Facilitating exits in a post-covid-19 world

By Nivedita Tiwari and Nandini Seth, Shardul Amarchand Mangaldas & Co
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The economic reforms of 1991 gave India a high growth trajectory making it the fifth largest economy in the world. While complete capital account convertibility is still not permitted, significant steps have been taken to facilitate investments in, and exits from, India. The ease of exit for foreign investors plays an integral role in attracting foreign direct investment (FDI). In the midst of navigating through challenges posed by the pandemic, an intriguing question is whether exits will be impacted in a post-covid-19 world?

Post covid-19
Nivedita Tiwari
Partner
Shardul Amarchand Mangaldas & Co

It is difficult to draw parallels with past events but, if the 2008 global financial crisis is taken as a comparable event, India survived the financial crisis and received FDI worth US$27.3 billion in 2008-09 despite the downturn. Be that as it may, it has been reported that 48% (by value) of all exits since 2003 occurred from 2015 to 2018. Based on an analysis of the growth of FDI and exits after the financial crisis, it can be inferred that most investments are in the holding period of their investment cycle and exits are due in the next two to five years.

While there has never been a lack of interest in the Indian economy, a robust regulatory regime needs to act in tandem with the market to provide much needed assistance to achieve exits. On the regulatory front, the government recently amended existing FDI laws to curb opportunistic takeovers of companies at low valuations during the pandemic. Under these amendments, direct or indirect FDI from bordering countries will require government approval, regardless of whether the Indian target company is engaged in a business which is otherwise under the automatic route.

These restrictions are likely to impact even genuine investments. However, the government is trying to counter adverse effects by taking active steps to support investors and enhance growth. As a welcome step, an empowered group of secretaries has been set up by the government, whose terms of reference, among other matters, include the identification of key focus sectors to drive development, the identification of potential investors in key sectors and geographies who have the capacity to invest in India, the supervision of new investment-related policies and support mechanisms, and the creation of an investment friendly ecosystem.

Recent investments in the Reliance Jio platform are a testimony to the fact that India continues to be an attractive destination for foreign investors. However, more steps need to be taken to facilitate exits and increase investor confidence in a post-covid-19 world. Past trends suggest that more investors choose to exit by means of strategic sales as opposed to using the public market route. Keeping this in mind, the government, besides augmenting distress sales through an effective insolvency mechanism, could take the following measures.

Pricing restrictions. Despite the pandemic’s immediate impact, the fundamentals of certain businesses may be strong, resulting in the intrinsic value of investments in such businesses being higher than the prescribed fair value. Easing FDI pricing restrictions by permitting a range of premium over the fair value of equity instruments may significantly boost investments, which would then help exits.

Structuring flexibility. Easing restrictions on deferred payments, retentions and earn-outs beyond the permitted 18-month period and 25% cap may help bridge the valuation gap in the long term and ease exits.

Public markets. To address the liquidity requirements of companies struggling to survive in a post-covid-19 world, the Securities and Exchange Board of India could make concessions in the regulatory framework for domestic initial public offerings (IPOs), including reducing the minimum subscription requirements for fresh issues from 90% to 75% and relaxing the financial performance criteria for undertaking an IPO. This would in turn make IPOs a viable alternative to strategic sales for exit. The government is proposing to allow direct overseas listing to provide Indian companies access to foreign markets. While this may prove to be another viable option for exits, regulators are yet to propose a framework that addresses tax inefficiencies, provide a choice of instruments and freely allow outbound remittance of foreign exchange.

With access to adequate reserves of capital, investors may elect to acquire new assets at lower valuations, thereby enabling exits for existing investors in the short term. Alternatively, some existing investors may choose not only to remain invested but also to provide further funds to help their portfolio companies tide over this crisis and wait for a better time to exit with higher returns. It remains to be seen, however, which of these two options existing investors will prefer.

Nivedita Tiwari is a partner and Nandini Seth is a senior associate at Shardul Amarchand Mangaldas & Co.

Shardul Amarchand Mangaldas & Co
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Managing Partner Mumbai: Akshay Chudasama
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