Mumbai: In a move that will benefit private equity (PE) and venture capital (VC) firms in India, the Securities Appellate Tribunal (SAT) has put to rest a long-standing dispute between the market regulator and the PE industry over what “control” of a company entails.
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; it typically appeals SAT rulings in the Supreme Court.
Seeking control: Sebi’s headquarters in Mumbai. The market regulator has not yet appealed against the ruling. Abhijit Bhatlekar/Mint
“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 goes back to October 2007, when Subhkam Ventures increased its stake in MSK Projects (India) Ltd, a listed infrastructure firm, from 8.8% to 24.6%. Because the investment crossed the 15% threshold, Subhkam had to make an open offer to acquire another 20% stake from public shareholders, under Regulation 10 of Sebi Takeover Regulations. However, Sebi 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.
PE firms are loathe to take on the role of a promoter because it brings its own set of regulations. One of the key norms is that if the company has a follow-on offering or any transaction relating to securities, promoters must disclose their shareholding in the company and investments in other companies.
“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 would 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 enter into an agreement with the promoter or shareholders to give them certain governance rights such as a board seat, a standstill clause —which requires the company to maintain its character between the execution and completion of agreement—and 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 points out 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.
In its order, SAT held that a single nominee on a board of 10 constitutes a “microscopic minority”, and that the purpose of such nomination is only to provide certain informational rights to the investor.
In relation to the standstill clause, 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. Similarly, the provisions relating to quorum rights have been held as not conferring any veto power or control over the target company.
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, among others, 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.