Home and profits are where the heart is

Some startups in India have set up foreign holding companies (HoldCo), attracting investment from venture capital and private equity funds. Often, HoldCos have been formed through restructuring, also known as externalisation or flipping, taking advantage of favourable foreign regulatory regimes, better protection of intellectual property, easier access to capital and product markets and the option of overseas listing.

However, the opposite trend has recently gained traction, where up to 20 Indian startups may be exploring reverse flipping, that is shifting their domicile back to India. Some have already done so in preparation for a public listing. This is due to the government’s efforts in easing doing business, bolstered by the successful listing of several coming-of-age startups on local bourses.

A common way of reverse flipping is through an inbound, cross-border merger of the HoldCo with its Indian subsidiary, the latter being the surviving company. Inbound mergers must comply with the Foreign Exchange Management Act, 1999 (FEMA), and its regulations, including the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019, and the Foreign Exchange Management (Cross-Border Merger) Regulations, 2018 (cross-border regulations). Mergers must also follow the Companies Act, 2013, and rules thereunder.

An inbound merger has to be approved by the National Company Law Tribunal (NCLT), which is a time-consuming process, and overall timelines vary depending inter alia on the workload of the NCLT, the regulatory approvals required, whether creditor meetings have been convened and if objections have been raised by stakeholders or governmental agencies. The amalgamating entities have to obtain corporate approvals, and prepare requisite documentation, including the valuation report and financial statements, to file with the NCLT. The scheme has to be approved by the stipulated majority of the shareholders and creditors of the entity in India. The NCLT will usually direct that notice be given to government agencies, such as the income-tax authorities, the Reserve Bank of India and the Competition Commission of India, any of which may make representations and raise objections.

Further, HoldCos that have raised capital from investors in jurisdictions such as China, which share land borders with India, must obtain government approval under Press Note 3 (2020 Series) of 17 April 2020, before issuing shares to those investors, pursuant to the merger becoming effective.

The HoldCo must also comply with the law where it is incorporated in respect of such mergers. While some foreign jurisdictions have straightforward procedures, others do not allow outbound mergers or have significant tax implications, making the process harder.

Founders and promoters of the foreign HoldCo are typically entitled to employee stock options (ESOP) or similar incentives. However, India does not allow promoters of local companies to be given ESOPs. Startups recognised by the Department for Promotion of Industry and Internal Trade (DPIIT) are exempt from such restrictions, but entities considering inbound mergers may not satisfy DPIIT eligibility. In an inbound merger, promoters’ ESOPs may have to be restructured to be legally compliant and tax efficient.

Debts of the HoldCo become those of the entity in India on merging. Borrowing has to follow Indian law relating to procuring loans from overseas lenders within two years. In addition, the Indian entity cannot send remittances to repay such loans during the two years. If the HoldCo has foreign subsidiaries or investments, they become overseas investments of the Indian transferee company after the merger and have to follow the FEMA regulations on overseas investments.

The government is keen to encourage the trend of “reverse flipping” and has recently set up the expert Padmanabhan committee to provide recommendations on how startups can be encouraged to relocate. If these efforts succeed, it will pave the way for more startups and their investors to re-domicile and list in India.

Puja Sondhi is a partner, Roma A Das is a principal associate and Harjas Singh is an associate at Shardul Amarchand Mangaldas & Co. The views expressed are personal.

Shardul Amarchand Mangaldas & Co

Express Towers, 23rd Floor, Nariman Point,
Mumbai, Maharashtra – 400 021.
Executive Chairman:
Shardul Shroff
Managing Partner:
Pallavi Shroff and Akshay
Chudasama

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