Private Equity

in 33 jurisdictions worldwide
Contributing editor: Casey Cogut

2011
Published by Getting The Deal Through in association with: Advokatfirmaet Steenstrup Stordrange DA Advokatfirman Delphi Appleby Beiten Burkhardt Borenius & Kemppinen Bowman Gilfillan Broseta Abogados Carey Olsen Dalgalarrando, Romero & Ca Abogados Esin Law Firm Gilbert + Tobin Gowling Lafleur Henderson LLP HJM Asia Law & Co LLC Homburger Kennedy Van der Laan NV Hamelink & Van den Tooren NV Kromann Reumert Latournerie Wolfrom & Associs Lee & Ko Lima Netto, Campos, Fialho, Canabrava Advogados Loyens & Loeff Luxembourg Lydian Narasappa, Doraswamy & Raja OMelveny & Myers LLP Proskauer Rose LLP Salomon Partners Simpson Thacher & Bartlett LLP Slaughter and May Wiesner & Asociados Ltda WongPartnership LLP Yangming Partners

CONTENTS

Private Equity 2011

Contributing editor: Casey Cogut Simpson Thacher & Bartlett LLP Business development managers Alan Lee George Ingledew Robyn Hetherington Dan White Marketing managers Ellie Notley Sarah Walsh Marketing assistants Alice Hazard William Bentley Subscriptions manager Nadine Radcliffe Subscriptions@ GettingTheDealThrough.com Assistant editor Adam Myers Editorial assistant Nina Nowak Senior production editor Jonathan Cowie Chief subeditor Jonathan Allen Senior subeditor Kathryn Smuland Production editor Anne Borthwick Subeditors Chloe Harries Davet Hyland Editor-in-chief Callum Campbell Publisher Richard Davey Private Equity 2011 Published by Law Business Research Ltd 87 Lancaster Road London, W11 1QQ, UK Tel: +44 20 7908 1188 Fax: +44 20 7229 6910 Law Business Research Ltd 2011 No photocopying: copyright licences do not apply. ISSN 1746-5524
The information provided in this publication is general and may not apply in a specific situation. Legal advice should always be sought before taking any legal action based on the information provided. This information is not intended to create, nor does receipt of it constitute, a lawyerclient relationship. The publishers and authors accept no responsibility for any acts or omissions contained herein. Although the information provided is accurate as of March 2011, be advised that this is a developing area.

Global Overview Casey Cogut, William Curbow, Kathryn King Sudol and Atif Azher Simpson Thacher & Bartlett LLP

3 7 13 21 28 34 40 47 54 61 67 75 80 86 93 101 107 115 122 127 134 141 150 157 163 168 174 178 184 192 197

FUND FORMATION
Australia Adam Laura & John Williamson-Noble Gilbert + Tobin Bermuda Sarah Demerling (ne Moule) Appleby Brazil Luciano Fialho de Pinho, Clara Gazzinelli de Almeida Cruz and Bruno Ribeiro Carvalho Lima Netto, Campos, Fialho, Canabrava Advogados British Virgin Islands Michael J Burns, Valerie Georges-Thomas, James McConvill and Christian Victory Appleby Canada Myron B Dzulynsky, Vince F Imerti and Bryce A Kraeker Gowling Lafleur Henderson LLP Cayman Islands Bryan Hunter and Richard Addlestone Appleby Chile Felipe Dalgalarrando H Dalgalarrando, Romero & Ca Abogados China Caroline Berube HJM Asia Law & Co LLC Denmark Lisa Bo Larsen Kromann Reumert England & Wales Bob Barry Proskauer Rose LLP Finland Paulus Hidn and Sanna Lindqvist Borenius & Kemppinen Germany Thomas Sacher, Steffen Schniepp and Michael Hils Beiten Burkhardt Guernsey Ben Morgan, Geoff Ward-Marshall and Emma Penney Carey Olsen India Siddharth Raja and Chitra Raghavan Narasappa, Doraswamy & Raja Jersey Robert Milner and James Mulholland Carey Olsen Luxembourg Marc Meyers Loyens & Loeff Luxembourg Netherlands Louis Bouchez, Floor Veltman and Maurits Bos Kennedy Van der Laan NV Jan van den Tooren and Reinier Noort Hamelink & Van den Tooren NV Singapore Low Kah Keong WongPartnership LLP Spain Julio Veloso and Javier Morera Broseta Abogados Sweden Anders Lindstrm, Anders Bjrk and Peter Sjgren Advokatfirman Delphi United States Thomas H Bell, Barrie B Covit, Jason A Herman, Jonathan A Karen, Glenn R Sarno and Michael W Wolitzer Simpson Thacher & Bartlett LLP

TRANSACTIONS
Australia Peter Cook and Rachael Bassil Gilbert + Tobin Belgium Peter De Ryck Lydian Brazil Luciano Fialho de Pinho and Flvio Santana Canado Ribeiro Lima Netto, Campos, Fialho, Canabrava Advogados Canada Harold Chataway, Daniel Lacelle, Ian Macdonald and Jason A Saltzman Gowling Lafleur Henderson LLP Cayman Islands Stephen James, Simon Raftopoulos and Samuel Banks Appleby Chile Felipe Dalgalarrando H Dalgalarrando, Romero & Ca Abogados China Caroline Berube HJM Asia Law & Co LLC Colombia Mauricio Rodrguez and Eduardo A Wiesner Wiesner & Asociados Ltda Denmark Bent Kemplar and Vagn Thorup Kromann Reumert

Finland Maria Carlsson, Andreas Doepel, Antti Hemmil, Ari Kaarakainen, Sanna Lindqvist, Jukka Leskinen and Timo Seppl Borenius & Kemppinen 202 France Pierre Lafarge, Jean-Luc Marchand, Claire Langelier, Jennifer Sourisse and Maxime Boh-Masson Latournerie Wolfrom & Associs Germany Thomas Sacher, Steffen Schniepp and Michael Hils Beiten Burkhardt Hong Kong Benita Yu and Clara Choi Slaughter and May India Siddharth Raja and Neela Badami Narasappa, Doraswamy & Raja Indonesia Joel Hogarth OMelveny & Myers LLP Korea Je Won Lee and Geen Kim Lee & Ko Netherlands Louis Bouchez, Fenna van Dijk, Floor Veltman and Maurits Bos Kennedy Van der Laan NV Jan van den Tooren and Reinier Noort Hamelink & Van den Tooren NV Norway Robert Sveen and Odd Erik Johansen Advokatfirmaet Steenstrup Stordrange DA Russia Anton Klyachin and Igor Kuznets Salomon Partners Singapore Wai King Ng and Liam Kheng Tay WongPartnership LLP South Africa Lele Modise and David Anderson Bowman Gilfillan Spain Julio Veloso, Javier Morera and Juan Manuel Prez Broseta Abogados Sweden David Aversten, Michael Juhlin, Peter Sjgren, Clas Romander and Emma Dansbo Advokatfirman Delphi Switzerland Dieter Gericke, Reto Heuberger and Jrg Frick Homburger Taiwan Robert C Lee and Claire Wang Yangming Partners Turkey Ismail G Esin Esin Law Firm United States William Curbow, Kathryn King Sudol and Atif Azher Simpson Thacher & Bartlett LLP 208 215 220 227 234 240 245 252 257 262 268 277 283 291 297 303 309

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India
Siddharth Raja and Neela Badami Narasappa, Doraswamy & Raja
1 Types of private equity transactions What different types of private equity transactions occur in your jurisdiction?

The Indian organised private equity (PE) industry is relatively young (the first foreign PE funds started entering India in the mid-nineties) when compared to sophisticated jurisdictions such as the UK or the US. Private equity deals in India are broadly of two types: growth deals, where a PE fund buys a minority stake in a company, but does not get involved with the day-to-day management; and buyouts, where a PE fund buys an ownership stake and runs the business as well. Leveraged buyouts (LBOs) are not popular in India, as Indian banks are forbidden by the banking regulator, the Reserve Bank of India from making loans to persons for the purpose of acquiring shares of domestic companies. India also sees a large amount of venture capital (VC) and angel investments. The types of private equity transactions also depend on the actors in the PE industry, which include both domestic and foreign PE and VC investors. Foreign venture capital investors (FVCIs) registered with the Indian securities regulator, the Securities Exchange Board of India (SEBI), as well as domestic venture capital funds (VCFs) registered with the SEBI are governed specifically by regulations made by it. VCFs are also eligible for certain favourable tax treatments, and FVCIs in particular are exempt from compliance with certain key foreign investment rules, including rules governing the price at which shares of Indian companies may be bought or sold by them. Apart from the above SEBI regulations, there is no single umbrella legislation governing PE/VC investment in India. Therefore, general rules of Indian company law and exchange controls govern investments made in India by these entities.
2 Corporate governance rules What are the implications of corporate governance rules for private equity transactions? Are there any advantages to going private in leveraged buyout or similar transactions? What are the effects of corporate governance rules on companies that, following a private equity transaction, remain or become public companies?

If, post the PE transaction, the company becomes or remains (i) a public company or (ii) a private company that is a subsidiary of a public company, the corporate governance rules to be complied with under the Act are of two types: first, provisions relating to directors, their appointment and remuneration; and second, additional procedural requirements from a good corporate housekeeping perspective. As to the first set, public companies and private companies that are subsidiaries of public companies are subject to restrictions on the total managerial remuneration that can be paid to directors, among other things. Such companies require the approval of the registrar of companies (ROC) before they can take certain specified corporate actions, including giving loans to directors. They also require prior permission from their shareholders before availing of loans in amounts exceeding certain specified limits. Such a company also requires the consent of its board of directors to enter into contracts with directors or certain parties related to directors for the purchase or supply of any goods, materials or services or for underwriting the subscription of shares or debentures in the company, subject to certain exemptions. Prior approval of the ROC would also be required if the companys paid-up share capital is in excess of 10 million rupees and no exemption applies. Some important corporate governance rules that would be applicable to public listed companies under the listing agreement executed with stock exchanges include rules governing the composition and manner of appointment of the board of directors and the constitution of specified committees such as an audit committee (charged with, among other things, the responsibility for the companys financial reporting and audit processes), and public disclosure of managerial remuneration. Therefore, the target companys status attracts a different set of rules requiring continuous compliance in such manner indicated above.
3 Issues facing public company boards What are the issues facing boards of directors of public companies considering entering into a going-private or private equity transaction? What is the role of a special committee in such a transaction where members of the board are participating or have an interest in the transaction?

The Indian Companies Act, 1956 (the Act) differentiates between (i) a private company, (ii) a public company and (iii) a private company that is a subsidiary of a public company. Categories (ii) and (iii) are subject to more corporate governance requirements than category (i). In addition, Indian securities regulation prescribes additional and further rigorous corporate governance norms for public listed companies. Therefore, the first issue to consider in a private equity transaction is what the status of the target company post the PE transaction would be. If the answer is a private company, it is pertinent to note that private companies in India are exempt from the applicability of several provisions of the Act. Consequently, it would be advantageous for a PE fund to take a company private. However, in practice such transactions are rare, as LBOs are not common in India.

The Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 1997 (Takeover Code) would apply to: any acquisition of shares in a public listed company that would take the acquirers stake in such target company over certain specified percentages; and to acquisition of control over the listed target, irrespective of whether any shares are being acquired. The Takeover Code defines control as including:
the right to appoint the majority of the directors or to control the management or policy decisions exercisable by a person or persons acting individually or in concert, directly or indirectly, including by virtue of their shareholding or management rights

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or shareholders agreements or voting agreements or in any other manner.

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include certain mandatory disclosures including the minimum offer price, number of shares to be acquired from the public, identity of acquirer, purpose of acquisition and future plans of acquirer, if any, regarding the target company.
5 Timing considerations What are the timing considerations for a going-private or other private equity transaction?

The acquirer is then required to make a public announcement in national and regional newspapers to let the listed targets shareholders know that the ownership of the target is in play, and to give them an opportunity to exit the target at a fair price. In case the PE transaction is in the nature of a takeover as contemplated by the Takeover Code, it should be noted that the Takeover Code casts several obligations on the board of directors of a target public company, once a public announcement has been made by a prospective acquirer for the purchase of such targets shares. The board cannot, without the prior approval of the shareholders, encumber or dispose of any assets other than in the normal course, issue or allot any unissued securities carrying voting rights or enter into any material contracts. The Takeover Code permits the targets directors to send their:
unbiased comments and recommendations on the offer to the shareholders, keeping in mind the fiduciary responsibility of the directors to the shareholders, and for the purpose seek the opinion of an independent merchant banker or a committee of independent directors.

If a director is interested in a proposed transaction by the company, such director is mandated to disclose such interest to the company; his or her presence at the board meeting considering the proposed transaction is not counted towards quorum, and his or her vote to that extent is void. Apart from this, there is no other special procedure that is followed in such cases the concept of a special committee of the board that reviews bids submitted by acquirers as seen in LBO scenarios in jurisdictions such as the US does not have an exact parallel in India.
4 Disclosure issues Are there heightened disclosure issues in connection with goingprivate transactions or other private equity transactions?

General timing considerations in private equity transactions arise in a variety of ways, and are captured sometimes as conditions precedent to the completion of the transaction, including the obtaining of required regulatory, statutory or government approvals (for example, from the Foreign Investment Promotion Board, Indias highest authority regulating foreign investment in India) and loan sanctions by banks or other financial institutions (for example, in cases where the PE investment is one part of the financing that a target company is availing of for the execution of a project). Going-private transactions involving a voluntary delisting may take around two to three months to complete. Takeovers that attract the provisions of the Takeover Code involving the making of open offers to the public and so on may also take up to three months to complete.
6 Purchase agreements What purchase agreement provisions are specific to private equity transactions?

Since LBOs are not popular in India, going private may be explained in two ways in the Indian context: (i) delisting by a company of its listed securities; and (ii) a change in constitution from a public limited company to a private limited company. Voluntary delisting by a company of its securities requires the company to obtain the consent of at least two-thirds of its members and an approval from the stock exchanges it wishes to delist from. The company is required to make a public announcement (containing specified disclosures, including the manner of determination of the price band) and offer its shareholders an opportunity to exit the company. Conversion of a public limited company into a private limited company requires the sanction of the ROC. The ROC will consider, among other things, whether a majority of the shareholders have given their consent, whether their interests are adversely affected by the proposed going-private transaction and whether there are any objections from shareholders and creditors of the company. In the context of acquisition of a public listed company by a PE firm, the Takeover Code stipulates that a potential acquirer who acquires shares and voting rights (or both) in excess of certain specified percentages in a target company is required to disclose such acquisition of shares to the target company and to the stock exchanges where shares of the target company are listed. In addition, the Takeover Code stipulates that a public announcement is to be made by the acquirers merchant banker within four days of execution of a share purchase agreement or the making of the decision to acquire shares and voting rights (or both) exceeding specified percentages. Such public announcement in national and regional newspapers states the intention of the acquirer to acquire a minimum of 20 per cent of the shares of the target company from existing shareholders by means of an open offer, and is required to

As mentioned in question 1, in India, banks cannot lend to persons for the purpose of acquisition of shares of a domestic company, and thus covenants related to financing are not commonly found, and neither is the consummation of the transaction conditional on the PE fund being able to successfully arrange for financing from banks or other financial institutions. If the PE investor is apprehensive that the company may not close the deal despite substantial costs having been incurred by such PE investor in terms of time and professional advisers fees, the investor can require the company to agree to pay a break fee (say, 1 to 2 per cent of the proposed investment amount). Typically the most amount of time is spent negotiating the extent of the representations and warranties that are to be given, and the time period for which the indemnification obligation for their breach survives. The PE investor likes the warranties to be as detailed as possible and its right to be indemnified against breaches of the warranties to survive in perpetuity, while the promoters and management prefer to keep the warranties bare (the selling shareholders who were neither part of the management team nor promoters themselves may succeed in carving themselves out of a majority of the representations and warranties that promoters would be required to give). The parties usually resolve this issue by agreeing that the PE investors right to be indemnified against breaches of warranties would survive for a period of three years from closing, except in the case of tax warranties. (Indias statute of limitations prescribes the periods within which suits can be brought for various breaches. Three years is the time limit for the majority of the causes of action specified in the statute, including cases for which no time limit is prescribed.) The exception for tax warranties is made because, under the Indian Income Tax Act, the relevant authority can reach back up to six assessment years (the 12-month period from 1 April to 31 March immediately following the previous year, or financial year. A person files his or her return for the income earned in the previous year in the assessment year) to determine if there have been, and make a claim for, any unpaid taxes. PE investors therefore like to include in the indemnity provisions that the promoters or selling shareholders liability for breaches of the tax warranties shall survive for a period of seven years (to cover the relevant previous year for which the last (ie, sixth) assessment year relates) from the closing.
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The private equity investor typically requires a list of matters (called veto matters, or affirmative right matters) to be included in the shareholders agreement on which the board and shareholders of the company cannot take action if the investor exercises its veto. A variety of covenants may also be included, depending on the actions that the PE investor wishes the company to take post closing. These may relate to specific issues identified during due diligence (such as renewal of expired contracts, rectification of irregularities in the running of the business) or to general issues with the operation of the business (for example, changing of accounting principles). Other standard clauses include non-compete clauses, which may be circumscribed by both temporal and geographical limits. Since shareholders agreements in the context of PE investments have only gained popularity in the last few years in India, the Indian apex court, the Supreme Court of India, has not had many opportunities to pronounce on the validity and enforceability of the various types of rights and clauses that they contain (unlike Delaware courts, for example, which have produced a body of case law on takeovers in the US). The Supreme Court has held in one case relating to restrictions on the free transferability of shares that a private agreement that imposes restrictions not stipulated in the articles of association is not binding either on the shareholders or on the company. While there are a few judgments of various high courts (notably the Bombay High Court, which has provided more liberal interpretations) these do not carry the same precedent value as a judgment of the Supreme Court. Since litigating contracts in India can take a significant amount of time, parties usually provide for arbitration as the dispute settlement mechanism in the shareholders agreement. This factor has contributed to the absence of binding judicial pronouncements in the field. It follows that the last word has not yet been said on the subject of enforceability of restrictive covenants in share purchase and shareholders agreements.
7 Participation of target company management How can management of the target company participate in a goingprivate transaction? What are the principal executive compensation issues?

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company back to the private equity investor or to the other promoters. What the definition of cause should be is open to commercial negotiation. Compensation is provided for in both cash and equity components. The equity component can be issued all at once up front to the executive, but restrictions on their transfer could be imposed linked to the term of the executives employment. For example, the contract could provide that upon the completion of a certain period say a year a specified number of shares are released of the transfer restriction. Such release can also be linked to the executives and the companys performance, thereby incentivising management to perform beyond targets. Note however that the Act provides that in a public company, shares or debentures shall be freely transferable. As mentioned in question 6, the interpretation of this term is not settled law yet in India.
8 Tax issues What are the basic tax issues involved in private equity transactions? Give details regarding the tax status of a target, deductibility of interest based on the form of financing and tax issues related to executive compensation. Can share acquisitions be classified as asset acquisitions for tax purposes?

Private equity investors would typically prefer that the promoters and management stay on and do not exit the company following the investment. This is especially true in the case of closely held businesses in certain industries, where all of the companys know-how is concentrated in the hands of a few individuals. In addition, most Indian companies follow the insider model of shareholding (ie, control is concentrated in the hands of a few promoters) as opposed to the outsider model (ie, large diffused public shareholding). Promoters and management are generally not comfortable divesting majority shareholding to outsiders. This means that most PE transactions are not structured to hand over control from the promoters to the investor, although of course cases exist to the contrary. Promoters regard PE investors a source of capital (similar to banks) instead of a strategic partner with value additions of their own; consequently, interference in management is not expected, with promoters envisioning a passive rather than an active role for the PE investor. It follows from the above discussion on the Indian context that sometimes, in the area of venture capital investment in earlystage companies, the VC investor may come across a promoterentrepreneur who resents having to sign an employment agreement that he or she perceives as diluting his or her status in the company. This calls for tactful negotiations on the part of the VC investor. Generally, the execution of executive employment agreements with key management personnel is made a condition precedent to the closing of the deal. These agreements typically contain non-compete and non-solicit clauses, as well as provisions for termination in a variety of scenarios, including if specified targets in the business plan are not met. In addition, if the executives employment is terminated for cause, the executive is compelled to sell all his or her shares in the
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For a private equity investor, the primary concern is how to achieve the most tax-efficient exit in order to maximise returns. India levies a capital gains tax on the sale of long-term and short-term capital assets. Long-term capital assets are assets held for more than 36 months before they are sold or transferred, with a shorter holding period of only 12 months required for shares and debentures. While different rates of tax apply for gains arising from the transfer of long-term and short-term capital assets, since typically, a PE investor would be holding shares or debentures (or both) in the investee company for a period longer than 12 months prior to exit, the long-term capital gains tax is attracted when the exit is achieved. The current rate of long-term capital gains tax can be as high as 20 per cent. The most common method of achieving tax efficiency has been for investors to structure their investments through a jurisdiction with which India has a double taxation avoidance agreement (DTAA) in place. Popular jurisdictions include Mauritius, Cyprus, Singapore and the Netherlands. The India-Mauritius DTAA has made Mauritius the most popular destination for PE/VC funds to set up, since the DTAA provides that capital gains made by a Mauritian resident from the sale of shares in an Indian company is not taxable in India (provided that the Mauritian company does not have a permanent establishment in India). This is beneficial for PE investors, since Mauritius itself does not tax capital gains. Therefore, foreign funds seeking to invest in India have historically set up funds in tax-friendly jurisdictions. Indian limited companies (the predominant type of entity that attracts PE/VC investment) are taxed at a basic corporate tax rate of 30 per cent, and dividends that are declared and distributed by a company are taxed at a rate of 16.609 per cent (inclusive of surcharge) in the hands of the company. The Minimum Alternate Tax (MAT) applies to any Indian company whose income tax payable on its total income as computed in accordance with the Income Tax Act is less than 18 per cent of its book profits. The MAT is primarily aimed at companies that utilise various exemptions available under law to ensure that they have almost no tax payable. Share acquisitions cannot be classified as asset acquisitions under Indian tax law.
9 Existing indebtedness What issues are raised by existing indebtedness at a potential target of a private equity transaction? How can these issues be resolved?

Loan documentation in India typically contains clauses that require the borrower company to obtain consent of the lender before any capital reorganisation or change of control can be carried out.

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Therefore, obtaining such lender consent is usually made a condition precedent to the completion of the transaction in the share purchase agreement. In addition, if there is existing indebtedness at the target level, the PE investor should ascertain the priority status of such debt ie, whether it would rank senior or junior to the PE investors own funds, once invested (especially if the PE investment instrument is through a convertible debt instrument).
10 Debt financing structures What types of debt are used to finance going-private or private equity transactions? Do margin loan restrictions affect the debt financing structure of these transactions? Are there any other restrictions in your jurisdiction on the use of debt financing for private equity transactions?

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If there is a transfer of property, delivery of goods or payment made in favour of some creditor within six months before the commencement of the winding up of the company, such transfer shall be deemed a fraudulent preference and will be invalid if it is proved that such transfer has an element of dishonesty and clear intention of favoured treatment that results in inequality among the creditors. In addition, any transfer of property made by a company within a period of one year before the presentation of a petition for winding up or the passing of a resolution for voluntary winding up of the company shall be void against the liquidator if the transfer is not made in the ordinary course of its business, the transfer was without consideration or the consideration was so inadequate as to raise a presumption of want of good faith.
13 Shareholders agreements What are the key provisions in shareholders agreements covering minority investments or investments made by two or more private equity firms?

LBOs are not very commonly seen in India because the Act prohibits public limited companies (and private companies that are subsidiaries of public companies) from rendering financial assistance in connection with the purchase of its own shares. Therefore, target companies cannot offer their assets and shares as security for loans to be availed of by the potential acquirer or PE firm. In addition, domestic banks are prohibited from providing loans to persons for the purchase of shares in any company incorporated in India. (Domestic banks may lend to Indian companies for purchasing equity in overseas joint ventures or wholly owned subsidiaries.) Borrowing from overseas banks is also not an option, since such borrowings (called external commercial borrowings, ECBs) may only be done for certain specified end-uses, and the acquisition of shares in domestic companies is not one of them. An additional condition to be kept in mind with respect to foreign PE investors is the fact that optionally or partially convertible debt instruments would not be considered equity and would be considered as debt (ie, ECBs). Such an outcome is not desirable, as there are several other considerations that have to be kept in mind with respect to ECBs, such as permissible end-use, maturity and so on that are not applicable to foreign direct (ie, equity) investment. Consequently, a foreign PE investor must always invest in fully and compulsorily convertible instruments.
11 Debt and equity financing provisions What provisions relating to debt and equity financing are typically found in a going-private transaction? What other documents set out the expected financing?

It follows from the discussion in question 10 that a PE transaction cannot be financed through bank loans or methods other than the PE investors own funds (or, if the PE investor is an entity incorporated overseas, through borrowings made overseas). If PE investment is being made into a company that is undertaking a project and has already incurred or proposes to incur senior debt from banks, it is important to ensure in the documentation that the order of priority between the financings is captured. Typically, banks would rank senior, and if there are multiple PE investors coming in at different points of time, they would rank pari passu or junior inter se, depending on the commercial negotiations. Such ranking assumes importance in the event that the company goes bankrupt or a petition is filed for winding up of the company.
12 Fraudulent conveyance and other bankruptcy issues Do private equity transactions involving leverage raise fraudulent conveyance or other bankruptcy issues? How are these issues typically handled in a going-private transaction?

As leverage is not a frequently used tool in India, the short answer is no. However, the Act deals with fraudulent preference and voiding of transfers in certain cases.

The rights that investors ask for depend to an extent on the investment instrument they choose. Foreign investment into Indian companies is typically structured through the issue of compulsorily convertible preference shares or fully convertible debentures. However, the lack of voting rights that ownership of common voting equity stock would have provided prevent the PE investor from having a say in the way the company is run. This obstacle is overcome by drafting clauses in the transaction documents that provide the PE investor with voting rights from day one at general meetings on an as-if-converted basis, ie, the PE investor enjoys the number of votes that would accrue to it once the preference shares and convertible debentures are converted into common voting equity shares. In addition, a PE investor requires the right to appoint at least one nominee director on the board of the company. The shareholders agreement will also provide that quorum cannot be constituted unless such nominee director is present at board meetings, and the investor as a shareholder is present at shareholder meetings. In addition, PE investors usually require a list of items or matters on which neither the board nor the shareholders can vote without the prior written consent of the investor. Shareholders agreements will also typically contain a lock-in of the promoters shares to ensure that they stay invested in the company and involved in running the business, or specify types of permitted transfers (such as transfers to affiliates or transfers that do not take the promoters below a specified percentage) (or both) as well as restrictions on transfers, including rights of first offer, first refusal, tag-along and drag-along rights. While these rights are now fairly common in the industry, their enforceability in court is yet to be tested, with finality at the apex court level. The shareholders agreement will also contain provisions to facilitate the investors exit. While IPOs are a preferred form of exit, they may not always materialise. Sale to a strategic investor or third party, buyback by the company, put options in favour of the investor and call options in favour of the company are the other ways in which PE investors seek to ensure an exit at a desired price. It is important to note that in the case of foreign PE investors, exit options (including drags, tags, puts and calls) remain subject to Indian pricing guidelines for transfer of shares from non-resident entities to resident Indian entities or vice versa. FVCIs, however, are exempt from compliance with the pricing guidelines. Investors also seek anti-dilution protection, ie, a covenant that shares will not be issued to subsequent investors at a price lower than the price at which shares were issued to the investor, or if they are, that the investor also be issued additional shares at no additional cost. Investors also ensure that the shareholders agreement contains detailed information rights, including the right to inspect the companys books and premises, as well as the right to conduct an independent audit if it so desires.
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Update and trends

Taxes and accounting India is set to welcome two major policy changes in the coming months. One is the Direct Tax Code (DTC), which seeks to consolidate and amend the law relating to direct taxes. One area in which the DTC would impact VC investors would be in its proposal to provide tax passthrough status for all VCFs. At the moment, only nine sectors (such as information technology, telecommunications, pharmaceuticals and bio-technology) enjoy complete tax pass-through status. The income received from investments in these sectors will be taxed only once, ie, in the hands of the investors and not in the hands of the fund itself. VCFs in other sectors do not enjoy such advantage. The Code proposes to treat all VCFs as tax pass-through provided they are registered with the SEBI and fulfil certain conditions as may be prescribed. Another point to be highlighted on the taxation front is in the context of the multi-billion dollar Vodafone transaction in 2007 (relating to the British telecom majors US$11.2 billion acquisition of the Indian telecommunications assets of Hong Kong-based Hutchison Telecommunications International Limited (HTIL)), which has been making waves for more reasons than one. The transaction structure was complex, involving the acquisition by Vodafone through its Netherlands entity of a Cayman Islands company that held a number of Mauritian and Indian subsidiaries, which cumulatively owned a 67 per cent stake in Vodafone Essar Limited, an Indian company. While technically both the buying and selling entities were incorporated abroad, the Indian IT department has claimed that since the underlying assets were Indian, the sale of which resulted in capital gains accruing to HTIL, Vodafone should have withheld tax on the consideration. In September 2010, the Bombay High Court dismissed a petition filed by Vodafone questioning the IT departments jurisdiction in this case. Vodafone has moved the Supreme Court against this order of the Bombay High Court, denying any tax liability as the deal was between two foreign entities, concluded offshore. The Supreme Court of India will hold final hearings on 19 July 2011. Pending final hearings, the Supreme Court has directed Vodafone to deposit 25 billion rupees with the Supreme Court Registry and provide a bank guarantee for 85 billion rupees. In light of these events surrounding the Vodafone transaction, coupled with the consolidation of the taxation regime proposed by the Direct Taxes Code, a recent trend that India has been witnessing is that of PE investors seeking to protect themselves from taxationrelated uncertainties through the use of tax insurance products and escrow mechanisms. Tax insurance cover, part of transactional risk insurance, is usually obtained from offshore insurers in high-value PE deals. The other mechanism that is being used in this context is the setting up of an escrow account into which a portion of the deal consideration is deposited, and against which the buyer can set-off tax-related liabilities that may arise. The second policy change relates to adoption of the IFRS. Indian accounting standards currently in force are scheduled to converge with the IFRS in April 2011 (see question 16). There are significant differences between Indian GAAP and the IFRS, which will make firsttime adoption a challenge. Takeover Code amendments With the aim of streamlining the current Takeover Code, the Takeover Regulations Advisory Committee (TRAC) was constituted by SEBI, which submitted a report in July 2010 proposing several fundamental changes to the Takeover Code. The TRAC has recommended, among other things, that the open offer trigger be increased to 25 per cent from the current 15 per cent, and that the size of the open offer to be made to the public by the potential acquirer be increased to 100 per cent from the current 20 per cent. Commentators opine that this would lead to an increase in the number of PE transactions that result in an acquisition of less than 25 per cent of the shares of a target. Takeover activity is also expected to initially become more difficult, especially for Indian acquirers, since mobilisation of resources to finance a 100 per cent open offer will be difficult considering that they cannot raise acquisition funds from Indian banks or through ECBs. Foreign acquirers and PE firms with access to financing will be put at a comparative advantage. FDI policy The Indian government appears to be moving towards allowing a limited entry for foreign firms into multi-brand retail, a sector that has traditionally been closely guarded due to the perceived threat to small neighbourhood stores and retailers if multinational department stores are allowed to enter India. If the sector is deregulated, even to a limited extent, PE firms would have another avenue for investment.

14 Limitations on transaction size Do private equity firms have limitations on the size of transactions they may engage in?

Certain types of funds do, by law specifically, VCFs registered with the Securities Exchange Board of India cannot invest more than 25 per cent of the corpus of their fund in a venture capital undertaking (VCU). In addition, the threshold disclosure plus open offer requirements of the Takeover Code incentivise investors to acquire only such number of shares that would keep them just short of such threshold as would compel them to make disclosures and cumbersome open offers. These rules act therefore as self-imposed limitations on the private equity investor proposing to invest in a listed company. The types of transactions that PE firms invest in also depend on the funds raised by them.
15 Exit strategies and investment horizons How do the exit strategies and investment horizons of private equity firms affect the structuring and negotiation of leveraged buyout transactions?

Investors may initially subscribe to convertible debt instruments that are convertible into equity shares at a point of time that is usually in the discretion of the investor. This enables the investor to receive interest on the debt-like instruments during the tenor of the instrument, and affords it the protection of control of the company through the equity stake upon conversion. The timetable for conversion depends, among other things, on the investors exit strategy. Apart from the above, depending on the status of the PE investor, there may be certain in-built restrictions imposed by law. For example, if the PE investor is registered as a VCF in India, it would be required to meet certain criteria at the end of its lifecycle in relation to its use of funds, at least 66.67 per cent of which should be invested in unlisted equity shares or equity-linked instruments of a VCU, and not more than 33.33 per cent in subscription to shares of a VCU in its IPO or debt instruments of a VCU in which the VCF already holds equity, and special purpose vehicles created by a VCF for the purpose of facilitating investment, among others. These legal requirements may be factored in by the VCF investor while contemplating its exit horizon.
16 Principal accounting considerations What are some of the principal accounting considerations for private equity transactions?

As mentioned in question 1, LBOs are not popular in India. However, structuring the exit is one of the important items to which negotiation time is devoted in any PE/VC investment transaction. As mentioned in question 13, qualified IPOs, sales to strategic buyers, puts, calls, drag-along and tag-along rights are some of the commonly used exit mechanisms. In addition, restrictions on the transferability of the promoters or sponsors shares are insisted upon by the investor.
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Accounting standards prescribed by the Institute of Chartered Accountants of India have been the accounting norms followed by companies to date. This is set to change, with the Indian Accounting Standards being scheduled to converge with the International

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Financial Reporting Standards (IFRS) in April 2011. The adoption of these converged accounting standards is structured in a phased manner categorised according to the net worth of the company. Significant differences between Indian accounting standards and the IFRS would include the mandatory adoption of the acquisition method of accounting in case of business combinations, and consequently the recognition of assets and liabilities at fair values. The pooling of the interest method and the purchase method, which were allowed earlier, will not be allowed in the new standards. In addition, goodwill cannot be amortised, but must be tested for impairment on an annual basis.
17 Target companies and industries What types of companies or industries have typically been the targets of going-private transactions? Has there been any change in focus in recent years? Do industry-specific regulatory schemes limit the potential targets of private equity firms?

Narasappa, Doraswamy & Raja

18 Cross-border transactions What are the issues unique to structuring and financing a cross-border going-private or private equity transaction?

The flow of PE investment in India (not going-private transactions or LBOs in particular) has shifted its course in line with the change in demand arising out of sector-specific growth, from information technology in 2004, to real estate in 2005, and to information technology and telecom the following year. By 2009, investment clustered in real estate, information technology and energy. Late 2010 saw energy (including clean-tech), health care, construction and engineering and financial services attract the most PE/VC investment. Limitations on the potential targets of PE/VC firms are of two types: industry-specific regulatory schemes as well as, in the case of FVCIs and VCFs, restrictions on the investor itself. As to the first, the Indian government updates its policy on foreign direct investment (FDI policy) on a biannual basis. Such policy expressly prohibits investment in certain sectors (such as atomic energy, multi-brand retail, casinos), regulates by means of caps on the percentage of permissible foreign stakeholding possible in other sectors (such as private sector banking 74 per cent; FM Radio 20 per cent; commodity exchanges 49 per cent; insurance 26 per cent) and expressly allows 100 per cent foreign direct investment with no prior permission required in certain other sectors (such as mining, airports, township development). Therefore, PE/VC funds incorporated abroad would need to tailor their investment strategy in line with the FDI Policy. As to the second, FVCIs and VCFs are each subject to a Negative List, ie, a list of sectors into which they cannot invest. These include non-banking financial services (other than equipment leasing and hire-purchase companies) and gold financing (other than gold financing for jewellery).

The most significant issue in a cross-border transaction (ie, where the PE investor is an entity incorporated outside India) is completing the sale of shares at a price that achieves the equity stake that the PE investor wants. In the case of PE investors incorporated abroad, exchange control laws dictate that only fully and compulsorily convertible instruments would be reckoned as equity. Partially convertible instruments would be reckoned as debt, subject to different guidelines. In order to avoid being categorised as a lender subject to onerous ECB rules, PE investors typically prefer employing compulsorily convertible preference shares or compulsorily convertible debentures as their investment instruments. Such instruments, when being issued to foreign investors, have to be priced at a figure that is equal to or higher than the fair value of the shares as determined in accordance with the discounted cash flow method (for private limited companies). Applicable exchange control laws also mandate certain regulatory filings disclosing the price at which the convertible instruments were issued to the foreign PE investor shortly after the issue of the instruments. Since the manner of arriving at the floor price is also mandated by law, it is important that the amount that the PE investor wishes to invest as well as the percentage equity stake that the investor desires to achieve in the investee company are considered in conjunction with the pricing guidelines in order to achieve the desired outcome at an early stage in the transaction.
19 Club and group deals What are the special considerations when more than one private equity firm (or one or more private equity firms and a strategic partner) is participating in a club or group deal?

Concerns may arise when there are multiple investors entering a transaction at the same time; or there is a series of investors entering a company at different points in time. In the first scenario, it is important to ensure that the incentives and interests of all the investors are broadly in alignment so that inter-se investor discord does not throw the functioning of the company into disarray. This can be a real problem if each of the investors is entitled to veto or affirmative rights. The common deadlock resolution mechanism is to have decisions taken by a majority or supermajority of the investors. In the second scenario, where there could be Series A, B, A-1, C, and so forth, sets of investors, it becomes important from an operational perspective to ensure that the various rights allotted to the

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different sets work in harmony, which can be challenging from a documentation perspective. Also, when, for example, the Series A investment involved an issue of debentures to, say, 100 investors, and the Series B investment is an equity investment by a PE investor who wants a majority stake in the company, the company may be required to go back to all 100 Series A investors for their consent. This is time-consuming in practice. Another issue that may arise is that the Series C PE investor receives certain benefits that the Series B investor did not, and the Series B investor may insist that its rights be renegotiated. This typically calls for careful redocumentation, which is sometimes inevitable in unwieldy club and group deals.

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20 Issues related to certainty of closing What are the key issues that arise between a seller and a private equity buyer related to certainty of closing? How are these issues typically resolved?

Closing typically turns on the satisfaction of a number of key conditions precedent. If any of such conditions remain unsatisfied, the obligation on the investor to fund and the company to issue securities are not triggered. In addition, if the investor has reason to believe that the company may not go through with the transaction despite substantial expenditure of time and resources by the investor, the investor may insist on a break fee. Documentation can also detail the termination rights of both parties in the interregnum between signing the share purchase agreement and closing.

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