In recent years there has been a sudden increase in private equity (PE) investors taking a controlling position or majority stake in Indian businesses.
This trend is definitely an indicator of increased risk appetite and confidence that PE investors have developed as regards the Indian market. The shift for PE investors from being pure ‘vanilla’ minority investors to a more aggressive controlling role can be attributed to a variety of factors and changes that have taken place in the recent past.
These include positive regulatory changes and new government policies, pro-investor rulings by Indian courts, the rise of new-age Indian promoters and the start-up culture, successful track record for PE exits (through both public offerings and private sale) etc.
Also, the advent of the regime under Insolvency and Bankruptcy Code 2016 has opened up new avenues for PE investors to acquire stressed assets.
Increase in control deals (both in size and numbers) have also resulted in evolving of new structures and trends. Such investments are not just limited to where the promoters give up majority stake in favor of an investor. Lately, many investments, particularly in the tech space (including consumer tech, fintech, e-commerce), have witnessed deals where multiple investors have acquired collective control of the portfolio company.
The PE investors with controlling stake also look to have a professional management team to run the business and create value – such management has skin in the game by way of stock options and exit linked upside sharing.
Irrespective of the structure, the controlling interest does offer PE investors an opportunity to have greater involvement in the governance of the portfolio company – thereby allowing investor to implement new ideas based on their sectoral expertise and global experience.
However, this still entails support from promoters (even if they hold minority stake) or the professional management team. A large focus on deal negotiations now involves clearly chalking out roles and responsibilities, detailed good leaver/bad leaver provisions along with consequences, more fleshed out provisions around equity kickers and claw backs, upside sharing and liquidation preference.
A promoter holding a minority stake may also negotiate certain veto/consent rights to protect value of his/her shareholding and management teams usually ask for representation on the board of directors and key committees.
In case of multiple investors, the inter-se governance rights are more complex and heavily negotiated as the decision making on key operational matters is usually linked to a majority shareholding threshold to prevent any single investor from running the show or having an ability to block material decisions. It gets more complex when the interest of all the investor may not be aligned due to different entry valuation and timing/objectives/exit timelines etc.
While creating an optimum governance matrix, PE investors should continue to be cognizant of liability of their nominee directors, which may get more pronounced in a control transaction and accordingly adequate contractual remedies should be built in to mitigate the risk.
Another factor that is significant for control deals is the ability of PE investors to drive the exit (including type of exit) and decide on exit terms. In case of multiple investors, a more crystalised process should be agreed upfront on mode of exit, exit waterfall and timelines, valuation, appointment of advisors etc. to avoid any disconnect in the future.
The ability and freedom of the controlling PE investors to decide on exit is not without its share of hurdles, irrespective of what has been agreed contractually. For instance, if the exit is through public offering, there is a likelihood of the controlling/majority PE investor being classified as a ‘promoter’ and being subject to certain regulatory restrictions (including post listing lock-in). Do note that a recent announcement by the securities regulator indicates significant relaxation to these restrictions, this is a welcome change specially for PE owned targets that are moving towards listing.
In terms of private sale/stake sale, parties continue to grapple with the challenge of “as is where is” exit or allocation of business risk when the controlling PE investor exits. However, this has also been largely addressed by availability of representation and warranty insurance from third party insurance companies.
All in all, regulatory developments and constant evolution of the ‘market standard’ have been paving the way for control deals. This adds to the certainty that Indian markets will witness more control deals by PE investors in the near future.
The writer is a partner Partner & Head – Private Equity, Cyril Amarchand Mangaldas. The article is co-authored by Aditi Manchanda, Partner, Cyril Amarchand Mangaldas.