Foreign Investment

Foreign Investment in Indian Capital Instruments

Foreign investment in capital instruments

The Government of India has brought out rules and regulations regarding the amount of foreign direct investment in India. One such rule that governs the amount of foreign investment in India is the Foreign Exchange Management Act 1999 (FEMA). The primary regulatory authority behind the laws related to foreign exchange is the Reserve Bank of India (RBI). The RBI plays a crucial role in amending foreign exchange laws in India. Foreign exchange can be earned by various means. Some modes of foreign exchange in India are through the following sectors:

  • Manufacturing Facilities
  • Industries
  • Angel Investors/ Start-ups
  • E-Commerce     
  • Educational Sector

Foreign investors invest in companies, partnerships, and start-ups. Therefore a significant portion of the gross domestic product is due to Foreign Investment in India. However, foreign investment must be through some form of source. A foreign company cannot just invest in some sector. The investment must be regulated, and it must be through some form of instrument or source. Such an instrument or source is called the ‘Capital Instrument.’ Under the laws related to FEMA, an investment can be made through a capital instrument.

The following businesses can make foreign investment in capital instruments:

  • Foreign Companies
  • Non-resident Indians
  • Foreign Partnerships
  • Foreign Venture capitalists

Routes for Foreign Investment in capital Instruments

According to the guidelines issued by the RBI, there are two routes for Foreign Investment in capital instruments. The following routes are:

Automatic Route- Under the automatic route, there is no requirement for prior approval from the government. Foreign Investment in capital instruments can be made through this route. Specific sectors allow 100% foreign investment in the capital instruments. Foreign investors would not require any prior approval from the government.

Approval Route- Under the approval route, foreign investors need to take permission from the government before investing in capital instruments. Therefore foreign investment in capital instruments under the approval route requires prior approval from the government. Without approval under the government route, foreign investment would not be allowed.

Types of Capital Instruments- Foreign Investment in Capital Instruments

Capital instruments are a form of securities such as debts, bonds, shares, debentures and preference shares. These instruments are used by companies to raise money for their operational expenses. Capital instruments are defined under the rules related to FEMA and RBI. Capital instruments can be understood as debentures, equity shares, preference shares and warrants which are issued by a company in India. The company raises capital through these instruments. A company in India is allowed to raise money by providing capital instruments to foreign investors. The following are the forms of capital instruments are:

  1. Equity Shares- The shares which represent the total ownership in a company or the equity that is held in the company is called as equity shares. These shares are used for raising long term capital in the company. Under the Companies Act 2013, equity shares are defined and means that the shares which are not considered as preference shares.  For Foreign Investment in capital instruments, equity shares are defined as the shares which have the same meaning under the companies act. Apart from this, equity shares also include the partly paid equity shares, which are issued on and after 08 July 2014.
  2. Share Warrants- A share warrant is not considered as a share. However, a warrant is a form of vested interest that is present in the shares of the company. Therefore a share warrant is a prospective right to ownership of the shares of the company. According to Rule 13 of the Companies (Share Capital and Debenture) Rules, 2014 provides a meaning related to share warrant. Share warrants can be issued for equity shares as well as preference shares. Share warrants come under the category of Foreign Investment in Capital Instruments. Share warrants which are issued after 08 July 2014 would be considered as capital instruments. Foreign investments in Capital instruments can be through share warrants.
  3. Debenture- A debenture is used to raise some form of debt capital for the company. The meaning of debentures is present in the Companies Act 2013 as an instrument which is evidencing some form of debt. A debenture can appear on the charges of the company assets. The company issues typically a certificate for debentures. Debentures can be secured debentures and unsecured debentures. Under the companies act, debentures can be issued with the option of converting such debentures into shares. Therefore a debenture can also be issued as a capital instrument. Foreign investment in capital instruments can be made through a debenture. According to RBI and FEMA Regulations, debentures would include fully convertible debentures, partially convertible debentures, and mandatory convertible debentures.
  4. Convertible Note- This note is considered as a capital instrument that is issued only by a start-up company. This is issued in the form of debt, which usually is redeemable. This can be given to the start-up company, which can be converted into equity shares. However, it has to be given in 5 years. A person resident can purchase convertible notes outside India. The amount of investment in the convertible note is 25 lakhs, which has to be in the form of a single tranch of investment. The price of the convertible note can go more than this.
  5. Preference Shares- From the name, only the term preference shares means there is some form of preference to the shareholders who have these. Preferential rights are present for these shares. An issue of preference share to a particular individual would provide the individual with preferential rights over the shares. Certain conditions have to be satisfied for preference shares. The following conditions are:
    • The shares that are issued to shareholders have a right to receive dividends. The dividend received by the preference shareholders may be tax-free or taxed.
    • When a company winds up its business, the shareholders will have a preferential right for repayment of capital. The capital can be considered as the paid-up capital of the company.

The Types of Preference Shares are:

  • Cumulative Preference Shares– These shareholders are entitled to a dividend payment. If no amount of dividend is paid for the particular period, then the dividend is carried forward to the year in which the company makes a profit.
  • Non Cumulative Preference Shares– No Form of dividend is paid for this type of preference shares.
  • Convertible Preference Shares- These shares can be converted into equity shares which are used by the company.
  • Non Convertible Preference Shares- These shares cannot be converted for the use of the company.
  • Redeemable Preference Shares- Company can redeem these shares. Redemption is the process in which the company would take back the shares by paying a specific amount to the shareholder. The period of redemption is limited.
  • Irredeemable Preference Shares– As the name states, these forms of shares cannot be redeemed by the company.
  • Compulsory Convertible Preference Shares- These shares can be issued as capital instruments to a foreign investor or a foreign company.

For Foreign Investment in Capital Instruments only the following type of preference shares can be issued to a foreign investor:

  1. Non Convertible preference shares
  2. Optionally Convertible preference shares
  3. Partially Convertible preference shares

For raising foreign investment in capital instruments, the above capital instruments are allowed.

For Debentures and preference shares which are provided as for capital instruments for foreign investment, the following conditions would apply:

  • The above three Preference shares which are issued on and up to 30 April 2007.
  • Optionally convertible/ partially convertible debentures are issued up to 07 June 2007, which have a maturity period as applicable.
  • Partly paid-up shares, which are issued after 08 July 2014, would be considered as capital instruments. These shares, when issued to an NRI or a person resident outside India, have to be called up fully. The commission received for these forms of shares is 25%. Such a form of consideration should be paid up front.
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Foreign investment in capital instruments above would be considered to comply with the norms related to foreign direct investments (FDI).

The following to capital instruments have to comply with the provisions related to external commercial borrowings which come under the laws related to Foreign Exchange Management (Borrowing and Lending in Foreign Exchange Regulations), 2000:

  • Non-convertible/ optionally convertible/ partially convertible preference shares which are issued after 30 April 2007.
  • Optionally Convertible/ Partially Convertible Debentures issued after 07 June 2007 with a maturity period.
  • These have to be compliant with the above regulations as these are treated as Debts.

Time of Issue of Capital Instruments- Foreign Investment in Capital Instruments

These instruments have to be issued within 180 days from the date of receipt of inward remittance. The inward remittance is received through normal banking channels, which are established.  Inward remittance is either through the escrow account or when there is a debit of the NRE/ FCNR account.

If the capital instrument is not issued within a stipulated period ( within 180 days), the amount of remittance which is received through the escrow account or the NRE/ FCNR account must be immediately refunded to the foreign investor or the NRI. The mode of payment of refund is through remittance from an authorized dealer/ bank. Therefore foreign investment in capital instruments has a limited timeframe for issuing.

Cost/ Valuation of Capital Instruments- Foreign Investment in Capital Instruments

  1. The valuation of capital instruments have to be according to the SEBI regulations. This will apply if the company is listed in a recognized stock exchange.
  2. For valuation norms, the fair valuation would be conducted in a method which is internationally accepted. Calculating the real value of the instrument is done by a Chartered Accountant or a Merchant Banker who is registered by the Merchant Banker.
  3. When it comes to the valuation of shares for Non-Resident Indians, then the following would apply:
    • If the company is a listed entity with a stock exchange, then the valuation would be according to the price, which is set by the SEBI. The price must not go above the valuation, which is set by SEBI.
    • If a company is not a listed entity, then the valuation price must not be higher than that according to internationally accepted standards. The price of valuation must not be higher than the valuation carried out by a SEBI registered Merchant banker or Chartered Accountant.
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Apart from the above provision, when an NRI Invests in an Indian entity, then the capital instrument provided to the NRI has to be compliant with the laws related to the Companies Act.

Foreign Investment in Capital instruments – Availability of Exit options for Non-resident Indian

NRIs are allowed to consider exit options when it comes to entities which are not listed in a stock exchange. Exit options here would be allowed for equity shares, compulsory convertible debentures, and compulsory convertible preference shares. The company should offer a price for the exit according to the standards which are internationally accepted. This price would be calculated on an arm’s length basis based on the certification, which is carried out by a chartered accountant or a SEBI qualified merchant banker. There is also a particular form of lock-in period, which would apply to the capital instruments. Therefore foreign investment in capital instrument is subjected to a minimum lock-in period.

Conclusion- Foreign Investment in Capital Instruments

Indian companies can raise money through capital instruments. Foreign investment in capital instruments is made when a foreign investor or a Non-resident Indian invest through securities in the company. Foreign investment can be made in the following capital instruments- shares, debentures, share warrants, and convertible notes. The RBI and FEMA regulate foreign investment in capital instruments. Proper timelines have to be adhered to for foreign investment in capital instruments. This is especially when the capital instrument is transferred for the foreign inward remittance. Foreign investment in capital instruments allows an Indian company to secure foreign funding.

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