Business acquisition in India: why due diligence is an essential step

Acquiring a company in India is not without risks, noted Johan de Boer, managing director of KROV. The Dutch manufacturer of train, office and store fittings decided to abandon the acquisition of a manufacturing partner in the Indian city of Bangalore after extensive due diligence.

Have thorough research done before you engage with an Indian partner

"It's not down to the products the Indian company makes," De Boer reflects. "The quality is fine. We offer their products in Europe and they themselves sell directly to customers in America." After the owner indicated a desire to sell the company, De Boer visited the factory in August for an initial thorough inspection. Then began the due diligence process, conducted by an Indian accountant and a local lawyer. In December, they delivered their report with the advice: don't do it.

Both financially and legally, the producer was found not to have its affairs in order. Those figures did not match the reporting. That was surmountable, according to De Boer, but the findings of the lawyer were less innocent. The company turned out to be incorrectly registered, irregularities regarding personnel contracts came to light, and the administration and payment of social security contributions were not in order. "That not only carries hefty fines, as an owner you can even end up in jail for that," he said.

Work with local advisors

For De Boer, this experience reaffirms the importance of recruiting good local consultants in India. "If we had conducted this process independently, we might not have been able to bring this to the surface. Then you are suddenly liable for a company in which things are not properly arranged. Afterwards, you can't fix that. The consequences, financial or worse, are then yours." To put it mildly, the current owner was not happy that De Boer renounced the deal. "He still tried to tone down the irregularities, but I didn't hire advisors for nothing. It would be stupid to go against their advice."

Still, De Boer remains interested in the Indian producer. "I know that this factory in India delivers quality and the relatively low production costs are of course attractive. That is why we have now discussed an alternative route. If the Indian owner liquidates the company, we would then like to take over the factory premises, machinery and some of the employees. That would remove the legal risks for us. The current owner is keen on this. We have agreed to discuss this further in the coming year."

Producing in India has interesting advantages

De Boer has another reason for wanting to manufacture in India. "KROV has a good reputation worldwide as a supplier of train equipment, such as tables, chairs and backrests. India has the ambition to build a nationwide network of high-speed trains and we are already in talks about this through main manufacturer Kawasaki. Our position is stronger when we have a production facility in India, because the Indian government would like to create as many jobs in India as possible. So an Indian plant would also be interesting with a view to sales there."

Do you want to enter the Indian market, but are unsure what is the best first step for your business? Or are you looking for a local party to conduct market research or due diligence for you?

The financing options for your Indian subsidiary: capital, ECBs or a bank loan

As the Indian operations of European companies grow, foreign shareholders often struggle with how best to finance the operations, given India's restrictive regulations. We therefore cover three strategic options for financing your subsidiary in India.

European companies in India have 3 options to finance their subsidiary

1. Share Capital

You can raise capital by issuing additional shares in your Indian company. Increasing share capital is a relatively sustainable and institutionalized way to grow the Indian subsidiary. Moreover, it signals to the outside world that the parent company is serious about developing the subsidiary's services or products in India.

There are two drawbacks to this route. Issuing new shares is a bureaucratic and time-consuming process and thus cannot be arranged at short notice. Thus, in the event of acute cash flow problems, it offers no solace. It can also affect ownership of the company, especially in joint ventures with Indian partners.

2. External Commercial Borrowing (ECB).

Your Indian subsidiary can borrow from the parent company in Europe, but this is only possible under the so-called External Commercial Borrowing construction (ECB). Applying for an ECB is a bureaucratic and time-consuming process, but it has a big advantage: the interest rate on an ECB loan to an Indian party is based on LIBOR + a premium of up to 300 basis points.

3. Bank loans

Indian Banks: Your subsidiary can apply for a loan from a local bank, but the enormously high interest rates rarely make this option attractive or feasible. Interest rates on credit from local Indian banks start at 10-12% and can easily exceed 15%. Only with a cash deposit as a guarantee can a lower rate be negotiated in some cases. In addition to sky-high interest rates, Indian banks routinely ask for collateral if you want to apply for a loan. To organize the paperwork with the bank, you need a local consultant. In addition, you pay the bank another administrative fee of 1% on average. With local banks, you can raise a maximum of 1-2 million euros this way.

If you need more capital, you can apply to several banks at the same time that can provide a loan as a consortium. Of course, this only makes obtaining the loan more complex and expensive.

International development banks: For projects supported by the Indian government, you can turn to development banks, such as IFC (World Bank) and the Asian Development Bank. In addition, Chinese banks may be an option, although these often impose the condition that the loan be spent on products or services from Chinese (state-owned) companies.

A comparison of the 3 financing options for your Indian subsidiary

CONSIDERATION	SHARE CAPITAL	EXTERNAL COMMERCIAL BORROWING (ECB)	LOAN AT LOCAL BANK
Interest expense	Not applicable.	Maximum: 500 basis point + acceptable reference rate. 3-4% interest rate would be ideal based on our experience and can be justified as arm's length.	Flexible structure with fixed and variable interest rates that can be negotiated with the lending bank. The average interest rate is about 10%.
Other costs	There are legal and filing fees associated with issuing new shares.	Exchange rate fluctuations for borrowers and monthly compliance costs for reporting data to the Central Bank of India.	Costs related to corporate guarantees or letters of credit issued by foreign banks of the parent company.
For- charges	Benefit from Income Tax Act -20% + surcharge & Cess.	Benefit from Income Tax Act -20% + surcharge & Cess.	Not applicable.
Corporate Income tax	Parent company must pay tax in the country of establishment. Tax deduction for taxes paid in India is applicable.	Parent company must pay tax in the country of establishment. Tax deduction for taxes paid in India is applicable.	Not applicable.
Payment terms	Repayment of capital occurs upon business termination. Dividend payment according to the rules of the Indian entity.	Average maturity requirements (ranging from 3 to 10 years) must be met, which provides flexibility in terms of repayment of interest and principal.	Strict payment terms and defaults affect credit scores and interest rates for future loans.
Regulatory considerations	Foreign lenders must meet tax liability through PAN registration, Form 10F and filing of Indian tax returns (only in case of dividend income).	Foreign lenders must meet tax liability through PAN registration, Form 10F and filing of Indian tax returns (only in case of dividend income).	Less hassle with regulations because established procedures are used.

Special guide for CFOs with operations in India

India can be a challenging country for European CFOs. Therefore, to give you a better understanding of the complex tax and financial system that every CFO in India faces, consulting firm IndiaConnected has created an insightful guide that addresses the most frequently asked tax questions.

We can, of course, support you at all times in such matters. From choosing the right financing option to helping you apply for ECB or bank loans, so you can always focus fully on your business in India. Contact us here.

Conducting due diligence in India

The Dutch translation of due diligence is 'with due care'. Unlike in the Netherlands, as a buyer you have no legal obligation to investigate in India. Nevertheless, it is crucial to extensively screen the background of the Indian party before engaging with your business partner. This is how you conduct thorough due diligence of an Indian company (Private Limited).

Due diligence in India

Due diligence is typically performed prior to the purchase of a business or investment in a business by the acquirer or investor. It is sometimes referred to as an audit, but a proper due diligence process goes beyond simply checking the financial statements.

Due diligence helps make the right decision and mitigate the risks associated with the business transaction. Both parties usually enter into a confidentiality agreement before a business due diligence is initiated, as sensitive financial, operational, legal and regulatory information is revealed during the due diligence process.

It is the responsibility of the seller of the company or the shareholder to provide the documents and information necessary to conduct due diligence. In India, it is no different. Typically, the documents listed below are required for conducting due diligence on a private limited. All these documents should be thoroughly reviewed by an expert in India to make an informed decision:

Review of MCA documents.

Much of a company's due diligence can be done with the help of the Ministry of Corporate Affairs (MCA). The MCA regulates business affairs in India through the Companies Act, 1956, 2013 and other related laws and regulations. All companies in India must file their financials and shareholder data with the MCA. These details (master data) of each company can therefore be accessed through the website the MCA.  

The documents, before being filed with the MCA, are approved by the Registrar of Companies (ROC). For a fee, all documents filed with the ROC are made available. The information provided by the MCA is available for one day and is provided under the Right to Information Act. The information collected in this step includes the following, among others:

1. Financial statements;
2. Annual reports;
3. Legal proceedings against the director or company;
4. Lien on assets;
5. Any problem with non-compliance law/regulations.

These are mainly documents filed after September 16, 2006. Prior to this date, documents were submitted to the ROC in the physical form. These documents were kept in the respective ROC and are not accessible online. To inspect these documents, one must visit the respective ROC.

Reputation

In addition to legal information, it is wise to examine the company's reputation in the marketplace. How is the company generally known to customers, suppliers, employees and other stakeholders? Does the company have a good and reliable name in the market? Does the company have a good payment reputation? Has the company entered into other strategic collaborations before and how did they work out? 

Apart from Indian companies' own websites (usually in English), the professional federation of the sector in which the company operates can be an interesting source of information for this purpose. There are also a number of important national business organizations in India, many of which have regional branches. The main ones are:

• Confederation of Indian Industry (CII): www.cii.in

• Federation of Indian Chambers of Commerce and Industry (FICCI): www.ficci.com

• The Associated Chambers of Commerce of India (ASSOCHAM): www.assocham.org

• Chamber of Commerce and Industry (PHD): www.phdcci.in

Finally, on the Credit Information Bureau (India) Limited (CIBIL) website, you can check the credit history of an individual, company or partnership. Any disputes/cases filed against the company can be checked and also whether they have ever been declared a wilful defaulter in the past.

Thinking about a merger, M&A or setting up a Joint Venture?

Partnering with an Indian company can be a great way to enter the Indian market. With a good Indian partner, you immediately have an extensive network, knowledge of the market and share the business risk. But there are legal rules and conditions attached to setting up such a partnership.

IndiaConnected helps companies realize mergers, M&A and joint ventures as a trusted advisor and sparring partner. We support parties throughout the entire process: from partner search to due diligence and negotiations.

Are you interested in finding a suitable partner in India? Or would you like to know more about what is required for an acquisition or joint venture?