Why control agreements in India suddenly increased

In recent years, there has been a sudden increase in the number of private equity (PE) investors taking a controlling position or controlling stake in Indian companies.

This trend is certainly an indicator of the increased risk appetite and confidence that PE investors have developed in the Indian market. The shift of private equity investors from outright 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, investor-friendly Indian court rulings, the rise of Indian new-age promoters and start-up culture, successful track records for exits. of PE (both through public offerings and private sales), etc.

In addition, the advent of the 2016 Insolvency and Bankruptcy Code regime has opened up new avenues for PE investors to acquire distressed assets.

The increase in control transactions (both in size and number) has also resulted in the evolution of new structures and trends. Such investments are not limited to cases where the promoters transfer a majority stake in favor of an investor. Lately, many investments, especially in the tech space (including consumer tech, FinTech and e-commerce), have witnessed deals in which multiple investors have acquired collective control of the portfolio company.

Majority-stake private equity investors also seek to have a professional management team to run the business and create value – such management has its skin in the game through call options. shares and an upward split linked to the exit.

Regardless of the structure, majority ownership offers PE investors the opportunity to become more involved in the governance of the portfolio company, thus allowing investors to implement new ideas based on their industry expertise and global experience. .

However, this always involves the support of the promoters (even if they have a minority stake) or the professional management team. The focus on negotiating agreements now means clearly defining roles and responsibilities, detailed provisions on good / bad starters and their consequences, more substantiated provisions on actions and recoveries, sharing of the rise and liquidation preference.

A promoter with a minority stake may also negotiate certain veto / consent rights to protect the value of its shareholder base and management teams typically request representation on the board and key committees.

In the case of multiple investors, the inter-se governance rights have become more complex and heavily negotiated, as decision-making on key operational matters is usually tied to a majority ownership threshold to prevent a single investor from running the show or to have the ability to block material. the decisions. It becomes more complex when the interests of all investors may not be aligned due to different entry valuation and different timing / targets / exit deadlines etc.

While creating an optimal governance matrix, private equity investors should continue to be aware of the liability of their appointed directors, which may become more pronounced in a controlling transaction and, therefore, adequate contractual remedies should be built in. to mitigate the risk.

Another important factor for controlling transactions is the ability of PE investors to conduct the exit (including the type of exit) and decide on the exit conditions. In case of multiple investors, a more crystallized process needs to be agreed upfront on the exit mode, exit cascade and timeframes, assessment, appointment of advisers, etc. in order to avoid disconnection in the future.

The ability and freedom of controlling PE investors to decide on exit is not without its share of obstacles, regardless of what has been contractually agreed. For example, if the exit is by public offer, it is likely that the controlling / majority PE investor will be classified as a “promoter” and be subject to certain regulatory restrictions (including post-listing foreclosure). Note that a recent announcement from the securities regulator indicates a significant relaxation of these restrictions, this is a welcome change, especially for targets held by PEs moving towards listing.

In terms of the private sale / sale of shares, 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 resolved by the availability of representational and warranty insurance from third party insurance companies.

Overall, regulatory developments and the constant evolution of the “market standard” have paved the way for control agreements. This adds to the certainty that Indian markets will witness more control deals by private equity investors in the near future.

The author is a Partner & Head – Private Equity, Cyril Amarchand Mangaldas. The article is co-authored by Aditi Manchanda, partner, Cyril Amarchand Mangaldas.

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