A Leveraged Buyout (‘LBO’) is a financial strategy where an investor, typically a private equity (PE) firm, acquires a company primarily using borrowed funds, with the target company’s assets or cash flows used as collateral to secure or repay the debt. The key appeal of an LBO lies in minimizing equity while maximizing return on investment, taking the risk that the business performs well post-acquisition. While LBOs have been a mainstream investment tool in the West since the 1980s, their evolution in India has been cautious, creative, and constrained by legal and regulatory barriers.
In an LBO, the acquirer usually sets up a special purpose vehicle (SPV) and contributes a small portion of equity, raising the remainder through loans or debt instruments. After the acquisition, the target’s revenue is used to repay this debt. This structure benefits the acquirer through ‘leverage’, increasing returns if the company grows while also transferring a significant portion of the financial risk to the acquired entity.
One of the earliest and most instructive examples of an LBO-style deal in India was the acquisition of Tetley by Tata Tea (now Tata Consumer Products). While the transaction was not structured as a textbook LBO, the deal closely resembled one in its economic logic. Tata Tea contributed only a small amount in equity, while the remaining significant amount was financed through debt—largely borrowed overseas by an SPV. The acquisition was funded without relying on Tetley’s assets pre-acquisition, but once the takeover was complete, the debt was serviced through Tetley’s earnings. This strategic move gave Tata access to global markets and highlighted how Indian firms could creatively leverage financial structuring to fund large global deals.
The expansion of LBOs faces significant legal and institutional barriers in India. One of the principal barriers stems from Section 67(2) of the Companies Act, 2013, which prohibits public companies, from providing direct or indirect financial assistance for the purchase of their own shares or those of their holding companies. However, it's important to note that private companies are not subject to Section 67(2). This means that, in principle, LBOs are legally permissible for such private companies, provided other regulatory conditions are met.
However, an exception exists for outbound LBO-style deals. Under Clause 2.3.1.12 of the RBI’s Master Circular on Loans and Advances, banks are permitted to finance Indian companies acquiring equity in overseas joint ventures, wholly owned subsidiaries, or even unrelated foreign companies, provided such acquisitions qualify as strategic investments. The loan given by the bank must comply with Section 19(2) of the Banking Regulation Act, 1949, and be guided by a board-approved policy that sets limits and eligibility criteria. While this provision does not apply to domestic LBOs, it opens a pathway for outbound acquisitions, demonstrating a contrast in regulatory treatment based on jurisdiction.
It is to be noted that for the purpose of LBOs in India, the External Commercial Borrowings (ECBs), regulated by the RBI’s 2019 Master Direction, could have offered a potential route for financing LBOs in India, especially in private deals. However, under the automatic route, ECBs cannot be used directly for equity investments, or for acquiring shares. However, a way through which LBOs can be practiced in India is Non-Banking Financial Companies (NBFCs). Unlike banks, NBFCs are not explicitly barred from financing share acquisitions or changes in corporate control, making them more flexible partners for structuring leveraged transactions. However, NBFC funding comes at a higher cost and is governed by the NBFC Master Directions issued by the RBI, which impose exposure limits, asset-liability guidelines, and enhanced due diligence, especially in deals involving control shifts.
In conclusion, LBOs in India are still limited by legal and regulatory restrictions, especially for public companies and deals involving a change in control. As the government works to ease regulatory compliances and expand financing options, LBOs can become a more common way to invest in India’s fast-paced economy.
[The authors are part of Corporate and M&A practice at Lakshmikumaran & Sridharan Attorneys, Hyderabad]
