Introduction
When it comes to exiting from a shareholding, or other venture, investors often find themselves at the short end of the stick. Faced with the uncertainty, possibility of loss, and a questionable return on investment, it is imperative that every investor must seek to divest their shareholding or plan an exit in a strategic and profitable manner.
Therefore, it can be understated that formulating an exit strategy is of paramount importance for any investor, and potential investors must expedite mulling over an exit strategy well in advance, whether it comes to private equity investments or strategic or governmental business holdings. This article shall elaborate on the options an investor can utilize to maximize their benefits whilst exiting taking into consideration several factors such as market conditions, return on investment, etc. The below-mentioned key strategies are some viable strategies for investors in the present business environment-
- Initial Public Offering (IPO)
An Initial Public Offering can be defined as the opening or sale of securities of the enterprise to the general public in the primary market per se. An Initial Public Offering acts as the largest mode of generating funds for the long term for the company. This is the best exit option for those investors seeking immediate returns or refunds on the investments made by them. Initial Public Offering also offers the advantage of negotiation for the best possible outcome for the investor before making a strategic exit. However, investors often face the inexplicable position of being misconstrued as a promoter and that must be avoided whilst exiting from a venture.
What Are the Different IPO Exit Strategies?
- Flipping: When an investor acquires shares in an IPO and then sells them on the listing date, it is known as flipping. Stock prices can change significantly on the listing date, which is the first day shares are traded on stock exchanges. Depending on investors’ demand and market outlook, prices may either rise or fall.
For instance, say you are allotted 1,000 shares in an IPO at Rs. 120 each. And on the listing date, the share prices increase to Rs. 180 per share. In this case, you can gain around Rs. 6,000 by simply flipping your holdings.
- Selling and Reinvesting: Often, investors sell off their shares at a loss when stock prices fall on the listing date and later reinvest in the same company at a much lower price in the secondary market. Then, they hold the shares till it generates the desired returns and profits.
For example, say you applied for an IPO and were allotted 1,000 shares at Rs. 450 per share. On the listing date, the price of the shares drops down to Rs. 380. You can choose to bear the loss of Rs. 70 per share and sell your holdings. And then, you can reinvest in the company at lower prices. You can then continue to hold the shares for several years, till the price increase is enough to deliver significant gains.
- Long-term investing: If you expect that the shares in an upcoming new IPO will perform well over the years, it may be a better idea to hold it in your portfolio for a few years rather than flip it on the listing date. This is a long-term exit strategy that you may also know as the buy-and-hold strategy. It works best for shares that are fundamentally strong and perhaps undervalued.
- Secondary Sale
An exemplification of a secondary sale can be best regarded as the sale to a third party by an existing and currently holding stockholder, with the proceeds cumulated being transferred to the stockholder that sells for his benefit.This can be distinguished from a primary sale, by way of ascertaining the end user of the generated funds, i.e., the funds being divested to the investor in a secondary sale, as compared to being set aside for corporate purposes in case of primary issuance. The benefits that an investor stands to gain from a secondary sale, is a lack of formal compliance as compared to a primary sale, thereby speeding up the process, and better rights for the investor vis-à-vis third parties, among other benefits.
- Strategic Acquisition
Companies pursuing mergers and acquisitions are involved in actively negotiating a bargain that comprehensively addresses their specific objectives, as well as returns that investors will end up bagging, in case of a successful deal. Nuanced and Extricate deal terms, regardless, can have a profound impact on future earnings of investors, and other associated parties. Strategic Acquisitions is one of the most widely considered exit strategy for an investor as it helps in the continuity of funding for the befuddled investor, and also provides a sense of security by way of ownership or major shareholding, depending upon the circumstances and terms of acquisition.
- Small and Medium Enterprise Initial Public Offering (IPO)
NSE EMERGE and BSE SME Exchange are the two platforms in India that allow small and medium-sized businesses to solicit public interest in purchasing shares of their initial public offerings. It is a simple and quick way to access the market where SEBI permission is not necessary. Although stock exchanges administer most SME IPOs, SEBI does not review the draught prospectus of an SME IPO business. To be qualified for listing on the SME Exchange, the company’s post-issue paid capital cannot be greater than INR 25 Crore. The success story of certain SME IPOs is turning into an alluring proposal if the firm is smaller in size and the promoters want to give investors an early exit.
- Merger and Acquisition
The term ‘merger’ is not defined under the Companies Act, 2013, or under Income Tax Act, of 1961. As a concept, ‘merger’ can be understood as a combination of two or more entities into one; the desired effect is not just the accumulation of assets and liabilities of the distinct entities, but the organization of such entities into one business. The Income Tax Act, 1961 however defines the analogous term ‘amalgamation’, as a merger of one or more companies with another company, or the merger of two or more companies to form a single/one company.
While acquisitions can be completed through the sale of an organization or an asset, mergers frequently involve legal proceedings. One can frequently encounter investors who reserve the right to cause an exit event if the investee company makes a merger or acquisition proposal with another company operating in the same or a similar industry. Depending on the possible benefits that a merger or acquisition may provide, investors may look to depart or exit completely or partially in such a situation. Given the extensive regulatory procedures and lag times involved, mergers of unlisted investee companies with listed companies are rare.[9]
- Buyback Options
Investors may bargain for a firm buyback clause or a forced promoter buy-out at a predetermined price. In this regard, it should be noted that a business repurchase involves significant regulatory procedures that must be met prior to implementation, much like a merger of an unlisted investee firm with a listed company. Also, there are opinions in the market that state that it is illegal to purchase back non-resident investors’ preferred shares unless those preferred shares have already been converted into equity. Thus, exiting through a business buyback is frequently viewed as a last choice. The promoter rarely consents to unconditional commitments in the case of a forced promoter buy-out because doing so puts them at danger of legal culpability or financial ruin.
- Put Options
A put option buyer has a bearish view of the market as opposed to the bullish view of a call option buyer. The put option buyer is betting on the fact that the stock price will go down (by the time expiry approaches). Hence in order to profit from this view, he enters into a Put Option agreement. A put option is a contract that gives an investor the right, but not the obligation, to sell shares of an underlying security at a set price at a certain time.
Rules 9(5) and 21(2)(c)(iii) of FEMA (Non-Debt Instruments) Rules, 2019 govern the pricing mechanism of equity shares transferred to a person resident in India from a person resident outside India. Therefore, where the payment obligation to the investor under the exit clause entails payment higher than the fair market value (“FMV”) of the shares, it is often argued that such clauses are void. However, schematically, FEMA provides for both, the general and special permission of the RBI. While transferring shares at FMV is allowed under the “general permission” route, a party may also apply to the RBI for “special approval” to transfer the shares at a price above FMV. The Bombay High Court in Videocon Industries Ltd. v. Intesa Saupaolo, interpreted the phrase “with the general or special permission of the Reserve Bank of India” as not mandating prior permission, and that contracts were not invalid for want of permission. Therefore, it is open for parties to apply to the RBI post-facto for permission to transfer shares at a price higher than FMV, and such transfers are not per se prohibited.
Another argument also deployed under FEMA is that exit clauses provide parties with an “assured return” which is prohibited. In Cruz City 1 Mauritius Holdings vs Unitech Limited[11], a put option clause provided for payment of the investment amount plus a 15% IRR (internal rate of return), if construction of a project was delayed. The counterparty failed to make payment upon such delay, and an award was made for damages. The Court upheld the award and rejected the argument that the clause provided for an assured return which was impermissible under FEMA, holding that “Cruz City had no assurance of exit at a pre-determined return… in the event the execution of the project was commenced on schedule.”
Although put option terms have drawn criticism from Indian regulatory authorities, emerging jurisprudence trends in India have demonstrated court willingness to support investors. The verdict of the courts in NTT Docomo Inc. v. Tata Sons Ltd. (2017), among other judgments, shows that the Indian courts have repeatedly affirmed the validity of put options. As a result, put option provisions may be stated as damages or a default remedy available to investors upon the investee company or even in some cases, key promoters committing a breach, whether in contract, tort, or otherwise. This is necessary for the hotly contested “assured returns” to be enforceable for the investors.
Conclusion
It can be concluded that various exit options can be employed by investors in order to maximize return on investments from the market. However, investors must carefully scrutinize factors such as market trends, stock prices, and other considerations before making a strategic exit. It is often advisable for investors to take note of long-term considerations and returns compared to short-term returns. Thus, the abovementioned options can be employed, either solo or partly in furtherance of each other, to seek the best possible return while also making a successful maneuver outside the realm of the market.
