Risky equity swaps useful for financing cross-border activity

AAs the Indian start-up ecosystem matures, companies in high-tech sectors increasingly tend to access new technologies, recruit top talent, and gain market share and advantage by buying companies. global offshore. Lack of liquidity or the pressure to use resources for other purposes can hamper such expansion, however, and this is where stock trading comes in handy.

Natasha Mahajan
Samvad Partners

A share swap is an agreement between two entities involving the exchange of one share-based security for another. The shareholders of the target company transfer their shares to the acquiring company and in return for this transfer, the acquirer issues shares to the shareholders of the target company. The acquirer does not pay cash, and target investors acquire shares of the acquirer, who owns the combined business and is often in a better position to provide investors with an attractive return on their capital. This may be the preferred option for investors when the invested company has not been able to raise growth capital and is unlikely to generate returns if sold for cash. Instead of liquidating their investments at a loss, investors will have better prospects by exchanging shares and acquiring a stake in the most viable acquirer.

While stock trading isn’t new, it has recently gained traction for the reasons mentioned above. With the Reserve Bank of India (RBI) liberalizing foreign exchange control regulations in 2015, expressly allowing stock exchanges automatically, under conditions Indian companies can now use stock exchanges to finance cross-border activities. For companies in the high-tech sector, this is particularly welcome as it gives them better access to technology and foreign markets.

The RBI has set out the regulatory framework for cross-border equity trading in its Main Directive on Direct Investments by Residents in a Joint Venture (JV) / Wholly Owned Subsidiary (WOS) Overseas (ODI Regulations), 2016, read with the exchange department. (Instruments other than debt securities), 2019 (NDI Rules). Rule B.4 (1) (iii), read together with Rule 6 of the ODI Regulations, permits the acquisition of shares of a non-resident entity by an Indian entity, the consideration being in the form of ‘shares issued by the Indian company, subject to the rules of NDI. Schedule 1, Rule 1 (d) (i) of the NDI Rules states that an Indian company may issue equity instruments to a non-resident person, if the Indian company is engaged in an auto road sector, ” for… an exchange of equity instruments “.

Vineetha Stephen, partner, Samvad Partners
Vineetha Stephen
Samvad Partners

Thus, provided that the Indian company concerned is covered by the automatic route for the purposes of the NDI rules, it may acquire a foreign target through an exchange of shares under the automatic route. Any such transaction must comply with the requirements of the ODI Rules and the NDI Rules, including with respect to applicable thresholds, restricted areas and regulatory filings. The issue must also comply with the preferential attribution rules under the Companies Act 2013, read with the Companies Rules 2014 (share capital and debentures).

Interestingly, the NDI Rules contemplate an exchange of “equity instruments,” which are defined as shares issued by an Indian company only. One interpretation could be that if a non-resident owns shares in one Indian company, they can exchange those shares for the issuance of shares in another Indian company. However, this interpretation would be inconsistent with other provisions of the NDI Rules, which state that in the event of an exchange of shares, a valuation may be given by an Indian appraiser or a host country investment banker. which implies that the RBI is considering an exchange of shares of a foreign company. This reference appears to be an oversight rather than a stipulation.

While the benefits of trading stocks are obvious, there is a risk. From the acquirer’s perspective, valuable equity is exchanged for a business or technology that may not add value. There is always the risk of poor integration, especially of work cultures, and regulatory considerations in different jurisdictions can lower the valuation of the combined entity.

Unlike a cash transaction, where the target’s shareholders are no longer in the picture, in a swap both parties are committed over the long term and exposed to the risk of a downturn that could erode shareholder value. It is imperative that the parties exercise due diligence and clearly negotiate their post-transaction rights and obligations in order to ensure the seamless continuity of the combined business.

Natasha Mahajan is a partner and Vineetha Stephen is a partner at Samvad Partners

Samvad Partners

Samvad Partners

Bangalore | Chennai | Hyderabad | Bombay | New Delhi

Contact details:

Phone: Bangalore | +91 80 4268 6000
Chennai | +91 44 4306 3208
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Email: [email protected]


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