The rise of Management Buyouts in INDIA

CA Maneet Pal

09810774806

http://www.capasricha.com/

Management Buy-Out is a form of acquisition that is purchase of a company by another; in this case the company’s existing managers acquire a significant part or whole of the company.   

Well as in most circumstances the management will buy out all the outstanding shareholders and then take the company private, the reason is because it may have the feeling the business could expand and it will be in the betterment of the company if they controls the ownership. And it usually requires substantial support from the bank or venture capitalists or other outside entities.

With the emergence of private equity players agreeing to risk and invest in the purchasing of such companies a rising trends has been in this perspective. Be it foreign, domestic or family run business everybody has shared this limelight. Various bids arriving from across the globe has opened a new possibility for the managers who had ambitious dreams to own and work for the success of their companies.

Back in 2007 Blackstone Group agreed to buy an Indian company Intelenet Global services Ltd., Blackstone owned about 80% of the company, the deal was said to be of a about $200 million. India ranked 16 among the with most Private Equity deals in 2007. With the number of family business coming up drastically and domestic companies splitting up the Management Buyouts have entered with arms wide open. PE brings a lot more focus into a company. They also bring corporate governance into companies, which are family-run businesses, by converting them into management-run businesses.

Management Buyouts in today’s era

Some of the buy outs can be simple, straight and advance while others can be rather of a complex nature. The main thing here is the Managers see a profitable business for which they put some of their money to gain owner and equity returns for their invested money. However what amount of sum is considered acceptable varies and it depends as to what extent the management puts in. The outsiders such as bankers accept a considerable promise from the management and this sum may not be very large as well.  

Financing Management Buyouts

There are three major ways to finance management buyouts in India:

1)      Debt Financing

In management buyout the company’s managers become owner but they don’t have that much amount of money to acquire the company. Therefore they look forward to outsider investors like banks. Banks usually do not lend such huge amount of money as it’s always a risky transaction on their behalf.  The management teams are asked to raise a significant proportion of the amount through their own funding and then the banks lend them the remaining amount of the capital.  

2)      Private Equity Financing

If in any circumstance the banks refuse to lend the required amount of money then the company will look forward to raise its capital through private equity funding. Equity investors will fund the company by either investing in the company’s stake in return for shares or can finance the same amount as debt to the company. Although the investors choose this of the two of the above is entirely their decision. But since debt is backed up with security and is not risky unlike equity, many will prefer debt.

Also the investors will want the managers who are the owners to make a considerable amount of investment. This will lead to the managers having a small portion of the company.

However the investors may ask the company to agree to certain terms and conditions in which the company would be run. This will ensure that the management works towards getting maximum returns for their investments on the contrary subject to the small goals of the investors the management may will have larger goals for the company. And this compliance may lead to the decisions of the management being restricted or rigid.

3)      Seller Financing

In some situations is possible that management and the original owner of the company agree to deal whereby the buy out will be financed by the seller. The price paid will be over the years of the company profits. But in this deal there are disadvantages to the seller, he must wait to receive his money which is dependent on over the years of company profits and he loses control over the company.   

The relatively closer term “Management Buy in”

When an outside management team purchases an ownership in the company’s stake and replaces the existing management team in a commercial act. It is basically known as management buy in. this type of action may arise when the outside team feels that the firm’s products can generate higher profits than what it generates in the current state.   

In this growing economic and corporate world there exists many management teams who buy in small or unprofitable companies if they feel these firms can run into good profits if the activities are carried on by the new management.

The Difference

The core differences between “management buy out” and “management buy in” is that in management buy out the managers of the same company invest in the company’s capital and become owners of the company and in management buy in the outside management team purchases the company and becomes owners, replaces the existing managerial team and runs the company as per their plans.

Buy in management buy out (BIMBO) – The combination

BIMBO is a combination of buy in management and management buy out. In buy out the existing managers acquire the company and become owners of it and in management buy in the outside investors replace the existing management and the business. This term came into existence in 1990.  

Conclusion

Management buyout is a term which enables the management section of an organization to emerge out of a restricted progress arena to an open space where the management discovers its leadership skills and works with utmost dedication and motivation. It’s the management that sees the true potential of the company and knows how to help reach those targets in future. Just like every other body in the universe MBO’s have their share of pros and cons but given a chance MBOs have flourished with time and that’s the core reason of the rising trends in India. Since 2007 MBOs have gained stable momentum and till date numerous deals have been cut and many small and large scale firms have benefited from it.   

“Concept paper on rent securitization”

CA Maneet Pal Pasricha

09810774806

http://www.capasrisha.com/

With the growing fiscal opportunities available in mounting India, financial needs of people are staring up to leverage these opportunities. To satisfy financial needs people are in constant search of easy money. To satisfy peoples appetite banks come with various innovative credit/ loan schemes. One of the lately becoming popular schemes in the list is “Loan against future rent receivables” or in banking tongue it is commonly known as “Rent securitization or Rent discounting scheme”. Rent securitization concept has been developed considering the growth potential in the real estate in India.
Many public and private banks like Vijaya Bank, Syndicate Bank, Corporation Bank, HDFC, ICICI etc have started rent discounting schemes to fund property owner’s needs.


In this paper, I would be discussing the subject on following margins:

• Meaning
• Pre-requisite
• Benefits
• Financial feasibility
• Tax impact
• Summarizing the profit of case study
• Conclusion


Meaning

Today many banks have scheme of “Rent securitization” in there credit portfolio. But the question arises what is it and how it can help you. In simple prose it means providing credit/ loan against the rent which is yet to be received. To exemplify, if you are owner of commercial properties anywhere in Delhi/ NCR or any metro city and is receiving assured rent against the same, then on the basis of these assured future rent receivables banks can provide you the attractive loan deals. In such credit facilities rent received every month is used as EMI towards the loan sanctioned. So virtually there is no cash outflow against interest or the principle amount of the loan as the same is adjusted with rent receivables.

One of the perfect examples for rent securitization is opening of banks next to your resident. You might have never studied the economics behinds opening of banks next to your locality, you might have never thought why would anyone shift his house and give the same on rent to banks/ MNC/ PSU. This concept paper will help you get all the answer of all these questions.


Pre-requisite

It becomes easier to avail such credit facilities if your premise is rented to any commercial bank, PSU or any multi national company, because in such cases it is easier for banks to vouch following pre-requisite:
• The space has been let out to organisation holding value in market
• Building has been constructed in accordance to the plan approved by the authorities concerned;
• There is a firm lease agreement between the borrower and the tenant;
• The borrower and the tenant both are credit worthy;
• Provide assignment of future receivable rents along with a guarantee from third party; and
• Rent agreement should not contain any clause which allows a downward revision in the rentals during the period covered by the loan banks.

In such cases, the loan amount should not go beyond the net future rent receivable of the property minus margin money (which may range from 20% to 25% of the future rent of the unexpired rent period).



Benefits

Such credit facility can be of great of help to meet any of your urgent requirements or it can even be a good fiscal decision to grow your wealth. Some of the key profits which can be derived from such credit schemes are:
1) Such facility provide an easy loan option to the borrower;
2) If such option is used wisely, it can help you create new asset;
3) It can help you meet the working capital requirement for your business;
4) These loan options are good substitute of personal loan. As your property is used by the bank as security against which you are given the loan, the interest rates on these loans tend to be lower than the rates for personal loans, helping you save more on total loan cost.
5) It can help you meet urgent financial requirements, like any medical emergency or children's education.
6) Banks generally have minimum and maximum loan limits which generally ranges between Rs.1 lac and Rs.1000 lacs respectively.


Financial viability of credit facility

If you have the rented commercial property and you are not completely depended on its rent for your bread and butter, then rent securitization scheme can be good financial decision for you to take. This scheme helps you to securitize assured future rent receivable and receive the lump sum amount from bank. This amount can be used for any viable investment proposal or to meet any other requirement. This credit facility is less costly than other facilities like personal loan. On an average, the rate of interest on personal loan ranges from 18-23% and the rate of interest on such loan facility is approximately around 15%, it straight away saves your pocket by 3-8%.

In addition to the above, such facility help you get the lump sum amount without any additional cash outflow from pocket. This is because your rental amount is adjusted to loan amount. In this way without shedding any additional amount you can enjoy the benefits of credit.


To illustrate lets assess the following facts:

Suppose Mr. A is living in South Delhi on approved commercial road and the same commercial property has been rented out to MNC for its operations at the rental value of Rs. 2, 00,000 per month for the period of 5 years (ignoring the clause of yearly increase in rent if any).

Now Mr. A can leverage these assured future rent receivables and can avail benefit of credit/ loan facility provided he is not dependent on rent amount for his bread and butter. For the contract of 5 years with MNC, Mr. A is to receive the rent amounting to Rs. 10,764,000/- (net of tax).

On this assured future rent receivable bank can provide him with loan which he can use for above mentioned benefits. Bank can provide him with the loan approximating Rs. 70 lacs to 80 lac (depending upon on bank’s credit/ loan policy).


Tax impact

Do the tax benefits of debt affect financing decisions? How much do they add value? Studies indicate that tax benefits are one of the factors that affect financing preference. There are certain tax benefits for the resident Indians based on the principal and interest component of a loan under the Income Tax Act, 1961.

The tax benefit of debt is the tax savings that result from deducting interest from taxable income. By deducting interest from his income, person can reduces its tax liability to great extent.

In the scheme of rent securitization, banks enter into three party agreements. Three parties to the agreement are namely tenant, landlord and bank. Future rent receivables are received directly by bank from tenant and such rent are adjusted against interest and principle amount of loan given to landlord.

In Income tax act profit and loss account is prepared on accrual basis. Accordingly in the scheme of rent securitization, rent to be received during the year is considered as Income, the interest component of EMI is considered expenses and the remaining component of EMI towards i.e. loan amount repayment is considered as capital outflow and is deducted from the loan amount in the books of landlord.

On the basis of above tax provisions, If Mr. A avails the above loan option of 70 lac then he can save his tax
cost by approximately 12-13 % by taking the benefit of deduction of interest cost.



Summarizing the profit of case study

Let us point out the broad benefits achieved by Mr. A in given case study:

1. By securitization of future rent receivables, he can get a loan of Rs. 70-80 lacs;

2. Interest cost of rent securitization is less than personal cost, thereby save the interest cost of approximately 3-8 %;

3. If used this money to buy another asset (say land) then he can have the benefits from capital appreciation of that asset; and

4. Can save his tax cost by 12-13%.


Conclusion

I would like to bring to a close that, it is one the few loan schemes in which it is a win-win state for both the parties (i.e. bankers and landlord). Any person having such commercial property and is not dependent on it for bread and butter then he should certainly analysis the rent securitization scheme and leverage it for his benefits.