International Finance International Finance
The Securities Appellate Tribunal (SAT) has finally helped in settling down a long-standing dispute between the market regulator and the PE industry over what “control” of a company entails. This move is definitely going to prove beneficiary for the private equity (PE) and venture capital (VC) firms in India.
On 15 January, SAT ruled in favour of Subhkam Ventures (I) Pvt. Ltd, "making it possible for PE investors to retain their contractual rights without having to become controllers or promoters of a portfolio company at the time of their listing or making a tender offer."
The Securities and Exchange Board of India, or SEBI, has not yet appealed the ruling whereas it typically appeals SAT rulings in the Supreme Court.
“This is a significant move because we have also faced this issue. When any of our investee companies look to file a DRHP (draft red herring prospectus), we have to disclose and/or give up those rights,” says Alok Gupta, managing director and chief executive, Axis Private Equity Ltd.
The case has gone to October 2007, where Subhkam Ventures has increased its stake in MSK Projects (India) Ltd, a listed infrastructure firm, from 8.8% to 24.6%.
Because the investment crossed the 15%, Subhkam has to make an open offer to acquire another 20% stake from public shareholders, under the Regulation 10 of SEBI Takeover Regulations.
However, SEBI has asked Subhkam to make an open offer under Regulation 12 as well, under which it is mandatory for persons who control the company to make the open offer.
“This is one of the major reasons why PE firms fear becoming the promoter,” says Somasekhar Sundaresan, partner and practice-head for private equity and securities law, J.Sagar Associates, which represented Subhkam. “They will then have to fulfil the tracking and reporting requirements every quarter.”
PE investors also say that "they do not want to be held responsible for the actions of the promoter. So if the promoter decides to take an issue to court, PE funds do not want to be in that position."
“Any investor will like to stick to its core competence which is picking the right company and staying invested in it with the objective of getting maximum capital gain. Our core competence is not running businesses,” says Manu Punnoose, managing director, Subhkam Ventures.
At the time of investment, PE firms have entered into an agreement with the promoter or shareholders to give them certain governance rights such as a board seat, a standstill clause that requires the company to maintain its character between the execution and completion of the agreement as well as on the affirmative rights which prevent the company from taking select decisions.
According to SEBI,"these rights amount to control and thus render the PE investor a controller; the regulator used the same reasoning when it directed Subhkam to make the open offer under Regulation 12."
Sundaresan declared that "PE firms have often been asked by SEBI to drop their governance rights when their portfolio companies are listed, in case of private investment in public equity deals, PE investors are asked to declare themselves as promoters if they want to keep those rights."
“These rights are defensive rights meant to protect the financial investors’ interest,” said Sundaresan.
SAT said "it is merely a provision to ensure that the company does not deviate from the basis on which the decisions to invest have been made and, therefore, does not amount to control."
PE firms such as ChrysCapital Investment Advisors India Pvt. Ltd, Warburg Pincus India Pvt. Ltd, IL&FS Investment Management Ltd, Citigroup Venture Capital
International and ICICI Venture Funds Management Co. Ltd, are among others, that have had to drop these governance rights in the past, the latest being Warburg Pincus at the time of listing of its portfolio company DB Corp. Ltd, in December 2009.