What is it?

In a dual structure, the Indian investor (Investor) invests directly in the onshore subsidiary (India Co.) of the offshore hold co (Offshore Co.) while the other investors and founders invest or hold stake directly in the Offshore Co. All the rights and obligations of the Investor is mirrored at the Offshore Co. level, as if the investment were made in the Offshore Co. Accordingly, at times, they are referred to as ‘shadow structure’. 

Why not directly invest in Offshore Co.? 

Largely, owing to regulatory restrictions under automatic route and to discourage ‘round-tripping’. To illustrate, (i) the overseas direct investment regulations do not permit an Indian investor to invest in an offshore company that already has direct/indirect investment in India under the automatic route unless specifically approved by the Reserve Bank of India; (ii) the Insurance Regulatory and Development Authority of India does not allow Indian alternate investment funds having insurance money or insurers to make overseas investments; and (iii) the Indian alternate investment funds are required to seek prior approval of the Securities and Exchange Board of India for making any overseas investments.

Implementation - Key Pointers

1. Instrument: Preferably, convertible instruments (CCPS, CCDS, OCPS) in the India Co - as it provides flexibility to mirror valuation, investment and exit rights. Also, an Investor may seek nominal equity shares for availing statutory rights (such as participation in rights issue).
2. Valuation: Valuation mapping of the India Co. and Offshore Co. to ascertain the actual and notional shareholding of the Investor. The number of shares proposed to be issued in India Co. may not always be equivalent to the number of shares the Investor would have gotten if it were to invest directly in Offshore Co.
3. Documentation to ensure parity: In absence of any actual securities held by the Investor in the Offshore Co., the rights granted to the Investor and recognition to its notional shareholding at Offshore Co. level are primarily contractual. Hence, it is imperative to adequately record the same in suitable documents, at both, the India Co. and Offshore Co. levels, to ensure parity with other stakeholders. Typically, the key documents include:

(I) Subscription agreement at India Co. level – to record the terms of subscription including warranties and indemnities

(II) Shareholders’ or rights agreement at Offshore Co. level – to recognise the rights and notional shareholding of the Investor at Offshore Co. level and ensure parity with other stakeholders 

(III) Call and Put Option agreement – to set out the exit routes for the Investor simultaneously upon change of control, strategic sale, listing of securities of Offshore Co. or occurrence of any other exit event 

(IV) Shareholders’ agreement at India Co. level – to replicate limited rights and obligations, particularly in relation to event of default, consequences of not facilitating exit to Investor, pre-emptive and anti-dilution rights

(V) Constitution documents of India Co. – to replicate the inter-se rights and obligations covered in India Co. shareholders agreement

 (VI) Constitution documents of Offshore Co. – to replicate the inter-se rights and obligations covered in Offshore Co. shareholders agreement

As some of these documents are governed by foreign laws (mostly English laws or laws of the respective states in the USA) and the rights granted therein are subject to contractual protection, it is important to align the dispute resolution mechanism. Parties can also opt for a neutral institutional dispute resolution mechanism. 

4. Key rights for the Investor: 

(I) Right to swap (of course, subject to applicable law) its stake in India Co. for securities of Offshore Co. representing the notional shareholding. To implement, Offshore Co. to reserve adequate unissued authorised share capital and undertake all necessary actions and other stakeholders to cooperate. 

(II) Suitable exit rights – can be structured as put option in favour of Investor (and a corresponding call option in favour of Offshore Co. or other stakeholders) and/or buy-back by the India Co. 

(III) Right to liquidation preference in parity with other stakeholders of the Offshore Co. (as applicable to the same round of subscribers)

(IV) Pre-emptive or anti-dilution right to protect the Investor in cases of any subsequent fund raise or dilution at Offshore Co. level – can be achieved by adjustment to conversion ratio or issuance of further securities in India Co. or change in swap ratio. 

(V) Event of default protection to ensure that rights of the Investor will be effected at all times in parity with those of other stakeholders. These may comprise of veto matters, operational rights or right to free transfer, etc. 

(VI) Based on the quantum of investment and resultant stake, the Investor may seek suitable management / operational rights (e.g., reserved matters and board / observer seat). At times, the India Co. and the existing stakeholders may not be in favour of granting the Investor these rights at India Co. level, to avoid any operational interference

(VII) Suitable information and inspection rights as offered to others. 

5. Tax and regulatory considerations: These considerations depend upon several commercial aspects such as nature of the Investor, instruments offered, valuation, nature of Indian business, possibility of exit, etc. Accordingly, the same (both at India as well as offshore level) to be appropriately evaluated and factored into.

To conclude, the dual structures act as a bridge between the domestic and externalized investments, and as seen at occasions, they have stood the test of implementation intricacies, including exits.