Mezzanine Finance

Summary Table

1. Eligible Instruments under Mezzanine Finance

• Mezzanine finance in India is usually structured as:
  • Convertible Debentures
  • Non-Convertible Debentures (NCDs) with equity kickers
  • Preference Shares
  • Subordinated Debt
• These are regulated under:
  • Companies Act, 2013
  • SEBI (Issue and Listing of Non-Convertible Securities) Regulations
  • RBI Prudential Norms for NBFCs/Banks

Domestic Acquisition Finance: NBFCs and NCDs

Because banks rarely underwrite equity acquisition:

• Acquisition finance is raised through NBFCs, public issuance of non convertible debentures (NCDs), or NCDs subscribed by mutual funds, AIFs, and FPIs.
• Unlisted NCDs cannot be used for capital-market investments like share acquisitions.
• Publicly issued/listed NCDs cannot be used to acquire shares of entities within the same group or under common management.
• Foreign Portfolio Investors are limited to 50% per issue, and rules around maturity, single/investor caps, and concentration limits apply unless investments are made under the Voluntary Retention Route (VRR), which relaxes many prudential norms.

Outbound (Cross Border) Acquisition Finance

For acquiring equity in foreign entities or subsidiaries, Indian acquirers can structure financing via:

• On shore loans from Indian banks or NBFCs, or issue of NCDs—subject to ECB conditions.
• 2. External Commercial Borrowings (ECBs), under RBI's ECB Guidelines:
  • Minimum average maturity: typically 3 years for outbound acquisitions.
  • Cost ceiling: For foreign currency ECB, interest plus fees must not exceed inter bank rate (6 month tenor) + 500 bps; for rupee denominated ECB, government security yield + 450 bps.

Alternatively, an Indian acquirer may set up an offshore SPV to borrow abroad and conduct acquisition via overseas financial markets or institutions, compliant with OI Guidelines.

Acquisitions of NBFC MFIs by Banks

If a bank acquires an NBFC MFI, RBI approval is mandatory for both parties:

• Bank’s shareholding beyond 30% of the NBFC’s paid up capital or exceeding 30% of the bank’s own paid up capital triggers mandatory permissions under Section 19(2), Banking Regulation Act, 1949.
• The NBFC MFI must obtain approval if there's a transfer of ≥26% equity or a management change beyond 30% of directors.
• Public notice and a 30 day standstill period are mandatory before completion, to allow public objections.

Bank Acquisitions of Banking Companies (Shares/Voting Rights)

Under RBI’s Master Direction on Acquisition & Holding of Shares or Voting Rights in Banking Companies (2023):

• Acquiring 5% or more of paid up capital or voting rights in a bank requires prior RBI approval.
• Promoters can hold up to 26% of equity/voting rights after 15 years of commencing operations, under RBI and SEBI rules.
• RBI may allow higher caps in specific circumstances (e.g., recapitalisation, regulatory restructuring), subject to conditions and dilution plans.
• RBI and the target bank’s board must ensure continuous ‘fit and proper’ monitoring of major shareholders, submitted annually via a board-approved process.

Other Relevant RBI Prudential Guidelines

• RBI has recently proposed limiting entity exposure to AIFs: REs like banks/NBFCs cannot invest more than 15% of total investments in an AIF, with additional limits on corpus exposure (5% unconstrained, 10% cap overall).
• For transparency in multi-lender loans, RBI has mandated guidelines to regulate Loan Service Providers (LSPs) to avoid opaque intermediation in syndicated or consortium funding.