Governance rights, anti-dilution rights, exit mechanisms and other key elements of a shareholders’ agreement

PrivateEquityLawyer_AngiraSinghviShareholders’ agreements govern the rights and obligations of the shareholders. The company is also made a party to such agreements so as to make it binding on the company. Among other things, they set out the various rights of shareholders and provide for the conduct of business, the transfer of securities, and how to resolve deadlocks. Often, the company is also made a party to such an agreement and in an investment transaction, this is done at a “closing” by holding board and shareholders’ meetings that result in the amending of the original articles of association.

Governance rights

These rights set out the level of control that a private equity investor may exercise in the management of the target company.

The common methods of exercising control include:

– the ability to appoint the investor’s representatives to the board

The number of such representatives depends on the level of investment. In cases where the number of representatives is less than 50 per cent but more than 20 per cent, the investor attempts to ensure that the quorum required for any meeting cannot be complete without some or all of its representatives present and voting.

Where the parties cannot agree on such compulsory quorum requirements, a list of “affirmative vote” items is set out. These are items that the board cannot take a decision on without the investor’s consent. Some common “affirmative vote” items include entering into key agreements, the appointment of key personnel, the incurring of indebtedness and creation of security, and bringing about any changes to the business. How comprehensive this list of items is, also depends on the negotiations and the investment. For most startups, the investment is low and their independence in relation to the operations of the business is often instrumental to a transaction. Achieving a balance between such independence and the security of investment is a key point in the negotiations.

– provision of voting rights

In most cases, since the money is routed through a tax-friendly jurisdiction, investment is made in the form of compulsorily convertible instruments with a conversion pricing formula. This means that the instrument shall convert into equity at a later time (with a specific conversion event that should be clearly set out) under a formula that the parties agree on.

Until recently, it was assumed in the agreement that the instruments have already been converted into equity. The proportion of the investors’ (assumed) holding in the entire shareholding of the company would entitle the investor to exercise higher voting rights. After recent amendments to the company law however, only equity shareholders are entitled to vote. It is not clear whether convertible instrument holders can exercise their right to vote in the company. This may have substantially curtailed the voting rights of private equity investors. So while it may be safe(until challenged) to retain in the agreement, voting rights on the basis of an assumed conversion, there may even be a case to increase control at the board level until there is more clarity in the law.

Anti-dilution rights

Usually, in any investment transaction, it is stipulated that if the company carries out a share split, issue of bonus shares, consolidation of shares, combinations, recapitalisations or any similar event that may result in the dilution of the shareholding of the investor, including the issuance of any securities by the company, then the investors will be protected against any dilution of its shareholding in the company. For instance, it may be provided that the company shall take all necessary steps (including but not limited to the issuance of new shares) to ensure that the investors maintain their shareholding at the level prior to the occurrence of such event, without any consideration. However, in a case where there is additional funding required by the company and a party provides for such funding without a similar contribution by the other party, dilution of the non-contributing party cannot be avoided.

Transfer of securities and exit mechanism

At the time of investment, the terms of exit are also clearly set out in the transaction documentation. Sometimes, in a joint venture or a private equity investment, some restrictions are placed on a party’s right to transfer shareholding because their involvement in the company has some value that is not monetary alone. The common forms of restrictions placed on the transfer of securities are lock-in, right of first refusal or offer, tag along rights, and drag along rights. Further, unless there is a sale of the entire shareholding of the company to a competitor, a part of the shareholding is not permitted to be sold to a competitor.

Lock-in refers to a period following the closing of a transaction during which the investor will not be able to sell his shares to a third party. This restriction is essential to maintain a sense of continuity and settlement to the business. In private equity transactions, the investor is not the person who intends to run the business of the company. It invests in the capabilities of the promoters to run the business in a particular manner. In some cases, the involvement of the promoters is key to business and it is not ideal if the promoters divest their shareholding and cease to be a part of the business mid-way through the investment cycle. Therefore, a private equity investor will usually require an undertaking from the promoters that they will not exit from the business of the company, including through the selling of any shares.

Rights of first refusal or offer, and tag along and drag along rights are particularly important when either party wishes to sell its stake to a third party. Prior to the conclusion of such a sale, any of these restrictions in the shareholders’ agreement will require the selling party to offer its shareholding, first to the other shareholder party at a price at which it was contemplating the sale to a third party. In several cases, the selling party provides the other shareholder party an offer at which a third party is ready to purchase its shares. The shareholder party then gets a right to either accept or refuse such offer. Upon a refusal, the selling party is free to sell those shares to a third party but not at a price lower than the price that was offered or provided to the other shareholder party.

Sometimes, when the sale of shares to a third party is acceptable, the other shareholder party is also entitled to sell its stake along with the selling party to such third party. It is often the case that when the promoter sells its stake to a third party, the investor is no longer keen to be in the company or may not be keen to maintain such a high stake in the company any longer and may “tag” its shares along for sale to the third party. This is usually when the promoter retains some shareholding in the company.

The sale of an entire shareholding (known as a buyout) is usually governed by different terms and the provision of drag along rights are very common in such cases. Drag along rights refer to a right where a selling shareholder is entitled to drag the shares of the other shareholder and sell them to a third party at the same price and terms as that of its shares.

Exit rights

In mature private equity transactions, the investor is provided a basket of exit rights including taking the company to an initial public offer where preference is sometimes given to investors’ shares. There may also be provisions for the protection of investors’ money when things go wrong with the target company, a consideration that also influences the investor’s choice of instrument. In private equity transactions, usually, an internal rate of return or a pricing formula based on an acceptable manner of share valuation is determined at the very outset. At the time of exit, a put option is provided to the investor through which it can sell its shareholding to the promoter this pre-determined valuation. On some occasions, parties also have a call option where the other party’s shares may be purchased at a pre-determined value.


Angira Singhvi is a Partner with Khaitan & Khaitan and handles general corporate, joint ventures and private equity investments.


Learn to draft a share purchase (or subscription) agreement for a private equity transaction

PrivateEquityLawyer_AngiraSinghviOnce due diligence has been conducted on the target of a private equity investment and the investor, satisfied with the outcome of due diligence, is ready to invest, the stage is set for drafting the documents needed to complete the transaction. Drafts of these documents are usually prepared while the due diligence proceeds simultaneously.

The key documents

The documents that are fundamental to a private equity investment are (1) the share purchase agreement (“SPA”) or the share subscription agreement (“SSA”) depending on how the investor acquires shares in the target; (2) the shareholders’ agreement (“SHA”); and (3) the disclosure schedule. Since a private equity investor invests in the company for a fixed amount of time rather than in the assets owned by the company, asset transfers are quite rare.

An SPA provides for the transfer of shares to the investor. It is executed when the shareholders of the target company agree to transfer their shares to the investor. Under such an agreement, the investor purchases shares that are already in existence. An SSA on the other hand, provides for a new issue of shares. Such an agreement is preferred when parties decide that instead of the current shareholders transferring their shares to the new investor, the company would issue new shares to the investor. The investor subscribes to these new shares and hence the name, “share subscription agreement”.

An SHA provides for the rights and obligations of the parties inter se, that is, in relation to each other. It includes provisions for the manner in which the target company will be governed and run after the closing. Common items covered in an SHA are the appointment of directors, the conduct of board and shareholders’ meetings, shareholding, the raising of finance, and the transfer of shares.

A disclosure schedule sets out the documents and information that the target has provided or given access to the investor during the due diligence process or at any time before the execution of documents.

Let us now discuss these documents in greater detail. I will cover SPAs and SSAs in this article and SHAs and disclosure schedules in the next one.

As we have seen, an SPA or an SSA (as the case may be) provides the framework for the investor to become a shareholder in the target company. Let us now see some of the major issues that this document will cover.

Transfer or issue of shares

The agreement will state whether the shares are being issued or transferred to the investor. It will also set out the price at which the shares are being issued or transferred, the mode of transfer or issue, and the manner in which the consideration is transferred. While the transfer is stipulated in the agreement, it actually takes place during the board meeting that is conducted at the time of closing the deal. I will discuss the details of how this should be conducted in a later article on closing.

While drafting this clause, it is also useful to keep in mind certain specific aspects that may affect a transfer.

Documents in escrow: The parties may, for example, only want the transfer to take effect from a later date. Until that date, they may want the executed documents to be deposited in an escrow account. While drafting such conditions, you should be able to identify any procedural and secretarial issues such as those in relation to the validity of resolutions for a particular period or the validity of share transfer certificates. An escrow arrangement for instance, will not work unless those documents are valid for the entire period of escrow.

Sale to a foreign party: Similarly, a sale to a foreign party must adhere to the pricing norms contained in the FDI Policy.

Encumbrances: In the case of a transfer of securities, lawyers advising on the transaction should ensure that the transfer is free from all encumbrances. For example, the shares may be pledged to third parties against loans and advances or there may be a charge on the assets of the company. Due diligence should be thorough so that any such possibilities can be crossed out. Further, documentation should mention that all transfers are without any encumbrance. Charges can be searched on the Ministry of Corporate Affairs’ website and a lawyer can draft the ‘transfer’ clause accordingly.

– Authorised share capital: In case of a new issue of shares, a lawyer should also ensure that the company will continue to comply with the ceiling of authorised share capital after such issue. Under law, a company cannot raise more capital than the authorised share capital provided in its memorandum of association. In case the capital after the raise is likely to exceed this amount, the memorandum should be amended to reflect that.

– Nature of security: In case the issue involves a party resident outside India and the automatic route is intended for the investment, a lawyer advising on the transaction should also ensure that the nature of security is such that it is a plain vanilla equity or that is compulsorily convertible into equity and advise the client accordingly.

Conditions precedent to closing the transaction

On completing the due diligence, lawyers advising the investor will be able to identify some key items that the target entity should fulfil before closing the transaction. For instance, the target company may not have complied with some laws.

Some common conditions precedent include:

(1) that target entity should obtain some prescribed licenses;

(2) that it should issue appointment letters to its employees in a prescribed format;

(3) that it should complete the statutory books and pending filings;

(4) that it should obtain necessary corporate approvals and resolutions for entry into the transaction; and

(5) that it should obtain a valuation of shares.

The SPA or the SSA will contain these conditions. A condition precedent has to be fulfilled by the seller after the agreement is executed but prior to closing the transaction. The buyer usually has the option to provide an extension of this period or even to cancel any such compliance as a condition precedent if it is not fundamental to the investment. Common examples of such conditions are the obtaining or renewal of ancillary licenses, such as, the license to operate a lift. However, fundamental conditions such as the license to operate the business or any corporate approvals necessary to undertake the transaction, cannot be dispensed with.

The SSA or SPA will also provide a date by when each of the conditions precedent should be complied with. This is usually called the “long stop” date. The agreement will stipulate that unless the conditions are complied with by that date, the agreement, despite execution, will terminate and there will not be any closing of the agreement.


The “closing” is the point at which the transaction is completed. Shares are transferred, money is paid, the board undergoes changes, and the necessary corporate actions are undertaken to formally make the investor a part of the target entity. Closing is usually undertaken 30 to 60 days after the execution of transaction documents. During this time, the target entity fulfils the stipulated conditions precedent or seeks from the investor, a waiver from fulfilling them.

On the closing date, a board meeting is organised. The main actions undertaken at such meetings include the issue or transfer of shares (as the case may be); the appointment of directors nominated by the investor; and the approval of the amended form of the target’s articles of association and then placing them before the shareholders for final approval. We will discuss the need for such appointments and amendments in a later post on SHAs. The process of closing will also be discussed in detail in subsequent posts.

Following the board meeting, a shareholders’ meeting is also organised. Some matters that are passed by the board, such as an amendment to the company’s articles of association, require shareholders’ meeting for final approval.

Once the closing has been successfully completed, an investor formally becomes a part of the target company. All these aspects are stipulated in the SPA or the SSA usually after the clause on conditions precedent. This clause provides the time and date of closing and also lists out the actions that will be undertaken on the closing date. Since there are numerous actions to be completed, usually, it is provided that upon one last action being completed, all closing items will be deemed to have been completed. This clause also provides the manner in which consideration will flow from the buyer to the seller unless a separate clause on consideration is provided for. There are several ways in which a transfer of shares may take place. For example, it may be in dematerialised form or through the endorsement of share certificates. Consideration may be paid through cash, cheque, or wire transfer. All these aspects are provided for in the clause providing for transfer or issue of shares. Where the investor is a foreign entity, Form FC-GPR in the case of an issue of shares or Form FC-TRS in case of a transfer of shares, need to be filed with the Reserve Bank of India. After all these actions are completed, share certificates are finally issued to the buyer and then the closing is deemed to have been undertaken.

This clause has a large bearing on the completeness of a transaction from a procedural point of view. All items should be carefully listed and completed in accordance with company law and the applicable secretarial standards.

Representations and warranties backed by indemnity

You will remember from studying the law of contracts and sale of goods that representations and warranties are usually made by a seller to a buyer regarding the product that is up for sale. To understand this clause in the SSA or the SPA, you can consider the target company as a ‘product’ that is being sold by its current shareholders. Extensive representations and warranties are made to ensure there will not be any liabilities or adverse consequences for the investor.

They include representations and warranties about the authority and capacity of the parties in entering into the transaction; corporate matters, filings, resolutions and approvals; licenses and approvals for the transaction and business; business of the company; taxation, accounts and records; borrowings; intellectual property; related party transactions; assets; and litigation.

As lawyer advising the investor, you should ensure that your list of representations and warranties should be extensive and cover every aspect in relation to the target company. A lawyer advising the target company will attempt to narrow down the list. For example, if the target company has already provided the investor with some information during the due diligence, you may refrain from providing any representation or warranty on that very aspect as the investor is expected to know the correct state of affairs. Also, if the investor has clearly come to know of any shortfall in the company’s affairs, you may not want to provide a representation or warranty to that item.

These representations and warranties are backed by indemnity. While agreeing to indemnify the investor, the company and its current shareholders promise to save the investor from any loss caused to the investor for any breach, falsity, or shortfall of the representations and warranties. It is important to draft the clause on indemnity carefully to ensure that liability is predictable. A company will want to cap its liability as much as possible while an investor will want to do the opposite.

This brings our discussion on drafting SPAs and SSAs to a close. I will discuss SHAs and disclosure letters in my next post.

Angira Singhvi is a principal associate with Khaitan Sud and Partners and handles general corporate, joint ventures and private equity investments.


Doing solid due-diligence for a private equity investment – here are the key steps

PrivateEquityLawyer_AngiraSinghviEvery private equity investor conducts due diligence on a target before the transaction is finalised and the documents are executed. Through this, a third party (and even the target entity itself) is able to know its actual position vis-a-vis the standards in various sectors.

With a legal due diligence, an investor wants to:

– ensure that the information provided by the target (and which forms basis for the investment) is accurate;

– find out any additional information the advisors should have been told, but were not;

– probe into the assumptions in the business plan and evaluate the possibility of achieving the targets set;

– identify the principal risks to the business and chalk out a mitigation plan; and

– conduct a more detailed analysis of the current state of the company.

There are several types of due-diligence, such as legal, financial, operational, and environmental. As lawyers advising on a private equity transaction, your focus area will be on the legal due diligence.

The term ‘legal due diligence review’ (“LDDR”) refers to the evaluation of whether the target entity has compied with various laws in letter and in spirit. This helps in identifying the major legal risks faced by the investor. Let us look at the steps involved in an effective LDDR.

Step 1: Prepare and circulate the LDDR checklist

An LDDR checklist will note all the possible documents needed from the target entity and to sub-divide them, they are typically grouped based on the areas of law.


Image above is from Oliver Tacke’s Flickr account and has been published under a CC BY 2.0 licence.

For example, you will need the incorporation documents of the target, the details of the shareholding and transfers made, the contracts that the company has entered into with third parties, environmental compliances, certificates of payments made under the Payment of Bonus Act and so on. You can accordingly sub-divide the LDDR checklist into main sections such as “General Corporate”, “Shareholding”, “Material Contracts”, “Finance”, “Employment”, and “IPR”. These sections can then be further sub-divided.

For instance, the general corporate information required from the target can include:

–  the company’s certificates of incorporation and commencement of business and the memorandum and articles of association, along with all amendments that have been made so far;

– the addresses of the registered office of the company, other office(s) of the company, and other locations from which the company operates;

– the legal structure of the group of which the company is a member, preferably in the form of an organisation chart, stating the names and addresses of all the companies in the group with the percentages of participating interest and describing the relationship between the company and other affiliated group companies, partnerships, and (un)incorporated business associations within the group;

– a summary of the history of the company;

– a brief description of the company business, for example, the business areas, the main products in each, and geographical presence;

– the details of any alliances entered into or to be entered into by the companies including copies of the agreements;

– the details of any branch, agency, place of business, or any permanent establishment of the company outside India including address, brief description of business carried on and numbers of personnel involved;

– the copies of all documents relating to any scheme, merger, amalgamation or restructuring, asset transfer, or acquisition involving the company or any of the group companies or subsidiaries.

The intention, as you can see, is to obtain as much information as possible.

Step 2: Know all the applicable laws

For an effective LDDR, the legal advisor should be aware of all the laws applicable to the target’s business. It is important to assess whether the target has complied with all thse laws and the consequences of any non-compliance. These consequences may pose risks for the target company and therefore, the investment as well.

For example, if the target is required to obtain a particular license prior to manufacturing a product and if it has not been obtained, there is a risk of having to cease the manufacturing activity. This may lead to immense losses to the target and therefore, the investor. Unless you know that this license was required, you will not be able to assess whether the company has complied with this legal obligation.

It is also important to understand the application of local laws. Land laws, for example, vary from state to state. Depending on the state in which activity is carried on, all applicable local laws should be identified.

Step 3: Review and comprehensively analyse documents

After circulating the LDDR checklist, a representative of the target entity, usually their lawyer or company secretary, will assess the applicability of each point. The relevant documents are then provided to the investor’s legal advisors.

documentsThese documents should be reviewed in detail by the lawyer and all possible outcomes should be analysed. For example, in case of an outstanding term loan shown in the books of the target, you should analyse all the restrictions in the term loan agreement such as whether any further funding (by the investor) is permitted, whether there are restrictions on the payment of dividend to the investor, and whether the charges are enforceable. If these activities require the prior permission of a lender, it may not be easy to recoup the investment. If an outstanding loan is shown in the balance sheet, for instance, all relevant documents should be obtained from the target in order to assess any restrictions on the investment, the enforceability of any charge, and the value of secured assets.

To take another example, agreements that reflect the business of the target need to be obtained and evaluated. Often, agreements have not been entered into and some times, such contracts have been entered into with related parties. This can be seen from the corporate details provided by the target. If there are any related party agreements, you should check whether all the required provisions have been complied with.

Since the LDDR is an investigative activity, it is important to keep your eyes and ears wide open. Often, attempts are made to hide information that may be detrimental to an investment. A glaring example is the Ranbaxy transaction. Important information was concealed during the due diligence and as a result, the joint venture party incurred losses. You may need to request the target for clarifications and seek further information backed by documents before you are satisfied on all the issues.

Step 4: Think about what can be done to mitigate risk

After the review of all the documents, you will often notice that further action is required to mitigate the investors’ risks. Usually, they belong to the following categories:

(i) obligations that have to be fulfilled as a condition precedent to closing the investment;

(ii) representations and warranties backed by indemnity;

(iii) creation of escrows; and

(iv) conditions subsequent.

For instance, after the review of loan documentation, you may conclude that prior permission is required before additional funding is brought in. It is your duty to make your client aware of this stipulation and then include it among the conditions precedent to closing the transaction.

Similarly, if the target is facing litigation with respect to an event prior to the investment, the investor should not be required to bear its costs. The amount of potential loss should either be set aside in an escrow or adequate representations and warranties backed by indemnity should be stipulated in the transaction documents.

Step 4: Draft and finalise the LDDR report

The outcomes of an LDDR exercise are usually set out in a report. Depending on your understanding with the client, it may either be a long form report or a report setting out only the main issues.

You should bear in mind that the report should be structured in a manner that all sections are classified and organised in the order of importance. Issues should be clearly identified and all risk mitigation solutions should be clearly set out.

In my next post, I will discuss the transaction documents in a typical private equity investment.

Angira Singhvi is a principal associate with Khaitan Sud and Partners and handles general corporate, joint ventures and private equity investments.


The four types of laws that all private equity lawyers must know

PrivateEquityLawyer_AngiraSinghviTo advise on private equity investments and their structure, lawyers need to be aware of the many laws that affect transactions. Let us look at the four major categories of laws that can regulate a private equity transaction.

1. Foreign investment laws

When investment flows in from countries located outside India for investment in some business activity and not merely stock or trading, the amount is treated as foreign direct investment (“FDI”) and the investment needs to comply with applicable regulations. Many private equity funds are based out of tax havens such as Mauritius and the British Virgin Islands and FDI is routed through such jurisdictions.

Every year, some time in the months of April or May, the Ministry of Commerce and Industry issues an FDI policy, governing areas such as the kind of instruments that may be issued, sectors in which investment may be freely made, and the procedure of issue. The policy is reviewed every year and changed if necessary.

Depending on factors such as the business sector, the nature of the instrument, and the intended percentage of shareholding, FDI can fall under the automatic route or the government route. Under the automatic route, the investor can directly invest into the target company without obtaining any prior approval from the government. Under the “government route” or the “approval route”, prior approval is required from the Foreign Investment Promotion Board. For example, prior government approval is necessary in mining, coal and lignite, and real estate unless some prescribed conditions are complied with.

The Foreign Investment Promotion Board is housed in the Department of Economic Affairs of the Ministry of Finance.

The Foreign Investment Promotion Board is housed in the Department of Economic Affairs of the Ministry of Finance.

Structure of the target: FDI investment into a company or a venture capital fund (not being a trust) is most straightforward because there are fewer restrictions and the investment is permitted through the automatic route. While investors may prefer investing in trusts and LLPs to take advantage of tax and operational benefits, additional structures are required for an FDI investment.

Types of instrument: Indian companies can issue equity shares; fully, compulsorily, and mandatorily convertible debentures; and fully, compulsorily, and mandatorily convertible preference shares under the automatic route subject to the pricing guidelines or the valuation norms prescribed by the regulations under the Foreign Exchange Management Act, 1999 (“FEMA”).

Convertible instruments get converted into equity after a specified period of time. A prescribed conversion formula determines the value of that instrument or the equity shares to be issued. Unless they are compulsorily convertible, they do not fall within the category of permitted instruments under the automatic route.

All other instruments (including optionally convertible instruments) are considered debt and require compliance with the Reserve Bank of India’s guidelines on external commercial borrowing.

The price or conversion formula at the time of conversion of a convertible capital instrument should be determined at the time of its issue according to any internationally accepted pricing methodologies and on arm’s length basis for unlisted companies. For listed companies, a valuation has to be made under the Securities and Exchange Board of India( Issue of Capital and Disclosure Requirements) Regulations.

In order to use the automatic route, the instruments need to be fully paid up and comply with the pricing norms, failing which, the government’s prior approval is required.

Reporting of the investment: The FDI policy requires that any amounts received by the target entity against capital should be reported to the Reserve Bank of India. An amount received against the transfer of existing shares should be reported by filing Form FC-TRS. An amount received against the issue of new shares should be reported by filing Form FC-GPR.

Business sector: FDI policy restricts the level of investment in certain sectors. In such sectors, investment above a certain percentage of the total shareholding requires the prior approval of the government. In some sectors, even indirect shareholding or control is not permitted. For example, in defence production, air transport services, ground handling services, asset reconstruction companies, private sector banking, broadcasting, commodity exchanges, credit information companies, insurance, print media, telecommunications, and satellites, no transfer is permitted that may result in ownership or control by foreign entities.

2. Laws governing listed companies

Acquisition of shares: Ordinarily, shares are freely transferrable in listed companies (unless there are agreements to the contrary). Some provisions of the Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 1997 (“Takeover Regulations”) however, can hinder the acquisition of shares in a company.

Any acquisition of shares or voting rights that will give the acquirer (or persons acting in concert with the acquirer) 25 per cent or more of the voting rights in the target company can only go forward after the acquirer makes a public announcement of an open offer to acquire at least 26 per cent of the voting shares from the public shareholders of the target.

The Takeover Regulations also lay down norms that apply to acquisitions where the acquirer already holds or controls a substantial amount of shareholding in the target company. Further, under Regulation 4 of the Takeover Regulations, irrespective of the acquirer’s shareholding or voting rights in the target company, it shall not acquire control over a target company without making an open offer for acquiring shares.

The term ‘control’ is significant for private equity transactions because investors tend to insist that their active consent should be taken before any main action affecting the company is taken, such as any future financing, entering into any agreement above a certain value, appointment of directors, deciding upon agenda of board and shareholders’ meeting, restrictions on sales and company assets, and sale of shares to third parties. Even when they have a minority stake in the company, they insist upon such rights and often, this list is so wide that it may be interpreted as exercising control over the company.  According to the SEBI, an agreement that incorporates such a condition would give the private equity firm ‘control’ over the company even though its shareholding is not high enough to trigger the Takeover Regulations.

In addition to the requirement of having to make an open offer, the target company and its board of directors become subject to a few other obligations. For instance, during the offer period, no person representing the acquirer (or any person acting in concert with him) can be appointed as a director on the board of directors of the target company.

If the private equity investor decides to acquire the entire public shareholding resulting in the delisting of the company, even more regulations apply in the form of the Securities and Exchange Board of India (Delisting of Equity Shares) Regulations, 2009 (“Delisting Regulations”). The company must be listed for a period of at least three years and the delisting cannot result from a buy-back or preferential allotment of shares by the company.

3. Insider trading regulations

It is an offence under the Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations, 2015 to ‘deal in securities’ while in possession of unpublished price-sensitive information, that is, any information that, if published, is likely to affect the price of the securities of a company. The Companies Act, 2013 has also introduced provisions on insider trading. Section 195 of the Act, which applies to unlisted companies also, lays down punishments of imprisionment and hefty fines for their contravention.

4. Other company law aspects

Since private equity investments are usually made in companies, a detailed understanding of the Companies Act, 2013 (“Act”) is necessary before advising on transactions. Some of the important provisions are discussed here.

Layered investment: Investments through more than two layers of investment companies, preffered by private equity investors because of their tax efficiency, are not permitted under the Act.

Restrictions on transfer of shares: Unlike its predecessor, the Act allows shareholders of ‘public’ companies to enforce restrictions on the transfer of securities. Private equity investors therefore, can freely stipulate conditions on the transfer of shares such as drag-along rights, tag-along rights, and right of first refusal (all of which will be explained in detail in a later post on transaction documents). The Act only protects these conditions as if they are a contract between private persons, and so, to bind the company, it may be advisable to incorporate these provisions into the articles of the company.

Differential voting rights: The Act also contains provisions relating to different classes of shares. Barring a few situations, private companies cannot issue preference shares with voting rights.

Representation on the board: In order to safeguard their investment, private equity investors usually nominate one director to the board of the target company. As their legal consultant, you should be able to advise the investors about the consequences of such an appointment. A director who becomes ‘aware’ of any contravention by way of his participation or receipt of information and does not object to such contravention can be subject to prescribed punishments. Such liability extends to non-executive directors as well.

Amendments to a company’s articles: The articles of a company are amended following a private equity investment to reflect the amended understanding amongst shareholders. You should verify whether the current articles of the company contain any provisions that may only be altered after following procedures that are more restrictive than those applicable in the case of a special resolution, and that these procedures are complied with at the time of the closing. Such provisions may also be inserted in the articles to protect the interests of the investor in its capacity as a minority shareholder.

Apart from these major laws that are essential to advice on private equity transactions, some other laws are important at the stage of conducting due diligence over the target. Let us look at those laws in a later post on conducting due diligence.

Angira Singhvi is a principal associate with Khaitan Sud and Partners and handles general corporate, joint ventures and private equity investments.



An introduction to strategies and risks in private equity for lawyers

PrivateEquityLawyer_AngiraSinghviCommon funding options available to companies include taking loans from banks, commercial borrowings, and issuing equity shares and convertible instruments. Even though the cost of borrowing is perceived to be lower than the cost of equity, companies often prefer not to take loans because among other reasons, loans require security, increase the repayment obligation on the company, and increase its debt-equity ratio.

Another option is to raise equity investment from a closed group of private persons directly. Well known examples of this category of investors, known as ‘private equity funds’ or ‘private equity firms’, include Blackstone, Goldman Sachs, Warburg Pincus, and Carlyle and their investments are called private equity (“PE”) investments. Their objective is to transfer back their shares in the company at a pre-determined rate at the end of a certain investment period and earn a return on these investments. In India, unless the gestation period of the target company’s business is long, this period ranges between three and five years.

In India, private equity investments are mostly made into private or public non-listed companies. While there is no bar, legally or conceptually, to making private equity investments in listed companies, the law governing the acquisition of shares in listed companies above a certain threshold makes them cumbersome.

Since it is aimed at maximising shareholder return in a fixed period, private equity helps in speeding up the process of achieving growth targets. Private equity can also help professionalise some mature companies that earn profits but do not have systems in place with respect to reporting, compliance, and accounting. It can also change the direction of a company and enable it to take calculated risks as opposed to the following the directions of one person. Remember also, that the private equity market is less transparent compared to the market for listed stocks and bonds, and so may offer more opportunities and higher returns.


Even though most PE funds are generalists and invest into all kinds of promising ventures in a variety of sectors, specialised PE funds focusing on particular sectors or a particular strategy of investment, have emerged. Private equity investments can be used for financing start-ups, injecting working capital into a growing company, or acquiring a mature company. It can also be used to strengthen a company’s balance sheet.

– Among all categories of PE investments, venture capital, which is provided to start-ups and early stage growth companies, has the highest risk and the highest potential for returns. The strategy here is to invest in companies that promise a bright future. Their business model typically involves high technology industries such as information technology, healthcare, and green or renewable energy. Companies, if successful, experience higher levels of growth.

– Growth capital is provided to mature companies that have already made it through the early stages and are able to generate constant revenues. Such financing is usually for a major expansion or diversification that the company cannot fund on its own. Recently, on 1 May 2015, Goldman Sachs and Rocket Internet invested USD 100 million into food delivery portal ‘Foodpanda’. The investment is aimed at further expanding Foodpanda’s own delivery activities and improving overall customer experience across global markets.

– The strategy behind buyouts is to acquire a stake in a mature, established company with a strong market position in order to exercise influence on it. Privatising a company allows the management to take decisions or adopt strategies that could otherwise be difficult or controversial in a publicly listed company. For example, disposing off an undertaking or a substantial asset of a listed company may be a cumbersome task since the same requires a special resolution to be passed under company law. It is much simpler to pass such resolution after acquiring a stake in a company through which the investor can influence the decisions of the company.


While a private equity investment may appear more appealing than a bank loan, there are risks involved in the transaction.

– The PE investor, even when holding a minority stake, exercises influence over the company and restricts the entrepreners discretion to a large extent.

– The costs of continuous and detailed reporting may be an added burden on the target company.

– There are likely to be restrictions on the transfer of shares of the current shareholders of the company for the benefit of the PE investor;

– The rights of the PE investor at the time of its exit from the company along with its return may often be unduly harsh on the promoters. For example, it may require the promoter to compulsorily sell his shares on terms and conditions agreed upon by the PE investor with a third party purchaser.

– Being pure investors, the interest of a PE investor in the company is limited to the recoupment of their investment.

These concerns, especially the risk of diluted control over the company, may often outweigh the benefits of PE investment.


To ensure a successful PE investment, lawyers advising the parties have to ensure that both investor and the target are well prepared.

– The target company should weigh the limitations that are likely to be placed on the discretionary powers of its current owners against the need for money from the investors. Clients that are not from a professional background must be clearly advised about these consequences.

The main concern of a PE investor is to ensure that it exits the company smoothly and with an acceptable return on its investment. An estimate of this return helps avoid disputes later. The target company should prepare this estimate professionally. This requires clarity on the current business situation as well as the forecast.

A PE investor, prior to investing in the company, always conducts a penetrating due diligence on the target company. The investor will examine every aspect of the company including its governance, compliance, and reporting structures. By ensuring that it is compliant, for example, that meetings are held in time, that books and registers are well maintained, that all filings are made, that proper contracts have been entered into for all activities, and that licenses and registrations have been duly obtained and maintained, the target company can remove uncertainty and delays in the conclusion of a transaction. In fact, the target company should even conduct an internal compliance due diligence on a regular basis.

– Disagreement during the finalisation of transaction documents can be largely reduced if, before entering into a transaction, the framework of the investment is set out in a term sheet. There should therefore be clarity on issues such as the nature and type of instrument (whether a convertible or plain vanilla equity), the structure through which equity will be infused, the exit rights of the investor, restrictions on the transfer of shares of the current shareholders, and the governance of the company. The agreement on these issues can be revised after the reviewing the results of the due diligence.

I will reflect about private equity transactions in greater detail in a few more posts here.

Angira Singhvi is a principal associate with Khaitan Sud and Partners and handles general corporate, joint ventures and private equity investments.