Currently, the one word that best describes the situation of many Indian companies and businesses is “distress”. The two-plus months of a fairly stringent lockdown in most major Indian metros, including Mumbai (which contributes 6% of India’s GDP), has badly impacted several businesses. The measured relaxation of the lockdown feels like the aftermath of a cyclone for companies, as they fix various broken pieces (shortage of raw materials, non-availability of labor, high logistics costs, reduced demand, etc.). Some will make it, but some may go under.
Distressed M&A is gaining traction
The pressure on good businesses that have liquidity issues or a demand loss is giving rise to distressed M&A deals. Depending on the industry sector, these are taking the form, among others, of:
- sales of non-core businesses;
- asset sales; or
- share sales.
How should buyers approach private distressed deals in India?
Identifying the deal and the stakeholders
Identifying the right deal is very important. This can be done through investment bankers or other professionals, or through commercial banks who have ready lists of borrowers in distress. Buyers will be well-served if they identify the real decision-makers quickly and commence discussions with them. Often times, it may be equally important to talk to the lenders of the company alongside the promoter. In the technology space, VC, PE or venture debt funds may play a pivotal role in the sale of a distressed company.
Putting in place a structure quickly
It is imperative to move quickly, especially to pre-empt an insolvency filing by the creditors or lenders of the distressed company and also considering that pre-packaged insolvency plans are not as yet recognized under Indian insolvency law.
Taking on low liability
The buyer will have to decide on the type of the deal and the liability it wants to take on. Typically, in a distressed deal, it is best to take on zero liability. However, that may not always be possible.
Asset sales are the lowest in terms of risk, simply because a lender’s hypothecation or lien on assets can be quickly released by paying the agreed portion of the sale consideration to the lender at closing.
For many technology companies, their employees and IP ownership rights form the core of their value. Therefore, an acqui-hire transaction (i.e., an acquisition comprising of the hiring of all employees) with a full release of all prior employee liabilities is an easier way to structure the purchase of a distressed technology company. Even the founders can be brought onboard the buyer company in this manner. Future compensation can be a mix of cash and ESOPs. Both, an asset sale and acqui-hire eliminate the requirement of taking on past liabilities of companies.
Sale of a business as a going concern or slump sale
The sale of a business as a going concern or slump sale can be slightly more long-drawn-out. Often times, valuing a running business impaired due to Covid-19 can be challenging. In addition, in a manufacturing business, there can be legacy land ownership issues and environmental concerns. Following a thorough due diligence, discussions with promoters and lenders become very important. Negotiating sale documents can also take time, especially if there are indemnification matters. R&W insurance is gaining some traction and is acting as a fix to remedy deal-breaker issues in these types of transactions.
A share sale transaction brings with it all the liabilities of the underlying company and its business. Although such a deal can be closed quickly if all the parties (including the lenders) are on board, an in-depth due diligence is a must. Issues relating to the cost of releasing any pledge of the promoter’s shares or promoter guarantees should be identified and addressed early. If the lender asks if for directors of the buyer to give personal guarantees to continue the credit lines, and if that is not acceptable to the buyer, then the buyer must be ready with alternate credit lines. R&W insurance is also being used to cover seller liabilities.
Tax benefits may be foregone
Tax benefits (some of which are listed below) are often the driver for many M&A transactions in India. However, if time is of the essence, buyers may have to forego some of the tax benefits, because complying with the tax law requirements to continue such benefits can be onerous.
- Depreciation allowances;
- Carry forward of losses; or
- Tax holidays under the Special Economic Zones or other schemes.
Foreign investment considerations for offshore buyers
India has a comprehensive foreign investment policy and regulations which govern foreign investment into India. Foreign investment in certain sectors is banned or restricted, e.g., the insurance sector where the foreign investment cap is 49%. But in most sectors it is fully liberalized, i.e., a foreign company can own 100% of the shares of an Indian company.
More recently, the Indian government has issued a notification under which it seeks to review all foreign investment (direct and indirect) into India from companies based in countries sharing a land border with India. This move is targeted towards Chinese companies and aims to restrict their investments in strategic sectors in India. Foreign investment policy and regulations, therefore, must be given adequate consideration at the time of deal structuring.
In conclusion, there are deals to be had by distressed and private equity funds, as well as strategic buyers, if they are willing to move fast.