For every entrepreneur, starting a business with personal funds or minimal external help commonly known as bootstrapping is a brave and rewarding path. However, building a successful venture isn’t just about scaling operations or attracting funding. Eventually, the founders and investors must think about an exit strategy to monetize their equity.

Whether through acquisition, merger, public listing, or management buyout, a smart exit plan is essential for maximizing value, ensuring regulatory compliance, and protecting all stakeholders’ interests. In India, structuring a legally sound exit requires careful planning under several legislations including the Companies Act, 2013, FEMA, SEBI regulations, and Income Tax provisions. This article explores how to strategically transition from bootstrap to buyout, with a strong emphasis on the legal.

In this article, CA Manish Mishra talks about From Bootstrap to Buyout: Structuring a Smart Exit Plan.

The Importance of Exit Planning

An exit plan is a strategic roadmap for founders, early investors, and stakeholders to reduce or completely divest their ownership in the business. It provides clarity on succession, valuation, and return on investment. Most startups defer exit planning, but experienced founders begin working on it early well before reaching Series A or growth stage. A structured exit increases negotiation leverage, ensures tax efficiency, and reduces post-deal disputes. Common exit routes include strategic acquisition, merger/amalgamation, IPO, ESOP buybacks, secondary share sales, and management or leveraged buyouts.

Types of Exit Options

Startups can choose from several exit options depending on their maturity, market positioning, and investor appetite:

• Strategic Acquisition: A bigger player acquires the startup to gain market share, talent, or technology.

• Merger or Amalgamation: A corporate restructuring under Sections 230–234 of the Companies Act, where two entities combine.

• Management Buyout (MBO) or Leveraged Buyout (LBO): Promoters or internal teams buy shares from existing investors or founders.

• Initial Public Offering (IPO): Going public allows broader investor participation and liquidity.

• Secondary Sale: Existing shareholders sell shares to new investors or funds.

• ESOP Exit: Employees liquidate their vested shares through buyback or secondary offerings.

Each route involves different legal, tax, and procedural obligations.

Legal Due Diligence and Corporate Hygiene

Before pursuing any exit strategy, the startup must undergo a comprehensive legal due diligence process. This includes ensuring that all statutory compliances under the Companies Act, 2013 are in place such as updated Registers of Members (MGT-1), Directors (DIR-12), ROC filings (MGT-7, AOC-4), and board/shareholder resolutions. Cap tables must be clean, and the company should have valid intellectual property rights, employee contracts, and customer agreements. Any pending litigation or regulatory non-compliance must be resolved to avoid valuation discounts or deal terminations.

Provisions under the Companies Act, 2013

The Companies Act governs most corporate actions related to restructuring and exit in India. Key provisions include:

• Sections 230–234: These govern compromise, arrangement, amalgamation, and merger schemes, including cross-border mergers subject to approval by the National Company Law Tribunal (NCLT).

• Section 66: Pertains to reduction of share capital, requiring a special resolution and NCLT confirmation.

• Section 68: Governs share buyback, limited to 25% of paid-up capital and free reserves in a financial year. Requires filing of Form SH-8, SH-9, and SH-11.

• Section 62(1)(b): Covers issuance of shares under Employee Stock Option Plans (ESOPs) for facilitating employee exits.

• Section 108 and 110: Relates to voting mechanisms and postal ballots during shareholder approvals required for exits or restructuring.

Adherence to these provisions ensures legal validity and enforceability of the exit transaction.

FEMA Regulations for Cross-Border Transactions

If the exit involves foreign buyers or foreign investors transferring shares, compliance with the Foreign Exchange Management Act (FEMA), 1999 is mandatory. Key requirements include:

• Pricing Guidelines: Shares must be transferred at a price not less than the fair market value (FMV), certified by a SEBI-registered Merchant Banker or Chartered Accountant.

• Form FC-TRS: This must be filed on the RBI’s FIRMS portal within 60 days of the transfer of shares between a resident and non-resident.

• Escrow and Deferred Payments: Must comply with RBI Circulars on permissible structures for staggered consideration.

• Sectoral Caps and FDI Rules: Exits must not violate foreign investment limits or prohibited sectors as per the Consolidated FDI Policy.

Failure to adhere to FEMA regulations can lead to penalties under the compounding scheme of the Reserve Bank of India.

Income Tax Provisions and Capital Gains Implications

Exits lead to taxable events for shareholders, promoters, and employees. It is critical to evaluate:

• Capital Gains Tax: For unlisted shares, LTCG (held >24 months) is taxed at 20% with indexation. STCG is taxed at applicable slab rates. For listed shares sold on stock exchanges, LTCG above ₹1 lakh is taxed at 10% (without indexation).

• Buyback Tax (Section 115QA): If a company buys back its own shares, a 20% tax is payable by the company on the distributed income.

• Angel Tax (Section 56(2)(viib)): This applies when shares are issued at a premium to FMV. However, DPIIT-recognized startups can claim exemption under CBDT Notification dated February 19, 2019.

• ESOP Taxation: Employees are taxed on the perquisite value at the time of exercising the option (Section 17(2)) and again on capital gains at the time of selling the shares.

To optimize tax liability, companies must structure their exits in consultation with tax advisors and obtain valuation certificates as per Rule 11UA of the Income Tax Rules.

SEBI Regulations for IPO or Public Exits

When a startup opts for an IPO, it enters the purview of SEBI regulations. Key frameworks include:

• SEBI (ICDR) Regulations, 2018: Governs IPO norms, disclosures, promoter lock-ins, and minimum public shareholding.

• SEBI (LODR) Regulations, 2015: Deals with post-listing compliance and corporate governance requirements.

• SEBI (SAST) Regulations, 2011: Covers substantial acquisition of shares and takeover obligations.

• SEBI Delisting Guidelines: Relevant in case of reverse mergers or buyouts of public shareholders during exit.

SEBI also prescribes norms for alternate exits through Innovators Growth Platform (IGP) for startups, allowing easier listing with relaxed requirements.

Shareholders’ Agreements and Exit Rights

A well-drafted Shareholders’ Agreement (SHA) is a vital legal instrument during an exit. Important clauses include:

• Drag-Along Rights: Enable majority shareholders to compel minority shareholders to sell their shares during an acquisition.

• Tag-Along Rights: Give minority shareholders the right to sell alongside majority stakeholders during a sale.

• Right of First Refusal (ROFR) and Right of First Offer (ROFO): Control who can purchase shares being sold.

• Exit Waterfall Clause: Determines the distribution priority of exit proceeds typically preference shareholders receive returns first, followed by equity holders.

These clauses must be clearly defined and backed by board and shareholder resolutions, especially when dealing with investor-led exits.

ESOP Exit and Buyback Structuring

Employee liquidity events such as ESOP buybacks have gained traction. The Companies Act, along with Rule 17 of the Companies (Share Capital and Debentures) Rules, 2014, provides the regulatory framework. Companies must ensure:

• ESOPs are approved via special resolution.

• Register of ESOPs (Form SH-6) is maintained.

• Buybacks do not exceed 25% of the paid-up equity capital in a financial year.

• Proper tax deductions and filings are made under TDS for perquisites.

ESOP exits can also be structured as part of secondary share sales during funding rounds.

Recent Legal Developments Affecting Exit Strategy (FY 2024–25)

• Expanded Angel Tax: Applicable to non-resident investors from April 2023; startups must ensure DPIIT exemption.

• SEBI Eases Reverse Book-Building Norms: Enabling faster and smoother delisting of shares for buyout exits.

• DPIIT Portal Integration: DPIIT now connects with MCA and Income Tax e-filing, simplifying compliance for recognized startups.

• Faster FC-TRS and FEMA Processing: RBI mandates stricter reporting timelines for cross-border share transfers.

These updates make it imperative for startups to adopt a proactive approach to legal and regulatory compliance during exit planning.

Conclusion

Frequently Asked Questions (FAQs)

Q1. What is an exit strategy in a startup?

Ans. An exit strategy is a planned approach for founders or investors to withdraw their ownership in a business, either fully or partially, through acquisition, IPO, buyout, or secondary sales.

Q2. What are the most common exit options for startups in India?

Ans. The popular exit routes include strategic acquisition, merger or amalgamation, management or leveraged buyouts (MBO/LBO), initial public offerings (IPOs), ESOP buybacks, and secondary share sales.

Q3. What legal checks should be done before planning an exit?

Ans. Ensure clean corporate records, updated ROC filings, valid shareholding structure, ownership of IP, signed shareholder agreements, and no pending legal disputes.

Q4. How does the Companies Act, 2013 regulate exits like mergers or buybacks?

Ans. Sections 230–234 regulate mergers/amalgamations, Section 68 deals with buybacks, Section 66 allows capital reduction, and Section 62 covers ESOP-related exits.