Financing of mergers and acquisitions is still nascent in India, whereas internationally a multiplicity of mechanisms are available. Indian regulatory and commercial policies currently give impetus to offshore rather than onshore acquisitions.

Banks cannot lend to anyone, offshore or onshore, buying shares of an Indian company. Further, the exposure of an Indian bank to capital markets is stringently restricted, proving to be a disadvantage for Indian acquirers and a missed opportunity for domestic banks and Indian companies facing funding constraints for domestic buys.

Indian companies and sponsors often resort to borrowing from non-banking financial companies (NBFCs). However, due to the capital adequacy and single- and group-borrower restrictions (which would effectively restrict the quantum of leverage) imposed by the Reserve Bank of India, NBFCs do not have the balance-sheet size to undertake big-ticket transactions. Adding to the complexities, Indian exchange control laws do not permit foreign currency loans, including proceeds of foreign currency convertible bonds (FCCBs) and external commercial borrowings (ECBs), for onshore acquisitions. Therefore, without debt financing options, companies often resort to raising funds through the equity route.

Equity could be raised through an initial public offer (IPO). However, in a volatile market this may prove inefficient, prompting companies to use other funding mechanisms such as

rights issue , whereby the company gives existing shareholders the right to subscribe to newly issued shares in proportion to existing holdings;

preferential allotment , wherein a company issues equity shares, securities convertible into equity, warrants, convertible preference shares for raising funds;

promoter financing , whereby the financing is usually against collateral of shares or other securities held by the promoter in any of the group companies; or

private equity (PE) funding , whereby funds are raised from a PE player by giving it a stake.

Another option for Indian acquirers is to structure the deal as a business purchase through slump sale or acquisition through a merger/ amalgamation/ demerger route. This is widely used where a cash pool is not available, as the acquirer can issue shares as consideration instead of a cash outflow.

Acquisition through merger is tax-neutral (on meeting certain conditions), which means the target company can be merged with the acquirer without any adverse tax or regulatory implications. Shares of the acquirer company can be allotted to the target’s shareholders. Further, where the acquirer wants only a certain business of the target, it can be carved out into an entity owned by the acquirer, with shares allotted to the target’s shareholders as consideration. However, such structures dilute the present shareholder stake to the extent of the consideration paid (in the form of shares), which may not be welcomed by such shareholders.

Given the challenges faced by Indian companies, there is a need to strengthen the domestic M&A process. The restrictive lending standards imposed by the apex bank on acquisition and debt financing has created an uneven playing field for acquirers in India compared to overseas acquirers. Further, a hurdle-free domestic legal and regulatory framework is needed for local companies embarking on acquisition, which will ultimately result in a dynamic economic environment and accelerate the deal-making ecosystem.

(The author is Partner, Global International Corporate and M&A Tax, KPMG in India.)

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