India reforms a boon for PE exits

The Securities and Exchange Board of India (SEBI) has unveiled rules allowing foreign investors to invest in non-convertible redeemable preference shares (NCRPS), according to a SEBI statement. 

The regulations, put forward in mid-June, allow foreign GPs to invest in Indian companies via such quasi-debt instruments without making the balance sheet of the target company too debt heavy, said Ruchir Sinha, partner at local law firm Nishith Desai. 

Many companies in India have been invested via non-convertible debentures, a debt instrument that does not allow the shares to be converted into equity. NCDs add significantly to the debt of the company and in the past have created huge challenges in terms of taking on further leverage. 

“If a company has already taken on a lot of non-convertible debentures, the company becomes debt heavy and banks will not want to lend to it,” Sinha explained. Therefore, if a GP invests through NCRPSs rather than NCDs, the company balance sheet will have less debt, which will increase the scope to add leverage.

The NCRPS instrument could also facilitate exits in India. He added that for a company to buy back its own securities in India – an option attractive to private equity firms to facilitate a sale in India’s tough exit market – debt-to-equity ratio post-buyback should be 2:1. In the past, many non-convertible debentures forced companies’ debt levels to exceed this ratio. 

Moreover, redeemable preference share investors will not be subject to certain foreign investment restrictions in India. For

example, if investing through this new instrument, GPs will not be restricted when investing in single-brand retail businesses, where typically only 51 percent foreign ownership is allowed.

“[The Indian government] is trying to make life easier for a lot of companies that want to raise money through foreign portfolio investment,” Sinha continued. “People are not able to access the equity capital markets. The debt market has just opened up, but a lot of companies don’t want to have debt-heavy balance sheets.”

The government has been taking a number of steps to liberalise foreign investment in India. 

For example, in October last year, a government committee recommended that the proposed tax on indirect share transfers should not be applied retroactively. This shift in policy means that offshore private equity firms with existing offshore assets that generate substantial value from India would not be taxed.

Moreover, in January the ministry of finance confirmed the deferral of the controversial General Anti-Avoidance Rule, which would subject offshore private equity investors to Indian tax until April 2015.

While industry sources recognize the efforts made by the government, they say few concrete measures have been taken to benefit private equity. 

“We think the government is getting the message and is starting to indicate that they will make India a more inviting place to put capital, but to-date we have not seen any dramatic move. It is more directional signals that we’re getting as opposed to real change,” said Naveen Wadhera, India country head at TA Associates.

With regard to the non-convertible redeemable preference shares, Wadhera noted, “These are things that are common everywhere else in the world and India has made those types of instruments almost completely non-enforceable and made the whole concept of legal documents a contract between individuals without having any weight in court.”

Sinha added that foreign investors are not currently able to invest in non-convertible redeemable preference shares, but a notification permitting them to do so is expected soon.