How the new CFIUS laws can hit Indian tech firms, Benjamin Schwartz explains
The United States (US) department of treasury has released new rules, governing investment into the US that Indian executives, especially in the technology, infrastructure and data sectors, ought to study carefully. The US is India’s largest trading partner, and over the last decade, Indian businesses have more than doubled their investment into the US, with foreign direct investment approaching $10 billion annually. This increased investment comes with an increased need for businesses to be sensitive to the unique regulations of both countries, especially when those laws reflect a major change in policy.
Such a change will go into effect on February 13. In 2018, in a rare instance of bipartisanship, the Congress granted new powers in the form of expanded authority and increased resources to the Committee on Foreign Investment in the United States (CFIUS). This body is charged with repelling what’s seen as unprecedented threats to American technological leadership. For at least a decade, there has been growing evidence that America’s military competitors — most notably China — are directing investments into the US in a manner that could serve political and national security objectives rather than purely commercial ends. Unfortunately, this has brought into suspicion a broad range of transactions, including well-intentioned business deals that could inadvertently provide foreign adversaries tools to compromise US national security.
The new CFIUS regulations are a historic expansion of the authority, intention and capability of the US government to scrutinise foreign investment. It directs regulators to examine transactions that grant influence to foreign entities through board seats, access to non-public sensitive information, and management of technology deemed to be critical to US national security — a very broad set of parameters. For the first time, there is no minimum threshold of investment to define “foreign control” such that an investment of even less than 10% can trigger government action.
This is due, in large part, to the fact that long gone are the days when America’s cutting-edge technology is produced primarily in government-funded research centres. Today, technology is resident in private hands that are open to transactions that maximise profit. So, CFIUS will now scrutinise such transactions among businesses that produce, design, test, manufacture, fabricate, or develop technologies deemed to be “critical”; or own, operate, manufacture, supply, or service “critical” infrastructure; or maintain or collect personal data judged to be “sensitive” and a “threat to national security” by the US government.
These new regulations move money in a manner that can have a major financial impact on unprepared businesses. Consider the example of an average $500 million merger or acquisition by a foreign firm of a US health care IT company. Such a transaction would likely include:
• $1.5 million in legal fees (for the merger and acquisition, due diligence, and so on)
• $7 million in investment banking fees
• $2 million in C-suite executive and management time (at least)
• $1 million in miscellaneous expenses (accounting, tax, consultants, etc.)
So that’s $11.5 million just to get the deal closed. Now if this deal wasn’t structured with CFIUS compliance in mind, a company could face $1-2 million in legal and crisis management/public relations expenses to defend the unwinding and convince the public that there has been no wrongdoing.
Yet, while substantial, this cost would likely pale in comparison to the loss in enterprise value caused by business disruption. Assume the company has $50 million in profit and is valued at 10 times its profit with projected growth of 10%. Now, as a result of the disruption, negative press, and turnover from employee departures, the company loses 10% of its profit and growth slows to 8% causing its valuation to decline to say 9x instead of 10x. The business is now worth $405 million, instead of $500 million. A $100+ million has just vanished.
As more Indian companies look to conclude deals in the US in the technology, infrastructure or sensitive data business, there is good reason for executives from the C-suite down to pay attention to these new policies and structure transactions with CFIUS in mind. For good or ill, it’s going to be part of the price of doing business in America’s booming economy.