Tuesday, May 20, 2008

Legal Hurdles to Private Equity Investment

Although the flow of foreign private equity into India has been quite steady, there continue to be several ambiguities in the legal regime relating to private equity investment. Through interviews with experts, CNBC -TV18 identifies some of the issues. These include the following:

1. Governance rights: When private equity investors acquire rights in listed companies (such as veto rights on key decisions), there is a possibility that they may acquire “control” over the company thereby triggering public offer requirements under the SEBI Takeover Regulations. This primarily arises because of an expansive interpretation of the term “control” that has been adopted by SEBI.

2. Lack of flexibility on convertible instruments: A popular instrument used for private equity in the past was convertible preference shares. However, since May 2007, preference shares with a conversion option have been treated as external commercial borrowings (ECB) necessitating onerous approvals for investment.

3. Minimum pricing norms: This prevents private equity investors from taking a stake at a discount to market price, a matter we had posted on earlier.

4. Other issues identified in the discussion are the lack of the ability of private equity funds to carry out due diligence (except in limited circumstances), which is owing to insider trading regulations prescribed by SEBI, and also the inability of private equity (or other) investors to carry out leveraged transactions (which involve leveraging the assets of the target company) in India.

Many of these issues ultimately boil down to a single structural problem – the lack of a special regime governing private equity investors. Private equity is treated as any other form of investment and hence is subject to the same regulations that are applicable to other foreign investors (whether financial or strategic), which bring along with it associated regulatory difficulties and ambiguities. A somewhat elegant solution to this problem would be to treat private equity separately and to take into account the special features of private equity investment and to provide a separate window to such investors. Although such a separate regulatory regime for private equity funds has been contemplated in the past, no concrete steps have been taken in that direction yet. Perhaps it is time that these issues are revisited because private equity is a predominant source of funding for Indian companies seeking expansion, especially when market conditions are not necessarily opportune for capital raising from the public through IPOs.

Public Shareholding: Listed companies are required to maintain a minimum level of public shareholding in order to ensure continued listing. However, there is some ambiguity on whether such ‘public’ shareholding would cover only retail investors or whether that would include large investors such as mutual funds, foreign institutional investors, banks, high net worth individuals and similar such investors. CNBC-TV18 has a related report on this topic.

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