India regulators question PE put options

Indian regulators are concerned about private equity firms using put options as exit mechanisms in India, arguing that they then become non-regulated creditors.

Regulators are examining the practice of private equity firms adding put options to their investment contracts, which allows them to sell their stake back to the promoter if other traditional exits such as an IPO or secondary sale are unavailable, said Reshmi Khurana, managing director of Kroll’s India office.

“If you are going to behave like a debt-provider, you need to come under the scanner of the Reserve Bank of India and comply with some of those stringent mandates that debt providers must comply with,” she said.

As the exit environment in India dries up, more private equity firms are including put options in their investment contracts. The put option mechanism allows a private equity firm to achieve a “modest return” by selling its stake in a business back to the entrepreneur.

“This has been picked up by the Indian regulators, whose argument was that private equity players should be risk-takers. They should not have put options, which make them behave more like debt-providers. So if there are no private equity exit options, you [shouldn't be able to] force the promoter to buy your stake back,” Khurana said.

This mechanism is very common in India in many types of investments and concerns raised by the Reserve Bank of India are “not significant”, according to KPMG’s head of transactions and restructurings in India, Vikram Utamsingh.

However, he says these clauses can put a lot of pressure on a business and also lose the private equity firm significant returns, so it is important to develop a strong partnership with the business. “If you have a really good relationship with the business in which you’re invested, you will find a [happy] medium.”