Putting Start-Up Mergers On The Speed Train: Fast Track Mergers Under The Companies Act
Published: Aug 20, 2021
By Prashanth Shivadass & Pooja Rao*
Introduction:
THE Indian business scenario, over the last few years, has witnessed the gradual growth of start-ups into successful corporate giants. The need for funding and expansion are ever-present in the start-up ecosystem and although much of this is made possible through private equity, venture capital and the like, a merger with a like-minded entity stands to benefit them in more ways than one.
Until recently, the elaborate scheme for mergers under Section 232 of the Companies Act, 2013 was the only option open to start-ups. However, the enactment of the Companies (Compromises, Arrangements and Amalgamations) Amendment Rules, 2021 (the "Amendment") is set to make mergers between two start-up companies a relatively simple affair by relaxing certain compliance requirements. This article discusses the Amendment in the light of start-ups and its benefits to them.
Fast Track mergers
Mergers and acquisitions are inorganic processes through which companies grow. It is symbolized by an instantaneous expansion in work force, customers, infrastructure resources, resulting in an overall increase in the revenues and profits for the merged entity 1. The concept of fast-track mergers was first introduced under Section 233 of the Companies Act, 2013 (the "Act"). It provides for relatively simpler compliance requirements for mergers between:
a) Two small companies; and
b) Holding company and its wholly owned subsidiary company
c) Any other company as notified by the Central Government
Mergers between the abovementioned entities do not necessarily 2 require the approval of the National Company Law Tribunal ("NCLT"), because the same can be accomplished through the ‘Fast track merger' route as they do not pose major market risks, and therefore the mergers can take place with minimum compliances. Section 233 of the Act, read with Rule 25 of the Companies (Compromises, Arrangements and Amalgamations) Rules, 2016 ("Rules"), provides for a comprehensive regime for mergers between the aforementioned entities. With an exponential increase in the number of start-ups, the process of fast-track mergers has been extended to start-ups by virtue of the Amendment.
Defining a "Start-up"
A start-up for this purpose is a private company as defined by the Department for Promotion of Industry and Internal Trade 3. In brief, a start-up can be a company, including a partnership firm, or a limited liability partnership (up to a period of 10 years from the date of incorporation/registration, whose turnover is less than one hundred crores), and can be an entity working towards innovation, development or improvement of products or processes or services. However, companies that are formed as a result of a split or reconstruction of an existing entity are excluded from this definition.
Companies (Compromises, Arrangements and Amalgamations) Amendment Rules, 2021:
By virtue of the Amendment, sub-rule "(1A)" to Rule 25 of the Rules has been inserted. The relevant portion is extracted as under:
"(1A) A scheme of merger or amalgamation under section 233 of the Act may be entered into between any of the following class of companies, namely:
(i) two or more start-up companies; or
(ii) one or more start-up company with one or more small company." .
By way of the above insertion, if one start-up proposes to merge with another, or with a small company, they are not required to follow the elaborate procedure laid down under Section 230-232 of the Act. However, under Section 233 of the Act needs to be followed by the emerging entities.
Steps for fast-track merger:
After framing a scheme of merger or amalgamation, the entities are required to issue a notice regarding the proposed scheme before the Registrar of Companies ("RoC"), the Official Liquidators and persons affected by the scheme, to call for their objections or suggestions, if any. Thereafter, companies are required to file a declaration of solvency to ensure that the merged entity will remain solvent. The time limit for the concerned authorities to submit their objections to a particular scheme, is 30 days.
Further, the companies are required to call for their respective general meetings, where the proposed scheme should be approved by majority of the respective creditors or class of creditors representing nine-tenths in value of the credit, and the respective members holding at least ninety percent of the total number of shares 4.
Thereafter, if the RoC and the Official Liquidator raise no objections, the merger should be duly registered by the Central Government.
The role of the NCLT under this provision comes only when the Central Government, upon the receipt of such objections, forms an opinion that the merger is not in the interest of the public, or of the creditors. In such a case, the Central Government will file an application before the NCLT for its consideration. The NCLT, if it deems fit, will direct the scheme of merger to be considered as per the procedure under Section 232 instead.
Therefore, in the first instance, if the scheme of merger receives approval of the members, creditors, the RoC and the Official liquidator, the process of fast-track merger is deemed complete, which shall result in the registration of the merger.
The significance to start-ups
India has about 50 unicorn-start-ups exceeding $1 billion in equities 5. The relaxation in compliance requirements for establishing a start-up is a pivotal step towards encouraging a booming start-up culture in the country. The largescale activity in India's start-up ecosystem is believed to aid India's fiscal recovery from the Covid-19 pandemic and this Amendment is of vital importance. The benefits to start-ups are as under:
- In order to bring out an effective strategy, many start-ups are inclined towards Mergers and Acquisitions as a solution to major challenges like economy of scale, economies of scope, vertical and horizontal integration, development of complimentary resources, effective application of surplus funds, and to enhance managerial effectiveness 6 . Therefore, by merging with another, they can gain access to a new market sector without paying for costly market research 7.
- Start-ups particularly cannot afford to expend additional resources in case a merger drags on longer than expected. Hence, the relaxed compliance requirements will reduce the time taken to complete a merger.
- As a growth strategy, mergers between start-ups can help increase their market share, and impact. 8 The merged entities can share their customer base with each other in order to have a sustainable growth, which shall allow to bring in fresh capital.
- Cultural differences between entities having different business models can often derail a merger 9. However, a merger between two start-ups is likely to balance the dynamics of the demographics within both the entities thereby increasing the potential of a compatible merger between the entities.
Conclusion and Way Forward
The process of fast-track merger has eased the compliance requirements, thereby encouraging many creative minds to execute plans. Undergoing a merger is a huge task for any company, as there are multiple statutory compliances which are required to be taken care of which can be much more daunting for start-ups. Therefore, the relaxation in the procedural / statutory requirements is a welcome relief. Start-ups may be more encouraged to pursue mergers between themselves. Given that the Amendment is quite recent, its practical utility is now being put to test. However, the released procedure will be looked at positively towards pushing India further up the Easy of Doing Business Index.
[The authors are Partner and Associate respectively, with Shivadass & Shivadass (Law Chambers). The Authors would like to acknowledge the contributions of Sudarshan B.K., a 4th Year law student from Ramaiah College of Law, Bangalore. The views expressed are strictly personal.]
1 "Mergers and Acquisitions", Report of The Expert Committee on Company Law
2 The Companies, however, may themselves prefer to follow the procedure under Section 232
3 Ministry of Corporate Affairs, G.S.R. 127(E) Notification dated 19/02/2021
4 See Section 233 of the Companies Act, 2013
5 See the Standing Committee Report, titled "Financing the Startup Ecosystem" dated 08/09/2020
6 Viral Upendrabhai Pandya, "Mergers and Acquisitions Trends: The Indian Experience", International Journal of Business Administration 9 [2018]
7 Pros and Cons of Merging Startups as a Growth Strategy | Northstar Investment Banking
8 Pros and Cons of Merging Startups as a Growth Strategy | Northstar Investment Banking
9 Cultural Clashes in a merger of equals: The case of high-tech start-ups - https://pdf.zlibcdn.com/dtoken/514e8931c6311f5ac1ec33fa01354511/hrm.20446.pdf