Country scanning of the region
Competitive advantages of India over the other options
Form of initial presence
Joint venture or not
Profile of joint venture partner
Market size in India
Target market segment
Profile of buyers
Profile of competitors
Quantification of financial performance objectives
Potential competition with other business,
Pricing & product mix
Regulatory of environment
Selection of a business model
Liaison Offices or representative office
They need and approval by RBI, the central bank of India. It undertakes liaison activities. It acts as a channel of communication between Head Office abroad and parties in India. It is not allowed to undertake any business activity. It cannot earn any income in India and survives on inward remittances. It collects information, carries out the business development activities, the Indian business environment, contact the regulatory authorities for feasibility of a certain type of project and the required approvals. It promotes the products of the parent company in Indian market. It can also look for exporters from India to procure goods for its foreign parent. It can enter into memorandum of understanding with the local companies with futuristic intentions. Liars and officers remove the their licence every 3 years. They file an Annual Activity Certificate to RBI every year.
Foreign companies can carry out a larger set of activities without incorporation in India by establishing a branch office to manage manufacturing or import export. Reserve Bank provides an approval for branch office. They cannot establish retail sale shops. They cannot acquire land. Applicable tax rate for them is higher. They have to produce certified activity reports to RBI.
They can carry out the following activities:
1. Import and export of goods of foreign company
2. Business services in the name of foreign company
3. Consultancy Services in the name of foreign company
4. Research and development either on standalone basis or in collaboration with local company
5. Formation of business alliances and business development
6. Technology Services to the Indian companies
7. Information Technology Services to Indian companies
8. Post sales support
Project officers are established to complete the contract awarded by Indian companies. RBI provides permission for the same. These are typically large scale infrastructure projects sponsored by the World Bank or the Asian Development Bank in which the foreign companies are EPC contractors. In case the project requires formation of a special purpose vehicle incorporated in India, FDI rules will be applicable.
When one company invests in the other, or buys the equity stake in the other company, or subscribes to the fresh issue of shares it need not be always 100%. When it comes to small and medium enterprises, Apohan has observed that, it is the personal strength of the founder/ promoter/ director that keeps the enterprise going on. He has the highest quality of relations and network with all the the stakeholders of the business. Hence, it would be kind of unwise to remove off this original promoter and put in place a completely new management. It depends on the circumstances, but the original management should continue at least for couple of years for hand holding, or for integration of the merger, or as independent directors, or on salary basis, or till the demonstration of potential performance promised at the time of the deal even in case a business is completely bought out.
The functioning of the board of directors and the General Body of members (shareholders) requires a specific percentage of the ownership or the control to be able to take a specific type of decisions. On one side, the importance of ability to lead the decisions (or importance of the power and authority to be able to take important company decisions without interference of the other shareholders) is very critical and on the other side, the available cash for purchase of adequate percentage of total holding is a serious limitation.
When it comes to listed companies, the degree of compliance for acquisition of control requires larger compliances including open offer to retail investors according to the takeover code. The companies also have to see that the cross holding of certain shareholders does not result in conflict of interest for tenders. If a company has more than 5% equity in another company and if both of them bid for a tender, both of them may be disqualified for conflict of interest. Increased acquisition of equity stake also results in requirement of compliance of related party transactions, the regulations also called transfer pricing regulations.
Following is the classification of the merger and acquisition activity based on the extent of acquisition of control:
Buyout or sellout deals:
It means the acquirer acquires 100% stake of the original shareholders. The basic objective behind a buyout deal is the complete flexibility in the new management and no interference from the legacy management in key decision making.
Absolute majority deals:
In the deals for absolute majority, the acquirer acquires 90% or more stake in the target company. With 90% stake, the number of corporate process complexities in terms of taking care of the minority shareholder reduce drastically.
Concept of majority stake:
Majority stake means more than 50% shares. Having more than 50% shares is as good as having veto power. Without the consent of the majority, not even a small decision can be taken in a company. However, it is to be noted that majority stake is not sufficient, it gives the shareholder the power to veto out the decisions that disapprove but it doesn’t give them the power to execute all the decisions that they want to undertake. For the special type of decisions, the board must pass special resolution which require minimum 75% holding in case there is friction or difference of opinion in the board.
Control deal are the merger and acquisition deals in which investors’ preference is to acquire more than 50% equity and replace the existing management or board of directors with new one or at least to substantially reconstitute it. Typically, the valuation of shareholding for 49% stake, 50% state, and 51% stake is not in the proportion 49: 50: 51. There is control premium for exercising equal control on the company and there is even more control premium for handing over the control at 51% stake. Control premium is the amount over and above the mathematically proportional valuation.
Minority stake deals:
Any state less than 50% of the total equity is called minority stake. While the financial benefits are proportionately available, the majority shareholders may oppress the minority shareholders as they have the control over the management of the company. There are several statutory provisions for the protection of interest of the minority shareholders.
Representation stake deals:
If a shareholder for a group of shareholders have more than 25% equity in the company, they have the right to nominate one director on the board of directors. The presence on board of directors does not help in leading any decision making, does not help much in avoiding adverse (to the group) corporate decisions. It provides a comfort that they are being treated fairly. Every director has access to critical company information and the shareholder group can rest assured that no siphoning of funds is happening.
Material stake deals:
When the stakeholding of a single shareholder or a single company or a single group of companies exceeds 5%, or exceeds 10% but is lesser than 25%, depending upon the domestic or foreign origin of the company, several reporting, declaration, disclosure, compliance, etc norms shoot in.
Marginal stake deals:
Marginal stake means very small equity shareholding (0 to less than 5%) in a company. It cannot exercise any kind of control but can be part of the financial benefits exactly on the same lines and in the same proportion as any other shareholder. In India, technically, ownership of a single share gives the right the to the shareholder to attend the Annual General Meeting of a company with even having the largest market capitalisation.
Some mergers and acquisitions take place in which both the companies continue their legal existence but they acquire shareholding in each other. This may be done by the shareholders as well in place of being done by the companies. If the companies have cross holding in each other, subject to compliance of transfer pricing and conflict of interest rules, they would not undertake any commercial decisions that will cause adverse effect on one another.
Differential voting rights (DVR):
Differential voting right is one of the key tools for retention of the financial benefits in proportion of (or more than) the proportion of financial investment. This is achieved by tweaking the control management with differential voting rights for different classes of shareholders. There are examples of 200 votes for one share (in the General Meeting) in some companies and also there are examples of 200 shares for one vote in some other companies. Dilution of control rights in a company results in lower valuation of DVR shares.
Apohan very well understands the various sensitivities around control management in JVs. Apohan helps its clients in the proper management of the control of the merged entity in the right hands so that no destruction of value happens. Apohan carries out professional, end-to-end, customized consultancy services by understanding how to allocate various control functions in the board of directors. Apohan manages the transaction right from the problem identification phase, to the closure of deal with perfection.
Untimely exit of intended partner:
The joint ventures are intended to be with specific partners and the rights of share transfers should be restricted in order to prevent a major shareholder from leaving immediately. Lock in period also can be introduced.
Diversion of business by the partner:
Joint venture partners are in the same or similar businesses, there might be a sense of competition. The joint venture contract must mention how the conflict of interest is avoided.
Difficulties in employee transfer:
Transfer of existing employees to the joint venture company resignation and rehire or transfer or deputation and this could be a sensitive issue.
Sudden depreciation of rupee:
From the perspective of the foreign investors, to the extent it is required for remittances, the trend in exchange rate can destroy excellent performance achieved in Indian market.
Applicability of the related party transaction rules:
Indian transfer-pricing regulations, the Indian joint venture and the foreign shareholders would be considered “associated enterprises” and any transactions between them would be required to be conducted on an arm’s length basis.
Disagreement on the management structure:
The parties should agree on a mutually acceptable management structure.
Incorporation documents at variance with JV contract:
For the equity joint ventures, all the issues agreed between the parties should be reflected in the incorporation documents.
There may be regulatory upper limits for remittances (both lump sum fees and periodic royalties) in case of technology transfers and license or use of trademark or brand name.
Complexity of tax laws:
The incremental proceeds of sale of shares are taxed as capital gains for foreign investor.
The double tax avoidance agreements (DTAAs) are applicable with many countries.
Biased method of share valuation:
While purchasing the shares of Indian companies, price paid should be more than DCF valuation prepared by a certified valuer. While selling the shares of Indian company, the price should be equal to or less than DCF value computed by a certified valuer.
Misuse of intellectual property:
The intellectual property should be registered in India for enforcement of protection.
The licensing agreement, know-how agreement, technical services agreement, royalty payment, franchise agreement should be made part of the main agreement.
Limited financial capacity of partner:
The financial capacity of the local partner should be checked.
Treatment as foreign entity:
The 50:50 equity joint ventures are treated as foreign owned Indian companies for the purpose of applicability of FDI norms for further Investments.
Place of effective management:
If a foreign equity joint venture has 50% or more foreign equity (making it a foreign owned and controlled company -FOCC), and if the place of effective management (POEM) is outside India, the double tax avoidance Treaty will come in picture. However, even if the place of effective management is outside India but the company is owned and controlled by Indian citizens (making it an IOCC), it will be treated as a 100% Indian company for tax purposes. This is also relevance from the perspective of being able to make for the downstream investment into two other Indian companies without requiring approvals under FDI for making investment, without requiring RBI compliances for running the company.
Apohan consultancy provides the following services for India entry strategy:
Understanding client objectives
Preparation of client profile
Secondary market research of the sector and industry
SWOT analysis of possible investment
Appointment of a market search agency
Appointment of a market survey agency
Review of market study report
Study of applicable Indian legal and regulatory framework
Inception report for entry structure
Analysis of broad entry options (presents in the form of a foreign company, wholly owned subsidiary, equity joint venture, contractual joint venture)
Analysis of mode of subscription to equity
Analysis of form of equity
Orientation of client management for the joint venture process
Preparation of the desired target profile of the Indian company
Anonymous advertising in print media, online media, social media
Circulation of opportunity among investor forums, business forums, online deal platforms
Identification of the a list target Indian companies
Groundbreaking discussions with target companies
Selection of the target company
Non disclosure agreement between principals
Structuring of the joint venture
Negotiation for sharing of control and scope of work
Formulation of a strategy for a new project (size, location, capacity, etc)
Preparation of project information memorandum
Preparation of project profile
Preparation of a Business plan
Preparation of time Schedule of investment requirement
Negotiation on mode of issue of equity
Determination of type of equity
Preparation of nature of amendments in MOA & AOA
Preparation of of drafts of board resolutions for internal approvals
Preparation of mutual India between principles
Preparation of the financial model
Preparation of valuation for various levels of Equity stakes in the company
Preparation of key strategic terms of joint venture agreement
Selection of accounting, taxation and secretarial experts
Valuation for the purpose of taxation through certified valuers
Identification of due diligence agency
Due diligence (corporate, financial, key contracts, marketing, procurement, key assets, real estate, manufacturing facility, permits & certifications, technology, operations, brand, intellectual property, compliance, associate companies, forensic, human resources, information technology, administration)
Preparation of due diligence report
Preparation of risk profile of the joint venture or WOS project
Compilation of data for specific query
Preparation of term sheet
Preparation of draft business transfer agreement
Assistance in board meeting and General Meeting as special expert invitee
Analysis of disclosure schedule
Assistance in negotiation of business transfer agreement
Assistance in execution of the investment document
Assistance in understanding the investment payment process
Resolution of deadlocks
Key inputs on integration process
Hand holding support for management of joint venture after the deal