data centers and development centers. Therefore, an exhaustive due diligence of immovable property owned by a target entity is required, keeping in mind the nature and location of the immovable property. While undertaking due diligence of immovable property, in our experience, verification of ownership, title, interests, and rights is the most important aspect. It is also necessary to verify if all statutory dues, municipal dues, and proper stamp duty have been paid with respect to such property. Another important aspect of the due diligence exercise of real estate owned by a company is to verify the number and nature of charges created on such property. These aforementioned issues may become hurdles in the consummation of the transaction, as there is a possibility that these entities may face legal or financial complications that could delay or derail the transaction. For instance, undisclosed encumbrances, unresolved statutory dues, or unregistered charges can create liabilities that affect the target entity's valuation and pose risks to the acquiring entity. Additionally, discrepancies in ownership or title can result in disputes or even potential loss of property rights. Therefore, a thorough due diligence process helps in identifying and mitigating such risks, ensuring that the property assets are free from legal or financial hindrances.
6. Third-Party Contracts: Due diligence of contracts involves a comprehensive review of various agreements, including customer agreements, vendor contracts, service agreements, and other key documents, to understand the scope and nature of rights and obligations that may affect the acquirer's position post-acquisition or merger. The validity and continuity of customer agreements and important vendor agreements are crucial to preserve the value of the business or the company being acquired. Also, if there are debtors in the business, robust agreements to enable the recovery of monies in the future should be thoroughly checked.
   If third-party services are critical to the target entity's business, the acquirer must ensure that agreements with such vendors include assignment rights in favor of the target entity. Similarly, when the target entity is providing services, it is important to assess whether any restrictive covenants exist in the contracts that could create operational or legal challenges during the assignment process. Additionally, due diligence should verify that proper stamp duty has been paid, documents are appropriately registered, and contracts are executed correctly. A crucial aspect of the review is to identify whether any consent or approval rights have been granted to third parties in the event of a change in the target entity's structure. This ensures that no unforeseen operational hurdles arise during the transaction process. From our experience, we often find that these contracts contain extraneous clauses, many of which are not fully understood by the parties involved, particularly in relation to assignment or change-of-control provisions. It is therefore essential during due diligence to identify any such restrictions, as they could force the parties to renegotiate the terms of the agreements with third parties, potentially affecting the commercial terms of the proposed acquisition.
7. Secretarial Compliance and Companies Act 2013: During due diligence, it is critical to verify compliance with the Companies Act, 2013 and the rules made thereunder ("CA, 2013"). This includes reviewing foundational documents, such as the certificate of incorporation, memorandum of association, and articles of association, to ensure the proper formation and governance of the target entity. Additionally, it is essential to confirm that the target entity has filed all required forms, annual returns, financial statements, and other regulatory filings with the Registrar of Companies ("RoC"), and that these filings are current and up to date. The register of shareholders must also be examined for accuracy and compliance with the CA, 2013. Furthermore, the due diligence process should assess whether the target entity has held all required board and shareholder meetings, and whether resolutions have been duly passed in accordance with the provisions of the CA, 2013.
   Failure to comply with the provisions of the CA, 2013 can lead to penalties and fines imposed by the RoC. These penalties may include monetary fines for the late or non-filing of documents, such as annual returns, financial statements, and other mandatory forms. In addition to financial penalties, non- compliance can also result in legal consequences, including restrictions on the company's ability to carry out certain transactions, the suspension of business operations, or the disqualification of directors. The accumulation of such penalties can significantly impact the commercial viability of the transaction, create reputational risks for the parties involved, and lead to costly delays or restructuring of the deal. Therefore, ensuring full compliance with the CA, 2013 is crucial to avoid such detrimental outcomes.
8. Competition Act: During due diligence, it is essential to assess the applicability of the Competition Act, 2002 with respect to the proposed transaction. The key areas to be reviewed include the market structure of the parties, the existence of any potential anti-competitive agreements, and the risks of abuse of dominance. It is imperative to evaluate the market share of the entities involved and the competitive impact of the transaction, ensuring compliance with the filing thresholds for approval by the Competition Commission of India. Additionally, all contracts, joint ventures, and other agreements should be thoroughly examined for any anti-competitive provisions. The parties must assess whether the transaction could result in a substantial lessening of competition and, if so, determine whether remedies, such as divestitures or structural changes, are necessary to mitigate any anti-competitive concerns. In our professional experience, we have observed that failure to properly assess the applicability of the Competition Act, 2002 during due diligence can lead to significant regulatory and commercial risks.
   One of the key issues arises when the market structure of the entities involved is not carefully analysed. If the merger or acquisition results in a high market share concentration, it could trigger the mandatory filing requirements with the Competition Commission of India ("CCI"). Failing to make the necessary filing or obtaining approval from the CCI can lead to severe consequences, including delays, fines, or even unwinding of the transaction. This could include damage to the reputation of the entities involved, and potentially even restrictions on future market activities, further complicating post-transaction integration and value realization.
9. Stamp Duty on Transaction: It is essential to assess the correct stamp duty implications under the Indian Stamp Act, 1899 ("the Act") during an acquisition or merger to ensure compliance. In a business transfer, where the target entity sells its assets and liabilities as a single bundle (i.e., the business undertaking as a whole), stamp duty is calculated differently. If the bundle includes land, stamp duty will be levied on the transfer of the land, based on the sale deed executed between the parties. In contrast, for a share purchase, stamp duty is assessed based on the value of the shares being transferred, in accordance with the Act. Proper structuring of the acquisition transaction is critical to minimize stamp duty implications, as it can significantly affect the financial feasibility of the transaction. Stamp duty can vary between 1% and 8% in certain cases, depending on specific assets involved.
   Each transaction type—whether asset transfer or share purchase—requires careful analysis to determine the correct stamp duty liability. Failure to pay the appropriate stamp duty can lead to enforcement issues in the event of a dispute and result in significant commercial setbacks, as penalties and interest on the shortfall will also apply. In our professional experience, we have observed that companies often fail to properly assess and account for stamp duty implications under the Act, leading to significant legal and financial challenges. For instance, in a business transfer, if the target entity is selling assets and liabilities as a bundle, including land, there is a risk of miscalculating the stamp duty due on the transfer of land. If the necessary stamp duty is not correctly paid or calculated based on the executed sale deed, the parties may face enforcement issues from tax authorities, including audits, penalties, and interest on the unpaid amounts. Similarly, in a share purchase, if the stamp duty on the value of the shares is not properly assessed in line with the Act, it could result in the transaction being flagged for non-compliance, leading to disputes or delays in registration.
10. Structuring: It is essential to carefully structure a transaction by selecting the appropriate legal, financial, and operational framework, as this choice can significantly affect tax liabilities, regulatory approvals, and post-transaction integration. The most common transaction structures are business transfers and share purchases. In a business transfer, the acquirer purchases specific assets and liabilities, which provides flexibility in assuming only selected liabilities. However, this requires the complex transfer of contracts, licenses, and permits. In a share purchase, the acquirer buys the target entity's shares, inheriting all assets, liabilities, and obligations, thereby simplifying operational continuity but potentially exposing the acquirer to unknown or contingent liabilities. A merger, on the other hand, combines two entities into a single legal entity, generating potential synergies but often requiring extensive regulatory approvals, particularly under competition law.
    The choice of structure depends on a careful analysis of the transaction's strategic objectives, tax implications, and regulatory requirements. For example, a business transfer conducted on a slump sale basis may offer tax advantages, while a share purchase ensures operational continuity but involves assuming all liabilities. Additionally, stamp duty implications vary between these structures and should be carefully considered in the decision-making process.
11. Documentation and Closing: The documentation for the proposed transaction shall be determined based on the structuring of the deal. In the case of a business transfer, a Business Transfer Agreement ("BTA") shall be executed, along with any supplementary agreements or documents necessary for the transfer of specific assets and liabilities. Conversely, in the case of a share purchase, a Share Purchase Agreement ("SPA") shall be executed between the parties, which will include any additional documentation as per the terms outlined in the SPA. Furthermore, all required filings and submissions shall be made in compliance with applicable regulatory requirements, including those under the CA, 2013, FEMA, Competition Act, 2002 and other relevant statutes. In the event, the documentation and regulatory compliance for a proposed transaction are not handled properly, it can lead to a range of serious issues. Failure to comply with statutory requirements under the Companies Act, 2013, FEMA, the Competition Act, 2002, or other relevant laws can result in penalties, delays, or even the reversal of the transaction. Inadequately drafted agreements, such as BTA or SPA, may lead to disputes over asset and liability transfers, unresolved post-closing obligations, or misrepresentation of key terms.

Conclusion

The M&A landscape for IT companies in India continues to evolve rapidly, driven by advancements in technology, digital transformation initiatives, and the need for organizations to remain competitive in a globalized market. Strategic acquisitions are playing a pivotal role in enabling companies to expand their capabilities, access new markets, and leverage cutting-edge technologies. The growing focus on data-driven innovations, cloud computing, and cybersecurity highlights the IT sector's critical role in shaping India's economic future.

As regulatory frameworks become more streamlined and global interest in India's IT prowess strengthens, the potential for transformative M&A activity in this sector remains immense. Companies that align their M&A strategies with market demands and technological advancements will undoubtedly emerge as frontrunners in this dynamic ecosystem. With robust growth prospects and a supportive investment environment, the Indian IT M&A space is poised to scale new heights in the coming years, setting benchmarks for other industries.

Footnotes

1. https://community.nasscom.in/communities/it-services/indian-technology-sector-ma-first-half-2024-trends-and-insights

2. https://www2.deloitte.com/in/en/pages/finance/articles/india-m-and-a-trends.html

3. https://www.mondaq.com/india/maprivate-equity/1528614/indias-2024-ma-report-card-promising-trends-amidst-a-shifting-regulatory-landscape

4. https://aventis-advisors.com/it-services-ma/

Originally published 16.12.24

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