Early stage Indian companies are increasingly looking at migrating their holding company structures to offshore jurisdictions. Such restructuring transactions, commonly known as “flips” or “externalizations”, provide a plethora of benefits to companies and their shareholders – the primary advantage being improved access to global clientele, a key factor for startups looking to establish an international presence.
Relocating to an overseas jurisdiction also enables early stage companies to leverage ancillary benefits such as access to improved infrastructure and sophisticated technology. Such jurisdictions may further provide companies with higher valuations of their businesses and easier access to venture capital. Certain foreign investors may allocate a greater portion of their available funds for investments in jurisdictions prominent in specific industries. If the business of an Indian company pertains to such an industry, flipping to the jurisdiction will provide it with access to the higher fund allocation.
Externalization is further viewed as a way to encourage investment from foreign investors who are disinclined to invest directly in India due to aspects such as the fluctuating regulatory regime, particularly in relation to structuring of exits, and concerns about retrospective taxation. Other reasons that could make externalization transactions appear to be prudent include: a simplified business and tax environment in foreign jurisdictions; avoidance of issues relating to exchange rate fluctuations; ease in listing of businesses; and an evolved understanding of non-traditional business models.
Execution of externalization transactions entail several legal and tax considerations in India and abroad. From a timing perspective, it may be commercially prudent to execute a flip at an early stage of operations, before significant value is built in the Indian company. This will provide maximum flexibility in structuring the flip efficiently, reduce tax leakage and minimize costs. Late stage companies may find flips challenging for a number of reasons, including the possibility of a broad-based capitalization table, large number of shareholders, and the commercial expectations of the shareholders.
The foremost regulatory challenge in implementation of a flip is to replicate the shareholding of the Indian company in an overseas holding company. One of the methods of carrying out a flip transaction is by way of a share swap, where the shares held by the shareholders in the domestic company are swapped with the shares of the overseas holding company. This results in the shareholders of the domestic company becoming the shareholders of the overseas company, and the overseas company becoming the holding company of the domestic company. However, the Indian regulatory framework imposes onerous restrictions on carrying out certain types of share swaps, including the requirement to obtain regulatory approvals. These are time-consuming and may require that the legitimacy of the structure be established to the satisfaction of the regulator.
Other flip structures involve the acquisition of shares of an overseas holding company by shareholders of the Indian company. The foreign company then acquires shares of the domestic company from the shareholders of the domestic company. However, acquisition of shares of an overseas company by the shareholders of the Indian company (which may be Indian companies and/or individuals) brings with it a list of attendant conditions, including requirements that the overseas company be engaged in a bona fide business activity, and/or that the overseas company cannot have a step-down subsidiary. Complex structures may need to be implemented to bring a flip within the paradigm of the Indian regulatory framework.
Externalization transactions are typically cost-intensive, chiefly because they involve assessment of and compliance with regulatory requirements across multiple jurisdictions. Further, various aspects of the restructuring may result in tax incidence in the hands of the company and its shareholders and will need to be carried out in a manner as to minimize tax leakage.
Despite the complexities in implementing externalization transactions, these transactions have been gaining traction over several years. Industry trends indicate that early stage companies prefer to undertake externalization together with foreign fund-raising, to ensure that the companies are able to leverage the operational and commercial backing of foreign funds to tap into foreign markets. While restructuring through externalization may be riddled with complexities, companies are keen to undergo this process, as the benefits seem to outweigh the complexities in some cases.
Nivedita Nivargi is a partner and Vandana V is an associate in the Bengaluru office of Samvad Partners.
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