Propelled by booming domestic markets, sustained regulatory developments, and evolving geo-political and economic priorities, the M&A and PE landscape in India has been undergoing a notable transformation. This article touches upon a few recent trends that we have witnessed in this space.
Sustainability: The modern business imperative
India seems to be slowly but steadily moving towards a deal-making environment where Environmental, Social, and Governance (ESG) considerations are viewed as significant value drivers rather than mere check-the-box requirements. This evolving ESG narrative means that enterprises with strong ESG practices are commanding market premiums, enjoying lower borrowing costs and building robust customer relationships.
This heightened importance on ESG in India is being driven by both a regulatory push as well as an increasing awareness among shareholders who aspire to associate with organisations that prioritise "purpose over profit". It therefore comes as no surprise that companies are increasingly looking at mergers and partnerships that can help them bring in ESG at the core of their operations, with investors deploying ESG-driven considerations when assessing the business feasibility of investment targets and the potential value creation.
In terms of the Indian legal landscape, whilst there is still a regulatory lacuna with there being no consolidated legislation governing ESG (compliance requirements are unhelpfully spread across various statutes and sector-specific regulations), there is an obvious nudge internally from the government towards developing ESG practices. The Business Responsibility and Sustainability Report (BRSR) introduced by Securities and Exchange Board of India (SEBI) in 2021 has recently been further strengthened through the introduction of the 'BRSR Core' framework, consisting of a set of 9 ESG KPIs. The BRSR Core reporting requirements are applicable to the top 1,000 listed companies (by market capitalisation) in a phased manner – with top 150 companies being covered in FY 2023-24 and gradually increasing to top 1,000 by FY 2026-27. SEBI has also mandated top 250 listed entities to monitor and report on BRSR Core compliance by their upstream and downstream value chain partners (accounting for 75% of the entity's purchases or sales by value annually) from FY 2025-26.
In sectors such as renewable energy, the push is also coming from lenders who are now insisting on specific ESG or sustainability covenants tailored to the particular project aligned with the lenders' internal policies. Compliance is being monitored by techno-economic viability consultants and independent engineers appointed by the lenders.
From a transaction standpoint, the growing focus on these considerations means that extensive due diligence exercises for ESG compliance is becoming critical, with investors also opting for materiality assessments to understand the ESG impact of the targets' business activities. Based on the diligence exercise, inclusion of extensive ESG action plans and robust default provisions in case of breach of the ESG commitments are becoming more prevalent.
With the rising importance being placed on ESG risks, a business model embedded with a strong ESG framework is critical – not only from an investment or acquisition perspective but also from a long term value creation and exit perspective. Given the uptick in the companies opting for ESG ratings as a part of their IPO strategy (presumably because of the better valuations they expect to get), SEBI now requires rating agencies to get certified. While the impact of ESG ratings over listing value and subscription rates currently remains unclear, it should become more visible over time.
New data protection law
Following over half a decade of deliberations, The Digital Personal Data Protection Act, 2023 (the DPDP Act) received presidential assent last year. Whilst the government notification to bring the DPDP Act into effect and the fine print by way of the underlying rules is still awaited (if reports are to be believed, the rules are expected to be released for stakeholder comments very shortly), it has become imperative for companies to start assessing the impact of the DPDP Act on their operations.
The DPDP Act introduces a comprehensive framework for data protection, establishing a framework for different stakeholders— (i) data principals (individuals whose data is being processed); (ii) data fiduciaries1 (entities determining the purpose and means of data processing), including significant data fiduciaries (i.e., data fiduciaries that process personal data of a higher volume and sensitive nature and will thus bear additional obligations); (iii) data processors (those processing data on behalf of data fiduciaries); and (iv) consent managers (entities that will enable data principals to review and manage their data-related consents). Unlike the current regime, the DPDP Act does not differentiate between different forms of personal data based on the sensitivity and applies to all personal data collected in digital form or in non-digital form and digitised subsequently.
Given the ubiquitous involvement of personal data across sectors, and the rising adoption of data driven strategies across businesses, the implementation of the DPDP Act is expected to have a significant impact on deal-making in India, especially in regulated sectors such as financial services, and consumer and data centric businesses.
Firstly, an extensive data-related due diligence is becoming a key focus area to check the target company's compliance with the law (which is in large parts due to the 'threat' of substantial penalties for non-compliance).2 Secondly, sharing of any personal data as a part of the transaction due diligence (including of employees, customers or vendors), will necessitate the target having the necessary consents to share such information in place (backed by appropriate privacy assessments where required). Given the purpose based approach, the up-front consents would also have to cover possible sharing of data in connection with fund-raising, or M&A/ PE transactions involving the company. Similar consents would also be needed for transfer of data in relation to any business transfers (other than data transferred for employment purposes).
In summary, an important step at the beginning of any M&A deal will include understanding the type of personal data collected by the target, the extent of disclosure of such personal data required at each step of the transaction, scope of the data sharing consents obtained by the target, and other existing policies and processes of the target and the acquirer/ investor in this regard.
For more information on the framework of the DPDP Act please refer to our infographic here.
IPO markets reach a crescendo
After making a quick recovery from the volatility caused by the narrow victory of the incumbent central government, the value of India's initial offerings has more than doubled this year, with Mumbai now taking over Hong Kong as the centre for IPOs in Asia, and dominating the global IPO market. This unprecedented rise in IPO activity which is undoubtedly a strong signal of investor confidence has created ripple effects in the deal-making space.
The access to capital through IPOs and strong valuations have acted as an incentive to accelerate investments. It has also helped to provide a clearer benchmark for valuation for M&A transactions, helping both buyers and sellers. In fact, a majority of investors have started preferring domestic IPOs and large open market trades as the mode of exit as opposed to the M&A route. This has also led to investors choosing a 'dual-track process' for exits in the transaction documents i.e. the target company being required to explore an IPO while simultaneously also pursuing a possible M&A exit. As the processes for IPO and M&A exit run simultaneously, the seller or target retains flexibility to opt for one route over the other until later in the process to maximise value realisation.
With the primary markets expected to remain bullish, pre-IPO placements, exits through offer for sale and open market trades are expected to drive the M&A activity.
A primer we prepared on considerations for pre-IPO investors, is available here.
Re-Domiciling of Indian start-ups
It is not too long ago when tech start-ups were making a bee line to "flip" overseas i.e. set-up a holding company in an offshore jurisdiction, to gain access to a larger pool of capital, expand businesses outside India from an internationally recognized and favourable tax and regulatory jurisdiction, and with a view to an eventual listing on an overseas stock exchange. However, in the recent past, there are multiple examples and ongoing projects where unicorns and other late stage ventures (for e.g. PhonePe and Groww) are "reverse flipping" their structures to re-domicile in India, and consolidate their global businesses under an Indian holding structure. There are a number of drivers for this including (a) increasing regulatory certainty and investor confidence in the 'rule of law' framework in India (although a lot more needs to be done to cement this); (b) greater flexibility and incentives from regulators to enable the reverse flip structures (including facilitating mergers of off-shore entities with domestic companies); and (c) perhaps most importantly, the burgeoning Indian IPO market, which is supporting lucrative listing valuations – with domestic markets now being increasingly more resilient to international market fluctuations.
The most common structure used to reverse-flip is through an inbound merger, whereby the overseas holding company merges with the wholly owned Indian subsidiary and the shareholders of the holding company become shareholders of the resultant Indian company. Giving a further push to this trend, the Companies (Compromises, Arrangements and Amalgamations) Rules, 2016 (Rules) were amended recently. To give a quick background, the Rules allow certain companies (such as a holding company and its wholly owned subsidiary) to undertake a fast track merger under which an approval from the National Company Law Tribunal (NCLT) is not required, and the merger scheme can be implemented by obtaining approval of 90% of the shareholders and creditors (in terms of value) and filing the scheme with the Registrar of Companies and Official Liquidator. As such, the fast track merger is significantly more streamlined and is cost and time efficient. However, so far, this option was not available for an inbound merger of an offshore entity with an Indian entity. The recent amendment now permits this under the fast-track merger route. This amendment is a significant step towards making reverse flipping less onerous. Further, whilst an approval from the RBI has always been required for cross border mergers, such an approval is "deemed" to have been given in the event the specific foreign exchange requirements around pricing, sectoral limits, etc. are complied with. Whilst such deemed approval should continue to apply to fast track mergers as well, it remains to be seen if fast track merger applications will indeed be sanctioned on the basis of this deeming provision.
There are other structures as well for achieving a reverse flip, like a share swap or undertaking a buyback exercise at the foreign company level and the shareholders using those proceeds to subscribe to shares of the Indian subsidiary etc., which can be explored depending on tax and foreign exchange considerations.
Dealing with the deal value threshold
The Indian merger control regime has undergone a significant overhaul. Whilst there have been periodic amendments to the merger control regime ever since it was brought into effect in 2011, this is the first comprehensive amendment which, inter alia, entirely replaces the existing set of exemptions with a brand-new set and introduces a new threshold related to the value of the transaction i.e., the deal value threshold.
By way of a quick summary, the deal value threshold will apply to all transactions where the value of transaction exceeds INR 2,000 crore (approx. USD 240 million)3, with such transactions having to be notified to the CCI provided that the target has "substantial business operations in India"4. Whilst this additional jurisdictional threshold will function independently of the existing assets and turnover-based jurisdictional thresholds, it is important to note that if the deal value threshold is triggered, the de minimis / "small target" exemption cannot be availed of.
Needless to say, this will significantly impact M&A activity in India, especially in the digital markets and IT space. Start-ups and early-stage companies in these sectors often did not have assets or turnovers that crossed the historical thresholds to require a merger control approval, but commanded significant valuations based on their market penetration, gross transactions value, growth prospects etc. Now, with the deal-value threshold being introduced, an increasing number of mid-to-late stage transactions in this space are likely to come under the lens of the CCI.
It is also interesting that the value of the transaction has been defined to include any "valuable consideration" including direct and indirect, immediate and deferred, and cash and non-cash consideration. The regulations contain a non-exhaustive list of examples of "valuable consideration", which notably include all arrangements entered into as part of (or incidental to) the transaction in the two year period from closing (which will include technology assistance and IPR licenses). A residual clause provides for this threshold to be assumed to have been exceeded if the deal value cannot otherwise be established with reasonable certainty. The parties will therefore carefully need to consider the value of the deal to assess notification requirements as merely relying on the ascribed purchase consideration will not suffice.
For a detailed analysis of the new regulations, you may see our article here.
Abolition of Angel Tax
Introduced in circa 2012, the unpopular "Angel Tax" was a direct tax payable by unlisted companies at the time of raising money from resident investors or onshore funds (other than VC funds), if the share price of issued shares was in excess of the fair market value of the company (it earned this moniker as this tax largely affected investors investing in start-ups and early stage companies, called "angel investors"). Implemented with a view to curb money laundering being projected as legitimate investments in unlisted companies, this tax regime created a deeming fiction where the onus was shifted on the investee company to prove fair market value.
The biggest impact of this tax was on the start-up ecosystem in India, as early stage companies which were often pre-revenue and asset-light, pegged their valuations on intangible factors such as potential of business idea. Whilst the regulations provided that a fair market value could be determined with reference to the net asset value or the discounted cash flow, its calculation and legitimacy were to be assessed by the tax officer, making it subjective and prone to challenge. This posed several challenges for companies looking to raising funds. Relaxations were introduced in 2019 which exempted start-ups if they fulfilled specific criteria.
Investments from non-residents originally did not fall under the purview of Angel Tax. In fact, in terms of the Indian exchange control regulations, foreign investments cannot be made at a price lower than the fair market value. This allowed Indian companies to agree to commercial deal values which could exceed their fair value at the time of issuance (and providing for facilitative performance based ownership ratchets, and / or adjustments for future down-rounds etc.). However, even this was brought within the ambit of the Angel tax in 2023 (with only certain categories of non-residents being exempted). As a result, it became tax-inefficient for Indian companies to raise capital at pricing which is higher than the FMV (and otherwise beneficial to existing shareholders).
Finally taking note of this, the government has abolished the Angel Tax regime with effect from Financial Year 2024-25. This would allow companies much needed flexibility in their capital raising activities, and buyers and sellers more leeway on closing and post-closing adjustments on deal pricing.
Footnotes
1 The primary responsibility for compliance under the DPDP Act will be on the data fiduciaries who will be responsible for, inter alia, obtaining necessary consents, taking reasonable security safeguards to prevent data breaches and implementing appropriate technical and organisational measures to ensure effective compliance.
2 The penalties under the DPDP Act can go up to INR 250 crore (approx. USD 30 million) for failure to take reasonable security safeguards to prevent personal data breaches and up to INR 200 crore (approx. USD 24 million) for failure to notify a reportable personal data breach.
3 For global transactions, the "value of the transaction" refers to the value of the transaction globally and not just the value attributable to the India leg.
4 The regulations set out the thresholds for determining "substantial business operations in India" and includes a turnover based threshold, a gross merchandise value threshold and for digital services a threshold based on the number of its business users or end users.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
