Analysis of global trends shows that share swap structures have become integral elements in most M&A transactions. The acceptance of stocks as currency for such acquisitions is well established, as Disney’s US$71 billion acquisition in the US of the entertainment assets of 21st Century Fox demonstrates. As the M&A market increasingly adopts global standards, acquirers more frequently use share swap structures in M&A transactions, replacing the all-cash deals that were the usual framework in the past.
A share swap transaction is one in which consideration for the deal is not cash, but the issuance to the other party of shares of the acquiring entity. These arrangements are commonly used in strategic acquisitions by growth stage companies, which have little liquidity and resources, any such being better used for operational purposes. Mature companies typically use this structure in combination with cash payments to minimize immediate and significant cash outflows.
One factor contributing to this structural shift, especially in cross-border acquisitions, was the part-liberalization of foreign exchange regulations in India (FEMA regulations). Before November 2015, FEMA regulations required that share swap transactions be undertaken only with the prior approval of the government. However, after that date foreign direct investment regulations as well as the overseas direct investment (ODI) regulations were amended to permit cross-border primary share swap transactions (that is share swaps involving the issuance of new shares by the acquiring entity to the existing shareholders) under the automatic route, subject to compliance with specified conditions.
At present, the FDI regulations permit only those companies that are engaged in sectors subject to the automatic route to issue shares to persons resident outside India under a share swap arrangement, without the prior approval of the government. Share swap transactions involving companies operating in sectors operating under the approval route still require prior government permission. From an outbound perspective, under the ODI regulations share swaps have become permitted funding sources for overseas joint ventures and wholly owned subsidiaries of entities resident in India. While the amendments are somewhat ambiguous, it appears that the government has liberalized the share swap regime only partially, as the 2015 relaxation related solely to primary share swap transactions. As a result of this, it has to be assumed that secondary share swap transactions (that is share swaps involving only transfers of existing shares between the acquirer and seller) still require the prior approval of the government.
Valuation of such share swap transactions and the determination thereafter of the swap ratio are crucial aspects of such deals. Both the FEMA regulations (to the extent that such swap arrangements involve persons who are resident outside India) and the Companies Act, 2013 play a substantial role in determining the valuation of the target company and the resultant swap ratio. Under the act, shares or securities to be allotted for consideration other than cash require that a valuation of the consideration being received in respect of such allotment be done by a registered valuer. Similarly, FEMA regulations require that the valuation of share swap transactions be carried by a merchant banker registered with the Securities and Exchange Board of India (SEBI), or by an investment banker registered outside India. An additional layer of complexity arises where such share swap transactions involve a listed company. In that case, the pricing guidelines prescribed under the relevant SEBI regulations will also need to be met. This usually involves a fluid situation, linked to the traded share price of the issuing entity.
While there are definite advantages to structuring M&A transactions through share swaps, the selling shareholders need to bear in mind the downsides involved, particularly the fact that they will not be receiving consideration and assets in the transaction that are liquid. This is especially relevant where individual promoters, being the selling shareholders, are required to discharge a heavy tax burden on the gains arising from the sale of their shares. Thus, the deal terms should be negotiated with sufficient particularity to ensure that the interests of each party to the transaction are fully addressed.
Taken as a whole, it can be seen that the M&A market is improving by aligning itself with global standards, at least as far as the way in which M&A transactions are structured. While the steps that have so far been taken are going in the right direction, complete liberalization of the FEMA regulatory regime in this area can only help the country to move closer to those global standards.
Jay Gandhi is a partner and Abhishek Parekh is a principal associate at Shardul Amarchand Mangaldas & Co.
Shardul Amarchand Mangaldas & Co
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Executive Chairman: Shardul Shroff
Managing Partner: Pallavi Shroff & Akshay Chudasama
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