Foreign Investment/Acquisition of Indian Companies by Foreign & Domestic Investors - Six Steps Mantr
By: Seema Jhingan | Posted: 08th January 2009
Foreign Investment/Acquisition of Indian Companies by Foreign & Domestic Investors - Six Steps Mantra
Joint ventures, strategic alliances and acquisitions are the flavor of the day that enable fast growth focused companies to have rapid inorganic growth and expansion in new sectors. However, prior to engaging in a joint venture relationship or acquisition of an operating Indian company ("Investee company"), either by way of private placement, or secondary market, or subscription of substantial equity share capital, it is advisable for the Investor to carefully and stringently undertake the following six step mantra to avoid future surprises and heartburns:
(i) Due Diligence/Operations Audit: Extensive legal and financial due diligence of the Investee company is advisable to assess Investee company's track record in compliance with Indian laws, statutory obligations and regulations applicable to it. The due diligence exercise (which usually takes between three (3) to four (4) weeks depending on availability of documents) not only enables the Investor to assess potential liabilities, evaluate unknown and potential, disclosed or undisclosed liabilities but also enables the Investor to assess the feasibility and viability of the proposed acquisition and rationalize enterprise valuation. If required, Investor can demand creation of an escrow account for safe deposit of a part of the acquisition cost, parked for an agreed period to mitigate against any future liabilities of the Investee company.
(ii) Resolution of Preliminary Issues: Preliminary issues, if any, arising pursuant to the conduct of the Due Diligence exercise would need to be resolved and a decision taken whether or not to proceed with the acquisition. For example, whether a change of control would affect the ability of the Investee company to carry on its business operations under the current regulatory framework and the approvals and licenses required. Unresolved issues that are not fatal to the acquisition may be identified and negotiated.
(iii) Regulatory/Pricing/Tax Issues: Identification of regulatory and tax issues that may impact the transaction is critical. In case the Investor is a non-resident, foreign direct investment ("FDI") guidelines will also need to be assessed.
FDI either by way of acquisition/transfer of issued equity capital or fresh subscription to the equity capital of Investee company in most sectors is presently unregulated and most sectors barring a few do not require the FDI approval from the Foreign Investment Promotion Board. However, the price at which the transfer takes place will need to conform to the pricing guidelines prescribed by the Reserve Bank of India ("RBI"), i.e., the fair valuation of shares have been done by a chartered accountant as per the prescribed guidelines; and the price per share arrived at has been certified by a chartered accountant. The share consideration in respect of the shares purchased by Investor will need to be remitted to India through the banks authorized to deal in foreign exchange.
In case of transfer of shares to the Investor the transaction would be subject to levy of stamp duty ranging from 0.25% to 0.75% of the value of the shares transferred and payable in accordance with the applicable rates prescribed by the respective State where is the Investee company is registered. The transferor usually bears the stamp duty for the transfer of shares in the absence of a contract to the contrary. Alternatively, Investor can consider to subscribe to the equity share capital of the Investee Company by way of preferential allotment and avoid the stamp duty payable on transfer of shares.
Capital gains arising from transfer of shares (in the event of an acquisition instead of an issue of fresh equity) would attract tax in the hands of the seller, i.e., the existing shareholder of the Investee Company.
(iv) Contract Documentation Preparation: Upon successful resolution of preliminary issues and an affirmative decision to proceed with the acquisition, parties would need to identify and prepare commercial documentation to record their understanding of the transaction and the manner in which such transactions would be closed.
(v) Closing: A reasonable time frame is agreed within which the share acquisition would be consummated. If Closing is delayed, parties may consider to put documents/consideration money in an escrow pending resolution and satisfaction of the closing conditions.
(vi) Post Acquisition Compliances: This would usually include corporate compliances such registration of the share transfer in the statutory books of Investee Company and intimation of change of control that may be required pursuant to any regulatory approvals and licenses already obtained. For instance, Investee Company will need to inform Registrar of Companies and the RBI about the change in the equity structure of the company.
The risk of acquiring an existing operating company with its past baggage of liabilities versus setting up a new company is a critical question that most Investors face. Needless to say, the cumbersome process of setting up a new company, obtaining necessary authorizations from regulatory authorities for establishing an Indian company and growing a new business is always challenging. It is for this reason that mergers and acquisitions are not only common but the preferred way for expansion and growth in the today's fast growing economies.
Seema Jhingan
Areas of Practice:
Infrastructure, Telecommunications, Power, Mergers/Acquisition, Software/Information Technology, Business Process Outsourcing, Media & Entertainment, Private Equity and Venture Capital, General Corporate and Commercial, International Arbitration.
Professional Summary:
Seema Jhingan's practice spans over fourteen years during which she has acquired substantial expertise in representing developers, sponsors/lenders, venture capital investors, international corporations, financial institutions, and other strategic investors involved in the establishment, development and financing of major infrastructure and IT projects in India.
Seema is a Partner with a Delhi Based Law Firm LexCounsel Law Offices and regularly contributes to journals and publications and often takes up speaking engagements. Seema can be reached at sjhingan@lexcounsel.in
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Tags: joint ventures, business operations, viability, strategic alliances, six steps, liabilities, escrow account, unresolved issues, foreign investment