COMING BACK HOME

Startups Returning to Indian Soil

Introduction

Over the past decade, India has become a major start-up hub and now has the third largest number of unicorns—companies valued over USD 1 billion.

This growth has largely come from foreign capital, especially venture capital and private equity. To access this, many Indian start-ups “flipped” their structure—setting up holding companies overseas (e.g., in the US or Singapore). The key reasons: easier access to capital, investor comfort with familiar jurisdictions, and potential for IPOs on global exchanges like NASDAQ.

Typically, such structures involve an offshore holding company owning a wholly owned Indian subsidiary that operates the business.

However, this trend is now beginning to shift. Many Indian-origin start-ups are now “reverse flipping” back to India—restructuring so that investors and founders hold shares directly in the Indian company. The reasons: strong Indian capital markets offering good exits; and the availability of domestic capital which was previously restricted by India’s exchange control rules on overseas investments.

Reverse flips – considerations

The appropriate mechanics for implementing such a reverse flip transaction depends on a number of factors, such as tax efficiency, closing timelines and the need for regulatory approvals.

Reverse flips can be done through a merger of a foreign company with an Indian company via a court-supervised process (amalgamation) or through ratification by regional directors, with the Indian company as the successor. While such mergers can be tax neutral under Indian tax laws, they may take up to a year. Alternatively, a share swap can be used, though it may attract capital gains tax and can be less tax efficient, depending on factors like the availability of double tax avoidance agreement benefits.

Mergers

In India, an in-bound merger of a foreign company with an Indian company is governed by the provisions of:

• The (Indian) Companies Act, 2013 (“Companies Act”) and the Companies (Compromises, Arrangements and Amalgamations) Rules, 2016; and
• The (Indian) Foreign Exchange Management Act, 1999 (“FEMA”) and the rules framed under it, mainly the Foreign Exchange Management (Cross-Border Merger) Regulations, 2018 (“FEMA Merger Regulations”).

In brief, the process in India to implement a merger can either require the approval of (a) National Company Law Tribunal (“NCLT”), a specialised tribunal set up under the Companies Act for issues relating to Indian companies or (b) Central Government of India through Regional Directors (“RD(s)”).

Approval through NCLT

The merger through NCLT (“Regular Route”) is open to all classes of companies and is usually seen as a more long drawn process, involving the following steps: :

• The parties to the merger approach NCLT with a “scheme of arrangement” which sets out the manner in which the re-organisation would be implemented.
• NCLT calls meetings of the shareholders and the creditors to approve the scheme. If 90% of consents are obtained from them before starting the process, NCLT may waive these meetings.
• NCLT approves the final merger order after resolving objections, and the order is filed with the Registrar of Companies.
• A foreign company may merge with an Indian company after both obtain RBI approval. Some mergers may qualify under the deemed approval framework (discussed below).

Additionally, such merger will only be allowed for a foreign company incorporated in a permitted jurisdiction and having filed prescribed declaration at the time of submission, if such foreign company is incorporated in a country that shares land borders with India.

Approval through Regional Directors

The merger approval by RD(s) allows a company to meet a lower threshold of requirements, such as the elimination of the advertisement requirement, and ensure a timely conclusion of the merger by relying on ‘deemed approvals’ from the RD, Registrar of Companies, and Official Liquidator once each of the regulators’ statutory timeline for objecting to the scheme has expired. Hence, this approval route is often referred to as the ‘Fast Track Route’.

Separately, the Fast Track Route is only open to specific class or classes of companies that includes inter alia (a) two or more small companies; or (b) holding company and its wholly owned subsidiary company or (c) two or more companies certified as ‘start ups’ by Department for Promotion of Industry and Internal Trade (“DPIIT”) or (d) one or more small company and one or more start- up company.

Effective from 17 September 2024, MCA has expanded the scope of the FastTrack Route to include inbound merger of a foreign company with an Indian company. The set of compliances for the Fast Track Route will pari-passu apply to a transferee Indian company undertaking inbound merger. In addition to this, both such merging companies will need to obtain prior approval of the RBI and file declaration with the merger application to RD, if the foreign company is incorporated in a country that shares land border with India.

Navigating Indian capital controls

Indian exchange control regulations add an additional layer of complexity to be navigated for such reverse flip transactions.

As background, FEMA and the regulations framed under it set out the framework for foreign investment into India as well as outbound investments from India. This includes matters such as pricing guidelines that apply to such transactions, sectoral restrictions, investment conditions and reporting conditions. Under the FEMA, such cross-border transactions are categorised as either falling under the automatic route, that is, transactions that can be undertaken without the approval of the RBI, or under the approval route, that is, transactions that require prior approval of the RBI.

Under the FEMA Merger Regulations, in-bound mergers of foreign companies with Indian companies are deemed to be approved by the RBI subject to certain specified conditions including:

• Issue or transfer of securities by the resultant Indian company to non-residents must comply with FEMA provisions, including sectoral caps, pricing guidelines, entry routes, and reporting requirements.
• Off-shore borrowings and guarantees taken over by the Indian company must be aligned with FEMA rules within two years; no repayment remittance is allowed during this period.
• The Indian company may acquire, hold, and transfer overseas assets per FEMA. If not permitted, such assets must be sold within two years of NCLT sanction.
• A foreign currency bank account can be opened for incidental transactions related to the merger, valid for two years post-NCLT approval.
• All FEMA-related non-compliances or violations prior to the merger must be resolved.
• Valuation of the foreign company must be done by recognized valuers in the relevant jurisdiction, following internationally accepted principles.

If a merger does not comply with the above conditions, an RBI approval would be required for such a merger.

Other considerations

There are other issues that need to be evaluated when considering a reverse flip transaction, including:

• Presence of investor from certain jurisdictions: If an investor or beneficial owner is based in a country that shares a land border with India, RBI approval may be required. This must be reviewed before finalising a reverse flip.
• Issues under listing regulations: If the reverse flip is aimed at an IPO in India, listing regulations like minimum shareholding periods, valuations, and disclosure requirements must be checked in advance.
• Sectoral approvals: Businesses in regulated sectors like financial services may need regulatory approvals or need to inform authorities due to change in ownership or control after the merger.

Catching up with the upward trend of reverse flip transactions due to continual strong run of Indian markets, the Government of India has eased the regulatory hurdles by extending the Fast-Track Merger to inbound mergers in India. This is a relatively untested process, the regulatory framework governing such transactions is likely to evolve over time and therefore several factors need to be carefully evaluated when planning and implementing such a transaction.

Authored by – Moksha Bhat, Managing Partner at AP & Partners,

And co-authored by – Udit Kapoor, Associate, AP & Partner