As India standouts as a true bright spot amid a global downturn and the west is increasing reliance on Indian companies for enterprise technology services, the time is apt for an increase in cross border M&A activity in the space. With the Indian government introducing liberal laws to attract FDI, cross-border M&A transactions have also increased. Cross border M&A can be either Inbound M&A (a foreign corporation merges with or buys an Indian company) or Outbound M&A (an Indian corporation merges with or buys a foreign company). In this article we will largely focus on the former i.e., Inbound M&A. Cross Border M&A has accounted for close to half of all M&A activity in India by value on an average over the last three years. Given the uniqueness of a cross-border M&A it is vital to understand the intricacies of such a transaction. This article will help you navigate around these unique aspects and successfully complete such a transaction and integrate post completion.
MOTIVATION FOR UNDERTAKING A CROSS BORDER M&A
With ever increasing globalization the inorganic growth strategy of companies is no longer bound by any geographical constraints. Companies are ready to look across borders to acquire capabilities, gain access to clients in new markets, leverage competent workforce, benefit from lower cost resources, diversifying operations among several other reasons. For enterprise technology companies some of the primary motivations of strategic acquirers include setting up or bolstering offshore presence which in turn can lead to margin expansion, adding capabilities in an adjacent technology service offering which is in demand and can be cross sold to their existing clients and gaining access to newer markets. Whereas the financial investors in the space largely follow a buy and build strategy and in turn create a platform company offering several in demand technology capabilities all in one company.
CHALLENGES IN CROSS BORDER M&A
Differences in Communication & Cultural Aspects: One of the most challenging aspects of a cross border M&A is different cultures of the two companies and their management. As a selling founder of an enterprise technology company, you will be required to help transition the company and work closely with the acquirer. Hence at this stage of integration you may realize that the culture of the two companies is so widely different that the purpose of the transaction itself is defeated, and synergies cannot be realized as initially envisioned.
Many cross-border M&As have failed, pointing to mismanagement as the main reason. However, when they dig deeper, it is often seen that the new manager had a management style that was deemed unfamiliar by the workforce. According to several surveys, around 50% of all post-merger integrations fail to meet their original objectives due to cultural clashes.
Some of ways you can avoid cultural differences creating a problem is by focusing on culture early on. Make sure that cultural integration is part of the overall M&A action plan and that all stakeholders agree on it. Communicate with all employees; change communication is a critical element in creating, managing, and distributing the messages at each stage of the cultural integration process.
Stringent Regulations: Cross-border mergers are highly regulated in terms of compliance with specific conditions and regulations. Firstly, the sector specific Foreign Direct Investment (FDI) norms must be checked for any caps on FDI investment in the sector. For instance, 100% FDI is allowed in Information Technology sector under automatic route (no prior approval from government/RBI required), whereas FDI in the insurance sector in India is restricted to 74%.
Cross Border M&A is largely governed by FEMA Cross Border Merger Regulation, 2018 and Chapter 15 of the Companies Act 2013.
These laws cover several regulations around transfer of securities, opening of overseas bank accounts, transfer of assets and borrowings among others.
Ensuring Compliant Transaction Structure and Tax Efficiency: One of the important regulations around structuring a cross border transaction is regulation 10A in the FEMA Transfer Regulations which mentions that the amount of deferred consideration should not exceed 25% of the total consideration payable by the buyer under the relevant transfer transaction and the deferred consideration should be paid by the buyer within a period not exceeding 18 months from the date of the transfer agreement.
The Liberalised Remittance Scheme (LRS) is part of the Foreign Exchange Management Act (FEMA) 1999 which lays down the guidelines for outward remittance from India. Under LRS, all resident individuals, are allowed to freely remit up to USD 250,000 per financial year. Hence, the transaction must be structured to ensure that the equity component of the pay-out to the selling shareholders must be either structured as a stock appreciation right (SAR) – the right to be paid compensation equivalent to an increase in the company’s common stock price or in the form of ESOPs.
If a foreign entity does not have any assets in India, there are no tax implications for the foreign entity in India. However, the tax efficiency of the sellers must be kept in mind. For the seller, Capital gains realized on transfer of unlisted securities, if held for more than 24 months will be taxed as LTCG; otherwise taxed as STCG. The overall transaction structure must ensure that there are no tax inefficiencies or cash flow mismatches.
Compliance: The foreign company i.e., the Buyer typically takes a highly prudent approach during due diligence to ensure that the target company is following all the required local compliances. In many instances the buyer would be entering the target company’s country for the very first time via the acquisition and the buyer would benchmark the target against high global compliance standards. Hence the target company must ensure it follows all the applicable local compliances.
Tracking Business Performance: The target companies must prepare for an eventual sale by possibly using a sophisticated CRM platform, that will keep track of the leads generated, sales pipeline etc. This data is typically needed by the acquiring company to access the strength of the sales pipeline and get a sense of the effectiveness of the company’s sales engine. Also, the target companies must regularly track key KPIs such as receivable, cash position etc and prepare a detailed monthly Management information system (MIS) report. These reports will provide the much needed comfort to the acquirer that the founders are tracking the business using the key relevant parameters and help expedite the buyers decision.
ROLE OF AN ADVISOR
It is important to have an experienced advisor who can foresee and prepare the target company for the above aspects. For instance, the advisor will access the important aspects of cultural fit upfront and advise the target company on narrowing down on the most culturally fit acquirer, evaluate the transaction structure both from a FEMA and tax efficiency perspective, make sure the communication between the local target company and the foreign buyer is smooth and efficient by communicating between the target and buyer keeping in mind any cultural differences , present the target company data during the diligence in a form that the foreign buyer can easily understand, ensure the company makes the relevant fillings (including FC-TRS; Foreign Currency Transfer) required by RBI post completion of an inbound cross border M&A in a timely manner.
To ensure an efficient process and timely transaction completion, a specialized advisor is needed who can guide you on the above points.
(The author is Mr. Sandeep Gogia , Managing Director- Investment Banking, Equirus, and the views expressed in this article are his own)
