PRIVATE EQUITY

Concepts And Types

MEANING

▪ Investment into private companies not quoted on stock exchange.▪Firms invest in underperforming companies with high growth potential.▪Can be used for development of new products and technologies, expand working capital.

CHARACTERISTICS

▪ Limited liquidity.▪ Investment follows high risk and high return objective.▪After the minimum investment period, the private equity fund can sell the stakes of the company to realize the gain.▪ Private equity market is not transparent.

ILLUSTRATION

▪A private equity fund XYZ wants to invest in a Start Up Company ABC Pvt Ltd, incorporated in 2014, which is a food delivery service, operating mainly from 7pm to 7am, with a primary focus on students and night shift office goers (BPOs). ABC Pvt Ltd is planning on expanding its operations to App based services and larger delivery area, and is looking for investments for the same.

Types of Private Equity

Venture Capital

Leveraged

Buyout

Angel Investor

sGrowth Capital

Mezzanine

Capital

VENTURE CAPITAL

▪ Money invested in new companies.

▪ The companies are startup companies which have difficulty in attracting finance.

▪ Different stages in which the venture capital funds finance companies:

Seed stage – Financing

for research

and developm

ent of initial idea.

Start-up stage – Finance

for product

development and initial

development.

Expansion stage –Finance

for growth and

expansion

Replacement

capital – The

venture capital funds

purchase shares from

another investor

ANGEL INVESTORS

▪They are high net worth individuals.

▪ Invest in new idea and help bring the new idea into the market.

LEVERAGED BUYOUT

▪ Investments consist in acquiring a stake in a private company with an intention to exercise influence on the company.▪Leverage - partly financed with a certain amount of debt in addition to equity.

GROWTH CAPITAL

▪ Investment in relatively mature companies that are looking for capital to expand or restructure operations, enter new markets or finance a significant acquisition without a change of control of the business.

MEZZANINE CAPITAL

▪Hybrid of debt and equity financing.▪ It is basically debt capital that gives the lender the right to convert the loan into equity in case of non-repayment in time and in full.

LEGAL REGIME

Laws regulating private equity in India are:

A) SEBI-▪ SEBI (AIF) Reg. 2012▪ SEBI (Investment

Advisors) Reg. 2012▪ SEBI (FVCI) Reg.2000▪ SEBI (SAST) Reg.

1997

C) FIPB

B) RBI▪ FEMA, 1999▪ Transfer or Issue of

Security by a Person Resident Outside India, Regulations, 2000

D) Income Tax, Act, 1961.

SEBI (AIF) Reg. 2012

Private equity funds placed under category II . The various requirements as per the regulations are :

PARTICULARS REQUIREMENTS

Registration Any fund established in IndiaForm Trust, LLP, companyInvestment in companies incorporated outside India

Permitted (subject to RBI guidelines)

Maximum investors 1000 (per scheme)Investment in associates Permitted only with approval of

75% of investor by value of their investment

Investment in other Category AIF In Category I AIF and Category II AIF

Investment in other Fund of Funds

Not Permitted

PARTICULARS REQUIREMENTS

Leverage / Borrowings Not permitted except for meeting temporary funding requirement subject to leverage of not more than 30 days, not more than 4 occasion in a year and not more than 10% of the corpus

Tenure Minimum 3 years, may be extended upto 2 further years by approval of 2/3rd unitholders.

Investment in one investor company Shall not invest more than 25% of its investible funds in one investee company

Tax “Pass Through” The income from such funds will not be exempt under capital section 10(23FB) of the Income Tax Act, 1961 Taxation of such hands would depend on the legal status of the fund i.e. company limited liability partnership or trust.

PARTICULARS REQUIREMENTS

Valuation AIF must disclose to the investors the valuation procedure and the methodology for valuing assets.Valuation should be carried out by an independent valuers once in every 6 months. This period can be extended to one year with the approval of 75% of the investors by value.

Reporting Within 180 days from the end of the year, an annual report is required to be presented to the investor.

merchant banker Category II Alternative Investment Funds may enter into an agreement with merchant banker to subscribe to the unsubscribed portion of the issue or to receive or deliver securities in the process of market making under Chapter XB of the Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2009.

SECURITIES AND EXCHANGE BOARD OF INDIA (INVESTMENT ADVISERS) REGULATIONS, 2013

Rule 4 of the said regulation exempts alternate investment funds to comply with its provisions.

SEBI (FOREIGN VENTURE CAPITAL INVESTORS) REGULATIONS, 2000 Private equity is no more in the same category of venture

capital as distinguished by the Alternate investment fund regulations,2012 it is ambiguous to comment whether the provisions under the said regulations would be applicable or not

SEBI (SUBSTANTIAL ACQUISITION OF SHARES AND TAKEOVERS) REGULATION, 1997 Rule 29 requires disclosure when acquisition is done in the

target company for more than 5% to disclose it to SEBI to be duly filled as per their form.

RESERVE BANK OF INDIA As empowered by FEMA,1999 RBI issued Transfer or Issue of

Security by a Person Resident Outside India, Regulations, 2000 to regulate foreign investments in India. As per this foreign investment is allowed in private equity.

FOREIGN INVESTMENT PROMOTION BOARD (FIPB) Prior approval by FIPB is required.

INCOME TAX, ACT, 1961 The private equity funds are no longer a part of venture

capital funds and so will not be exempted under section 10(23FB) of the Income Tax Act, 1961.

Private Equity Fund

Business Structuring and Taxation aspect

Business Structure

▪ While structuring an international or multi-jurisdictionaltransaction, care should be taken to avoid ‘double taxation’.

▪ The structuring can be influenced by tax as well as non tax factors.

▪ For taxation purpose, it is important to understand the taxation systems of both the countries

▪ It should also consist of the domestic internal tax systems of thecountries involved in the transaction and the manner in which the general rules embodied in such systems are affected by the juxtaposition of the other systems

▪ It may also be necessary to include some non-tax factors like exchange controls, political environment, investment incentive programmes, legal systems etc. in the database.

DOUBLE TAXATION

▪ ‘Double Taxation’ has been defined as the "the imposition of comparable taxes in two (or more) states on the same taxpayer in respect of the same subject matter and for identical periods.

▪ The main reason forthe double taxation to occur is that the taxpayer is a resident in one country but has hissource of income in the other country.

▪ Double taxation could also arise if the taxpayer isresident in more than one country or has source of income in more than one country.

▪ Different countries use different criteria for taxation e.g. residence, control and management,source, situs of property, domicile, etc. For these reasons, it becomes essential to use andto ensure that the taxpayer is entitles to the benefits of DTAA between the countries involvedin the transaction.

Another Important point to be considered in this aspect is that:Whenever a national or resident of a third country avails of the benefit of the DTAA between two countries, by setting up a conduit resident company or otherwise, is this kind of structuring legal?

Structuring is often looked with suspicion because in the veil of structuring we are basically using offshore structure to minimise the tax implications with an intricate interplay of domestic tax system and a DTAA.

IS STRUCTURING LEGAL ?

But it is important to understand that while domestic tax is an obligation, foreign tax is cost. Therefore, a tax payer is free to use all legal means to organize his affairs in a manner so as to minimize this cost.

A “conduit company” is a holding company formed to avoid paying tax on income to two different countries. If the home nation of a business does not have a tax treaty with the country where a subsidiary is located, the business might be required to pay tax on the same income to both countries. To avoid this situation, a company may set up a holding company in a country that has tax treaties with both nations. This conduit company would serve as a pipeline for income from the subsidiary to the patent company.

The issue of Treaty shopping raises the question of interpretation of DTAAs

. The OECD interpretation of this issue is that 'conduit' company is a resident of that country and has to be

granted benefits of DTAA.

IS TREATY SHOPPING LEGAL?

IS TREATY SHOPPING LEGAL? (contd.)

▪ But it is not always that treaty shopping is legal or a conduit company has to be given away the benefits of DTAA between two countries. ▪ Many DTAAs include anti-abuse or anti-treaty shopping

provisions which prevent the non- treaty partner country residents to take advantage of the DTAA.▪ For example, the India-U.S. tax treaty provides an

article on 'Limitation of Benefits', which restricts the benefits of the DTAA only to residents of both India and the U.S.▪ Similar clause has been inserted in the India-Singapore

DDTA.

Offshore Fund Vehicles

Tax Haven Countries : The best destinations to strategize setting up private equity fund vehicles?

▪ Tax havens are those countries which have nil or low rate of taxation. They are often used to route a transaction between two countries with a high rate of taxation. Many countries have announced a list of countries which they consider as 'Tax havens'.

Examples of Tax Haven Countries:

SingaporeMauritiusIrelandNetherlandsUnited Arab EmiratesAnd many

others………

Mauritius

Mauritius has emerged as a favorite destination for overseas investment into Indian corporates, currently accounting for about 40 % of total foreign inflows into India.

Mauritius has special relevance because of the BIPA (Bilateral Investment Promotion and Protection Agreement) between India and Mauritius. Currently, India does not have a BIPA with countries such as the US or the Cayman Islands.

The BIPA provides a number of benefits including fair and equitable treatment, compensation for losses, protection against expropriation, ability to repatriate capital and returns, efficient dispute resolution framework, etc.

The tax treaty between Indian and Mauritius includes a provision that exempts a resident of Mauritius from Indian tax on gains derived from the sale of shares of an Indian company. Presently, the capital gains tax relief under the India- Mauritius tax treaty continues to be available

SINGAPORE

▪ Favorable Geographical position and Socio-Culturally Accepted (security or otherwise)

▪ Ease of doing Business, Transparency in Business Governance, Regulatory Transparency, Financial stability, openness

▪ Easy to list a fund on the Singapore stock exchange

▪ The availability of talent pool of investment professionals makes it easier to employ / relocate productive personnel in Singapore

▪ India-Singapore DDTA provides no tax on the capital gains however subject to certain conditions known as LoB

▪ India grants underlying tax credit (of taxed paid by Singapore Sub) if the Indian shareholder holds more than 25% of share capital.

▪ India also grants credit for Tax Spared by Singapore Government in certain cases. Singapore also grants credit for Tax Spared by Indian Government u/s. 10A, 10B, 80-I, 80-IA or like provisions

Ireland

▪ Ireland is a tax-efficient jurisdiction when investment into the Indian company is in the form of debt or convertible debt instrument. Interest, royalties and Fees for Technical Services (FTS) arising in India and paid to an Irish resident may be subject to a lower withholding tax of 10% under the Ireland India tax treaty.

▪ This is a significant relief from thewithholding under Indian domestic law which can be as high as 42% for Interest and around 27% for royalties and FTS.

▪ Ireland can, therefore, be explored for debt funds or real estate funds that provide structured debt and also film funds that provide production financing for motion pictures where cash flows received fromdistributors could be in the nature of royalties.However, the characterization of income would needto be assessed on a case to case basis.

NETHERLANDS

▪ Netherlands emerges as an efficient jurisdiction for making portfolio investments.

▪ In certain situations, the India Netherlands tax treaty provides relief against capital gains tax in India (that follows a source based rule for taxation of capital gains) i.e. Gains arising to a Dutch resident arising from the sale of shares of an Indian company to non resident buyer would not be taxable in India.

▪ Such gains would be taxable if the Dutch resident holds more than 10% of the shares of the Indian company in case of sale to Indian residents.

▪ For a Dutch entity to be entitled to relief under the India-Netherlands tax treaty, it has to be liable to tax in the Netherlands except for Dutch Limited Liability Companies, public companies or Cooperatives investing or doing business in India.

▪ In the case of KSPG Netherlands [2010] 322 ITR 696 (AAR), even a conduit company is allowed to reap the benifits of treaty shopping and therfore cannot be exempted fromthe benifits of the Netherlands- India tax treaty.

UNITED ARAB EMIRATES

The DFSA regulations governing DIFC funds are based on best practice from more established fund jurisdictions, thereby bringing a level of familiarity and comfort to investors.

DIFC funds are classified as GCC (Gulf Cooperation Council) vehicles. This enables them both to take advantage of certain advantageous tax treatment between the six members of the GCC, and to mitigate local ownership and asset specific investment restrictions that exist in the region with respect to "non-GCC" investment.

On the basis of current law and practice, any investment fund established within the DIFC (and indeed, any company incorporated within the DIFC) will be exempt from any DIFC income, capital gains and corporation tax for a guaranteed period of 50 years from the date of enactment of DIFC Law No. 9 of 2004. This zero rate of tax also extends to transfers of assets, profits or salaries in any currency to any party outside the DIFC for the same period of time

The Dubai International Financial Centre ("DIFC") has provided an attractive alternative for domiciling a collective instrument vehicle within the Middle East and North Africa

It free zone established within Dubai, in the United Arab Emirates ("UAE"), with its own laws, regulations, court systems and, critically for those looking to establish a fund here, its own regulatory authority, the Dubai Financial Services Authority ("DFSA").

In most circumstances, DIFC entities benefit from the UAE's extensive, and continually expanding, double taxation treaty and agreement network

Tax Pass through for Alternative Investment Funds (AIFs)

▪ The Budget 2013 through the AIF Amendment Regulations 2013 brought tax pass through status to category I of the AIFs meaning that the income is tax exempted at the fund level and is taxed in the hands of the investors.

▪ Category II or Category III AIFs will be taxed according to the structure of the fund

▪ Therefore to indirectly get the tax pass through benefits, investors started structuring their funds in the form of Trusts.

▪ Under the Income Tax Act in India, in case of business trusts, pass-through may be claimed in case the trust is a determinate, irrevocable trust with several riders

Internal Tax Compliances to be fulfilled?INCOME TAXACT, 1961:

▪ Section 9 (1) (i) of the Income Tax Act, together with the recent judgement of the Vodafone International Holdings by the SC cleared the position regarding that a share is legally situated at the place of incorporation of the company. Therefore while the shares of an Indian company would be considered situated in India, the shares of a company incorporated outside Indiawould ordinarily be viewed as situated outside India.

▪ This position of law has now completely changed amended through the insertion of Explanation 5 of the Tax Act through the insertion of Explanation 5.

▪ Therefore now, where the shares of an offshore company are deemed to be capital assets situated in India under Section.9(1)(i), the entire gains arising of such transfer would be subject to the charging provisions of the Act, regardless of the extent to which such shares may also derive their value from assets and revenue abroad

The SEBI (Alternative Investment Funds)(Amendment) Regulations,2015

▪ However the Finance Act, 2015 which propose again to amend the AIF Regulations, has now finally brought in some clarity related to the taxation aspect of these AIFs.

▪ The bill has inserted a new chapter, Chapter XII-FB has been inserted in the Income Tax Act, which provides the provisions pertaining to taxation of income of such funds.

▪ However this chapter is applicable only to Category I and Category II AIFs

▪ It provides a tax pass through structure to these AIFs

DUE DILIGENCE BY A PRIVATE EQUITY FUND

PRE INVESTMENT INVESTIGATION

WHAT IS DUE DILIGENCE ▪ “Due diligence” is an analysis and risk assessment of an impending business transaction. It is the process by which confidential legal, financial and other material information is exchanged, reviewed and appraised by the parties to a business transaction and is done prior to the transaction.

IMPORTANCE OF DUE DILIGENCE

▪Due diligence is used to investigate and evaluate a business opportunity. It helps the investor take an informed investment decision and mitigate risks associated with the business transaction.▪Due diligence is designed to protect the interests of the investor by providing objective and reliable information on the target company before making any written commitments.

OBJECTIVE OF DUE DILIGENCE ▪ The objective is to allow the investor to consider the following options, considering the facts found in the course of due diligence:

I. Proceed with the investment II. Solving of problems uncoveredIII. Adjusting the valuation of the investment IV. Withdrawal of deal

STAGES OF DUE DILIGENCE

▪ A due diligence process can be divided into three stages

(i) Pre Diligence (ii) Diligence (iii) Post Diligence

STEPS OF DILIGENCE REVIEW

1. Ministry of Corporate Affairs (MCA) Website:The documents and information gathered in this step include:i. Company Informationii. Date of Last Balance Sheetiii. Director Informationiv. Charges Registeredv. Details of Secured Lenders of the Company & Quantum of

Secured Loansvi. Certificate of Incorporation.vii. Memorandum of Associationviii. Articles of Association

STEPS OF DILIGENCE REVIEW (Contd’)

2. Business Aspects▪ Market Evaluation and

Industry Growth ▪ Competitive Landscape ▪ Monetization Strategy▪ Capital Requirements ▪ Operational Aspects ▪ Human Resource Aspects

STEPS OF DILIGENCE REVIEW (Contd’)

3. Financial Aspects ▪ Book of Accounts and Financial Statements▪ Projections and Capital Budgets▪ Analyst Reports ▪ Schedules- inventory, accounts etc;▪ Tax Structures

STEPS OF DILIGENCE REVIEW (Contd’)

4. Legal Aspects▪ Company law – Licenses and Permits ▪ Real Estate ▪ Intellectual Property ▪ Labour law ▪ Contracts and Agreements ▪ Litigation ▪ Insurance ▪ Health and Environment

FUND DOCUMENTATION

General Introduction

Fund counsels are now required to devise innovative structures and advise investors on terms for meeting expectations on commercials, governance and maintaining discipline on the articulated investment strategy of the fund. All these are to be done in conformity with the changing legal framework.

Fund documents are an important aspect of the fundraising exercise. They are also critical to determining whether a pooling vehicle is in compliance with the applicable law across various jurisdictions.

Major Parties Involved

Investor/Sponsor

Investment Manager Trustee

Eligible Investm

ent

1. Private Placement Memorandum

AIF Regulations require that a concerned fund’s PPM should contain all material information about the Fund (Regulation 11)

Major Information's like, details of the manager, targeted investors, fees, investment strategy, risk factors and risk management tools, conflicts of interest and other related information as deemed fit.

Essential Features.

2. INDENTURE OF TRUST : The Indenture of Trust is an instrument that is executed

between a settlor and a trustee whereby the settlor conveys an initial settlement to the trustee towards creating the assets of the fund.

This instrument also provides the various functions and responsibilities to be discharged by the appointed trustee.

3. INVESTMENT MANAGEMENT AGREEMENT : The Investment Management Agreement is entered into by

and between the trustee and the investment manager. Under this Agreement, the trustee appoints the investment

manager and delegates all its management powers in respect of the fund.

4. CONTRIBUTION AGREEMENT:The Contribution Agreement is to be entered into by and

between each contributor (i.e. investor), the trustee and the investment manager and, as the context may require.

The Contribution Agreement records the terms on which an investor participates in a fund.

This includes aspects relating to computation of beneficial interest, distribution mechanism, list of expenses to be borne by the fund, powers of the investment committee, etc

5. Shareholders Agreement

Transfer Restrictions:▪ Promoter Lock-in▪ Right of First Offer (ROFO) / Refusal(ROFR)▪ Tag-along / Co-sale Right Downside Protection: Downside protection

essentially means protection when things go wrong with the investee company.

▪ Bonus Issue▪ Issuance at Lowest Legally Permissible Price▪ Adjustable Conversion Prices Exit Option:▪ IPO▪ ADR / GDR Listing▪ Strategic Sale▪ Buyback

5. Miscellaneous Documents: 5.1 INVESTOR SIDE LETTERS : Contains specific arrangements with respect to their

participation in the fund. Typically, investors seek differential arrangements with

respect to management fee, distribution mechanics, participation in investment committees, investor giveback, etc.

5.2 AGREEMENTS WITH SERVICE PROVIDER : Sometimes, investment managers may enter into

agreements with placement agents, distributor and other service providers with a view to efficiently market the interests of the fund.

At Offshore Level

1. WRAPPER :

A wrapper is a short supplement that is attached to the PPM of a domestic fund (in case of ‘unified structure’) to help achieve compliance with the requirements for private placement of the securities / interests of an offshore fund to investors in jurisdictions outside India.

2. CONSTITUTION DOCUMENT: A constitution is the charter document of an offshore fund

in certain jurisdictions.

3. SUBSCRIPTION AGREEMENT : The Subscription Agreement sets forth the terms and

conditions of on which an investor will subscribe to the securities / interests.

It is the “sales contract” for purchasing the securities (opposite of a public offering). The subscription agreement sets out the investor’s capital commitment to the fund and also records the representations and warranties made by the investor to the fund.

4. ADVISORY AGREEMENT: The board of an offshore fund may delegate its investment

management / advisory responsibilities to a separate entity known as the Investment Advisor or the Investment Manager.

It contains the general terms under which such investment advisor render advise in respect of the transactions for the fund’s board.

THANK YOU

PRESENTATION BY :

GARIMA GOYAL

NEHA BALODHI

LAASYA BHAVISETTI

AKSHAY MADAN

ABHISHEKH GUPTA