Private equity (PE) investors will now have to waive their special rights in their investee companies that are slated for initial public offerings (IPOs), which gave them a say in the running of these companies, without being sure of an exit through a public listing.
Prior to these new rules issued by the Securities and Exchange Board of India (SEBI), they had to give up these rights only at the time of listing.
Guidelines issued by the market regulator to lead managers (LMs) of public issues asks them to ensure that all special rights given to any entity or person are cancelled before the filing of the updated draft red herring prospectus (UDRHP).
It states: "LM is advised to ensure that any entity/person having any special right under AoA or SHA, the same should be cancelled before UDRHP." AoA is articles of association and SHA is shareholder's agreement.
With the new directive, PE investors will need to give up their special rights even if they do not have a guarantee that the new share sale will go through and that the company will be listed on the stock exchanges, pointed out Manshoor Nazki, partner at IndusLaw.
The UDRHP may be filed months before the actual listing.
Usually, a company that is looking to list files a draft red herring prospectus (DRHP). Then, SEBI seeks clarifications (if any) from the lead manager regarding the DRHP following which the UDRHP is filed and the market regulator gives the go-ahead for the issue of shares. This approval is valid for 12 months, that is, the company can choose to list at any time within the year following the endorsement.
"If the market is not favourable, then they may not list at all. Then the PE investor is left holding shares in the company without the rights to protect their investment in the company, unless those rights are reinstated," said Nazki.
Sindhuja Kashyap, partner at law firm King Stubb & Kasiva, explained why these special rights are crucial for PE investors.
"Special rights provide PE investors with control over key company decisions, protective provisions that safeguard their investment, ensuring their investment is managed in a way that aligns with their strategic objectives," she said.
"If these special rights are taken away, PE investors lose their ability to influence key decisions and protect their interests, potentially leading to decisions that could negatively impact their investment, making them no different than a shareholder with minimum risk in the company," she added.
Shiju PV, senior partner at IndiaLaw LLP, too said that financial investors such as PE funds were justified in seeking such rights during the time the company is privately held because of their limited management control over the company.
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That said, the experts do not believe that PE interest in domestic investments will be significantly affected by the new guideline.
As Kashyap pointed out, there may be a short-term impact as PE funds reassess the risk-reward balance of investing in IPO-bound companies without the safety net of special rights, but over time this will be overcome by PE investors by negotiating different terms or assurances.
Kashyap even sees a possibility of new investment structures or strategies that do not rely on special rights coming up.
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