Sponsor Side Leveraged Finance In India: A Legal And Regulatory Overview

Introduction

The private equity landscape in India has witnessed remarkable growth over the past decade, with financial sponsors increasingly looking to deploy capital across sectors ranging from technology and healthcare to infrastructure and consumer goods. A natural corollary of this growth is the evolution of leveraged finance including the use of debt to fund acquisitions, recapitalisations, and buyouts as an instrument of choice for sponsors seeking to amplify returns.

Unlike the mature leveraged buyout (LBO) markets of the United States and Western Europe, where high-yield bonds, term loan B facilities, and covenant-lite structures are commonplace, India’s leveraged finance market has developed under a distinct and complex regulatory architecture. The interplay of Reserve Bank of India (RBI) regulations, the Foreign Exchange Management Act, 1999 (FEMA), the Companies Act, 2013, and sector-specific guidelines has historically constrained the ability of sponsors to execute textbook LBO transactions.

This article examines the key legal and structural considerations that govern sponsor-side leveraged finance in India, the instruments available to financial sponsors and their portfolio companies, recent regulatory developments including landmark RBI reforms in early 2026 and the direction in which the Indian leveraged finance market is likely to evolve.

What Is Sponsor-Side Leveraged Finance?

In a classic leveraged buyout, a private equity fund (the ‘sponsor’) acquires a target company using a combination of equity contributed by the fund and a substantial tranche of debt, which is typically secured against the assets and cash flows of the target. The structure derives its name from the financial leverage employed, debt typically constituting anywhere between 50% and 75% of the total acquisition consideration in mature markets.

‘Sponsor-side’ leveraged finance refers to the perspective of advising or acting for the acquiring private equity fund rather than for the lenders. This distinction is significant because the sponsor’s interests maximising leverage, minimising security, retaining operational flexibility, and optimising exit structures frequently diverge from those of lenders, who prioritise repayment certainty, security enforcement rights, and protective covenants.

Key features of leveraged finance transactions from a sponsor’s perspective include:

• Maximising debt quantum relative to equity contribution to enhance returns on invested capital (ROIC);
• Structuring debt at the holdco or intermediate level to insulate the operating company from direct lender intervention;
• Minimising equity cures, mandatory prepayment triggers, and restrictive financial covenants;
• Preserving dividend and upstream payment flexibility to facilitate fund-level distributions; and
• Engineering exit-friendly capital structures that facilitate secondary buyouts, IPOs, or strategic sales.

The Indian Regulatory Framework: Key Constraints

1. RBI Restrictions on Banks

The most fundamental constraint on leveraged finance in India has historically been the Reserve Bank of India’s prohibition on Indian scheduled commercial banks financing the acquisition of equity shares. Under the RBI’s Master Directions on Loans and Advances, banks are generally prohibited from extending credit for the purpose of acquiring equity shares in Indian companies, subject to narrow carve-outs.

This restriction effectively precluded classical LBO financing by Indian banks, a position that stood in stark contrast to global practice and significantly limited the scope of domestic acquisition finance. As discussed in Section 6 below, this position has now been fundamentally altered by the RBI’s February 2026 reforms.

2. FEMA and External Commercial Borrowing Restrictions

For inbound acquisitions involving a foreign sponsor, the Foreign Exchange Management (Borrowing and Lending) Regulations, 2018 impose significant restrictions on the use of External Commercial Borrowings (ECBs) for equity acquisition purposes within India. Specifically:

• ECB proceeds cannot be utilised for the purchase of equity or quasi-equity instruments in India (save for specific exceptions such as AD Category I bank lending and OCB investments);
• A Foreign Owned or Controlled Company (FOCC) incorporated in India is not permitted to avail acquisition finance from Indian banks, financial institutions, or domestic funds for the purpose of acquiring shares of another Indian company; and
• Cross-border security structures involving pledges over shares of Indian companies are subject to FEMA restrictions that limit their utility as enforcement security.

These restrictions have necessitated the deployment of creative offshore financing structures, often involving intermediate holding companies in jurisdictions such as Mauritius, Singapore, or the Cayman Islands, where financing documents are typically governed by English law.

3. The Companies Act Prohibition on Financial Assistance

Section 67 of the Companies Act, 2013 prohibits a public company from providing financial assistance, directly or indirectly to any person for the purpose of or in connection with the subscription for or purchase of its own shares or the shares of its holding company. This prohibition, which mirrors the now-repealed Section 77 of the Companies Act, 1956, significantly limits the classic LBO mechanic of using the target’s assets as collateral for acquisition financing.

Notably, this prohibition applies only to public companies; private companies are exempt. This has led sponsors to structure acquisitions through private limited company vehicles wherever possible, and has also informed structuring decisions around the conversion of target companies from public to private post-acquisition is a practice that itself carries regulatory complexity.

4. Pledge and Security Limitations

The enforcement of security over shares of Indian companies held by non-resident entities is governed by FEMA’s pricing and transfer regulations. A pledge by a non-resident over shares of an Indian company to secure offshore financing is generally permissible only where the loan proceeds are used for genuine business purposes outside India and are not repatriated into India. In a typical inbound acquisition financing, these conditions are frequently not satisfied, rendering direct pledges over Indian target shares unavailable as enforcement security.

In practice, sponsors and their counsel rely on non-disposal undertakings (NDUs), personal guarantees from promoters or sponsors, and pledge structures carefully engineered around the disposal rights embedded in the NDU to approximate the economic effect of a pledge without technically constituting one.

Available Instruments for Leveraged Financing

1. Non-Convertible Debentures (NCDs)

Non-Convertible Debentures have emerged as the instrument of choice for offshore investors seeking to deploy leveraged capital into Indian portfolio companies. NCDs are rupee-denominated debt instruments issued by eligible Indian corporates and subscribed by investors registered as Foreign Portfolio Investors (FPIs) with the Securities and Exchange Board of India (SEBI).

The NCD route offers several structural advantages from a sponsor’s perspective:

• FPIs registered under the SEBI (Foreign Portfolio Investors) Regulations, 2019 can subscribe to NCDs issued by Indian companies without the ECB restrictions that apply to cross-border loans;
• NCDs can be structured as high-yield instruments with customised covenants, payment-in-kind (PIK) features, and mezzanine economics;
• NCD documentation is governed by Indian law, providing a familiar and enforceable legal framework for Indian courts; and
• NCDs can carry security interests over the assets of the issuing company, including first or second ranking charges over moveable and immoveable property, receivables, and intellectual property.
• The NCD market has been supported by SEBI’s regulatory framework for debt issuances, including the SEBI (Issue and Listing of Non-Convertible Securities) Regulations, 2021, which streamlined disclosure and issuance requirements for private placement NCDs.

2. Non-Banking Financial Companies (NBFCs)

NBFCs have historically served as the primary domestic providers of acquisition finance in India, given their relative freedom from the banking sector’s restrictions on equity acquisition lending. Unlike scheduled commercial banks, NBFCs are not explicitly barred by the RBI from extending credit for share acquisition purposes, making them more flexible partners in leveraged transactions.

However, NBFC-sourced acquisition finance comes with important caveats. NBFC lending rates are typically higher than bank lending rates, and the sector has faced periodic regulatory tightening following the high-profile failures of IL&FS, DHFL, and certain other large NBFCs in 2018–2019. The RBI’s enhanced regulatory framework for large NBFCs including the Scale-Based Regulation (SBR) framework introduced in 2021 has brought the top-tier NBFCs closer to bank-equivalent regulation in terms of capital adequacy, exposure limits, and governance standards.

3. Private Credit Funds

The most significant structural shift in Indian leveraged finance over the past five years has been the rise of domestic and offshore private credit funds as primary providers of acquisition and growth capital. Attracted by higher yields, limited competition from the banking sector (historically), and the growing sophistication of Indian promoters and sponsors, private credit managers including both global names such as Ares, Blackstone Credit, and Kohlberg Kravis Roberts, and domestic managers have deployed billions of dollars into the Indian credit market.

Private credit investments into Indian companies can be structured as:

• Offshore loans or bonds at the level of the foreign sponsor or its holding company, governed by English law;
• Onshore NCD subscriptions by FPI-registered credit funds; or
• Combinations of offshore and onshore instruments forming an integrated capital structure.

The Indian private credit market reached all-time deployment highs in 2024, reflecting both investor appetite and the maturation of the Indian corporate credit ecosystem. Alternative Investment Funds (AIFs) particularly Category II AIFs have also become increasingly active participants in the private credit space for domestic sponsors.

4. Rupee Term Loans and Working Capital Facilities

For portfolio companies that do not involve foreign sponsors or offshore holding structures, Indian banks and NBFCs can provide rupee-denominated term loans and revolving working capital facilities. These facilities are more readily available where: (i) the borrower is an Indian company (not a FOCC); (ii) the purpose of the facility is for the ongoing business of the borrower and not for share acquisition; and (iii) the security package is conventional (i.e., assets of the operating company rather than shares).

Post-acquisition restructuring can sometimes facilitate conversion of bridge acquisition financing into more conventional rupee facilities once the target company has been integrated and its asset base made available as security.

Security Structuring in Leveraged Transactions

Given the constraints outlined above, security structuring in Indian leveraged finance transactions requires particular care and creativity. A typical security package for an inbound leveraged acquisition might include:

• Offshore: Pledge over shares of the offshore intermediate holding company (HoldCo) by the sponsor in favour of offshore lenders, governed by English or Cayman law;
• Offshore: Assignment of rights under the share purchase agreement (SPA), shareholders’ agreement, and related transaction documents;
• Onshore: Charge over the assets of the Indian operating company (subject to any financial assistance restrictions);
• Onshore: Pledge over shares of the Indian operating company held by the Indian HoldCo (if structured through a domestic HoldCo), subject to FEMA compliance; and
• Onshore: Personal guarantees or corporate guarantees from promoters, as applicable.

Non-Disposal Undertakings (NDUs) remain a key tool in the Indian sponsor-side toolkit. An NDU is a contractual commitment by the shareholder not to dispose of the relevant shares except in accordance with the terms of the financing documents. When structured to include detailed enforcement mechanics including automatic transfer rights triggered by an event of default, an NDU can approximate the economic effect of a share pledge without technically constituting one under FEMA’s transfer and pricing regulations.

Careful coordination between offshore and onshore counsel is essential to ensure that cross-border security structures comply with both FEMA and the Companies Act, and that enforcement mechanisms remain practically effective across jurisdictions.

A Landmark Shift: The RBI’s 2026 LBO Framework

The most consequential development in Indian leveraged finance in recent years is the Reserve Bank of India’s amendment to its capital market exposure framework, announced on 13 February 2026 and effective from 1 April 2026. For the first time, the RBI has explicitly permitted Indian scheduled commercial banks to provide acquisition financing for leveraged buyouts, subject to a defined set of eligibility and prudential conditions.

The key features of the new framework include:

• Banks may finance up to 75% of the total acquisition consideration, with the balance to be funded from the sponsor’s equity contribution;
• The acquiring entity must have a minimum net worth of INR 500 crore;
• The acquiring entity must demonstrate a profitability track record over three consecutive preceding financial years;
• Unlisted entities seeking acquisition finance must carry an investment-grade credit rating;
• Post-acquisition leverage at the level of the combined entity must not exceed a 3:1 debt-to-equity ratio; and
• Mandatory valuation and guarantee requirements apply to all transactions within the framework.

The 2026 reforms represent a fundamental re-orientation of Indian banking regulation with respect to acquisition finance. By providing a structured pathway for bank participation in LBO transactions, the RBI has significantly expanded the potential capital pool available to financial sponsors and reduced the historically higher cost of acquisition finance channelled exclusively through NBFCs and private credit funds.

The prudential safeguards embedded in the framework including net worth thresholds, profitability requirements, and leverage caps, reflect the RBI’s continued focus on financial stability and suggest that the new framework is primarily targeted at larger, well-capitalised sponsors and their portfolio companies rather than the broader mid-market.

Documentation and Intercreditor Considerations

Leveraged finance transactions involving multiple tranches of debt for example, a combination of senior bank facilities, mezzanine NCDs, and sponsor equity require careful documentation and intercreditor architecture. Key documentation considerations include:

• Intercreditor Agreement (ICA): Governing the relative priority and enforcement rights of different classes of creditors, including standstill periods, enforcement waterfalls, and consent rights. For cross-border transactions, ICAs are frequently governed by English law;
• Facility Agreements / NCD Subscription Agreements: Setting out financial covenants (leverage, interest coverage, minimum liquidity), representations and warranties, events of default, and prepayment mechanics;
• Security Documents: Deeds of hypothecation, mortgage deeds, pledge agreements (where permissible), and NDUs governed by Indian law and registered with the relevant authorities; and
• Guarantee Documents: Sponsor support instruments including keepwell deeds, letters of comfort, and in some cases, direct guarantees.

For offshore facilities, English law governed Loan Market Association (LMA) standard form documentation is widely used and accepted by global private credit providers. Indian law documentation must comply with the Indian Stamps Act, Registration Act, and SARFAESI Act requirements to ensure enforceability and priority of security interests.

Exit Structures and Refinancing

Financial sponsors in India have access to a range of exit strategies, each with distinct implications for the leveraged capital structure:

• IPO Exit: An initial public offering of the portfolio company’s shares, which typically requires pre-IPO deleveraging and the redemption or conversion of any outstanding NCD or mezzanine instruments;
• Secondary Buyout (SBO): Sale to another financial sponsor, which may allow the capital structure to be maintained, refinanced, or upsized at a higher valuation;
• Strategic Sale: Sale to a corporate acquirer, typically involving full repayment of outstanding leveraged debt at closing; and
• Dividend Recapitalisation: Extraction of value through a leveraged dividend prior to exit, subject to distributable profit constraints under the Companies Act.

Refinancing of existing leveraged facilities for example, replacing NCD financing with lower-cost bank debt following the 2026 RBI reforms is increasingly relevant for portfolio companies that have demonstrated credit quality during the holding period. Refinancing transactions raise their own FEMA, stamp duty, and security release/re-registration considerations that counsel must anticipate at the time of initial transaction structuring.

Outlook and Emerging Trends

The Indian leveraged finance market stands at an inflection point. The convergence of a maturing private equity ecosystem, a rapidly growing private credit market, and transformative regulatory reform positions India to develop a leveraged finance market of genuine global significance over the coming decade. Key trends to watch include:

• Bank participation in LBOs: The practical implementation of the RBI’s 2026 framework will be closely watched. Sponsors and their advisers will be assessing how banks interpret eligibility conditions, navigate exposure limits, and structure enforcement mechanisms in the context of actual transactions.
• Covenant convergence: As global credit funds increasingly deploy capital into Indian transactions, there is pressure toward covenant-lite or ‘cov-loose’ structuring norms that more closely mirror global LBO market practices.
• Domestic HNI and family office capital: The growth of Category II and Category III AIFs as leveraged lending vehicles reflects the increasing participation of domestic institutional capital in acquisition finance.
• ESG-linked leveraged finance: The emergence of sustainability-linked loan (SLL) and green bond structures in India’s corporate credit market is beginning to influence leveraged finance, with sponsors increasingly under pressure to demonstrate ESG credentials in their portfolio company capital structures.
• GIFT City: The IFSC at GIFT City in Gandhinagar offers a separate regulatory regime for offshore leveraged finance transactions, with potential structural benefits for sponsors accessing international capital markets within a regulated Indian framework.

Conclusion

Sponsor-side leveraged finance in India operates at the intersection of sophisticated private equity deal-making and one of the world’s most complex regulatory frameworks for debt financing. While structural constraints have historically limited the direct transposition of Western LBO mechanics into the Indian context, the market has demonstrated considerable creativity and resilience in developing workable alternatives through NCDs, NBFC facilities, and private credit structures.

The RBI’s 2026 reforms represent the most significant regulatory milestone in the history of Indian acquisition finance and have the potential to catalyse a new generation of sponsor-driven LBO transactions with conventional bank financing at their core. Sponsors, their legal advisers, and lenders will need to navigate the detailed conditions of the new framework with care, while continuing to deploy the full range of structuring tools that characterise the Indian leveraged finance market.

Co-authored by Sindhuja Kashyap