A detailed study on Foreign Venture Capital Investors

Foreign Venture Capital (VC) is an essential source of funding seed capital for start-up ventures and significant technology projects. Venture Capital is a type of funding which is different from traditional sources of financing as unlike conventional source of financing, Venture capitalists finance innovation and ideas which have potential for high growth with inherent uncertainties. Hence, Venture capital funds (“VCF”) are professional money managers who provide risk capital to businesses.

Before starting with the procedure involved for Foreign Venture capital Investment in India,  it is worthwhile to understand the exact meaning of venture capital.

What is Venture Capital?

Venture capital is a high-risk, high return investment. In simple words, Venture capital is money provided by an outside investor to finance a new, growing, or troubled business. The venture capitalist provides the funding knowing that there’s a significant risk associated with the company’s future profits and cash flow.

How is Venture Capital an essential source of funding?

Under Venture capital, the capital is invested in exchange for an equity stake in the business rather than given as a loan, and the investor hopes the investment will yield a better-than-average return.

• It is an essential source of funding for start-up and other companies that have a limited operating history and no access to capital markets.
• A venture capital firm typically looks for new and small businesses with a perceived long term growth potential that will result in a large payout for investors.
• A venture capitalist is mostly limited partnerships that have a fund of pooled investment capital with which to invest in many companies. They vary in size.
• VCs may be a small group of investors or an affiliate or subsidiary of a large commercial bank, an investment bank, or insurance company that makes investments on behalf clients of the parent company or outside investors.
• VC aims to use the business knowledge it has, experience and expertise to fund and nurture companies that have high potential to yield a substantial return on the VC’s investment.

Regulatory Framework governing the Foreign Venture Capital in India

Have a look at the following regulations which govern the foreign venture capital in India:

• SEBI (Foreign Venture Capital Investor) Regulations, 2000^[1]
• FEMA (Transfer or issue of Security by a Person Resident Outside India) Regulations, 2017
• SEBI (ICDR) Regulations, 2009
• SEBI (Intermediaries)Regulations, 2008
• Income Tax Act
• SEBI ( Substantial Acquisition of Share and Takeovers) Regulations, 2011
• The Companies Act, 2013
• SEBI (Alternate Investment Fund), 2012
• Tax Treaties
• Foreign Exchange Management (Deposit) Regulations, 2016.

Who are Foreign Venture Capital Investors (FVCI)?

Definition of Foreign Venture Capital Investors has been provided under two regulations:

• SEBI (FVCI) Regulations, 2000
• FEMA (Transfer or issue of Security by a Person Resident Outside India) Regulations, 2017

Eligibility Criteria for Foreign Venture Capital Investor [FVCI]

An FVCI has to apply for registration to SEBI. For the grant of a certificate to an applicant as a Foreign Venture Capital Investor, the Board shall consider the following conditions for eligibility, namely:

• the applicants track record, professional competence, financial soundness, experience, general reputation of fairness and integrity.
• Whether the applicant has been granted necessary approval by the Reserve Bank of India for making investments in India;
• whether the applicant is an investment company, investment trust, investment partnership, pension fund, mutual fund, endowment fund, university fund, charitable institution or any other entity incorporated outside India; or
• whether the applicant is an asset management company, investment manager or investment management company or any other investment vehicle incorporated outside India;
• whether the applicant is authorised to invest in venture capital fund or carry on activity as a foreign venture capital investor;
• Whether the applicant is regulated by an appropriate foreign regulatory authority or is an income taxpayer; or submits a certificate from the banker of its or its promoter’s track record where the applicant is neither a regulated entity nor an income taxpayer. 
• The applicant has not been refused a certificate by the Board.
• Whether the applicant is a fit and proper person.

The applicant can be a pension fund, mutual fund, investment trust, Investment Company, investment partnership, Asset Management Company, endowment fund, university fund, charitable institution or any other investment vehicle incorporated and established outside India etc

Conditions for the investment by FVCI

All investments to be made by FVCIs shall be subject to the following conditions:-

• It shall disclose to the Board its investment strategy,
• it can invest its total funds committed in one venture capital fund
• It shall reveal the duration of the life cycle of the fund.

Apart from the above, the following conditions also needs to be taken care of:

• An FVCI have to  invest at least 66.67% of the investible funds in unlisted equity shares or equity-linked instruments of Venture Capital Undertaking
• On the other hand, not more than 33.33% of the investible funds may be invested by way of:
  • Subscription to initial public offer of a venture capital undertaking whose shares are proposed to be listed.
  • Debt or debt instrument of a venture capital undertaking in which the foreign venture capital investor has already invested by way of equity;
  •  Preferential allotment of equity shares of a listed company subject to lock in period of one year.
  • the equity shares or equity linked instruments of a financially weak company or a sick industrial company whose shares are listed.
  • special purpose vehicles which are created for the purpose of facilitating or promoting investment in accordance with these Regulations. (d)It shall disclose the duration of life cycle of the fund.
• Every Foreign Venture Capital Investor shall maintain for a period of eight years, books of accounts, records and documents which shall give a true and fair picture of the state of affairs of the Foreign Venture Capital Investor.
•  Foreign Venture Capital Investor or a global custodian acting on behalf of the foreign venture capital investor shall enter into an agreement with the domestic custodian to act as a custodian of securities for Foreign Venture Capital Investor.
•  Foreign Venture Capital Investor shall appoint a branch of a bank approved by Reserve Bank of India as designated bank for opening of foreign currency denominated accounts or special non-resident rupee account.

Benefits and Relaxations to FVCIs

FVCIs enjoy a number of regulatory relaxations; some of the significant ones are:

• Exemption from pricing norms at the time of entry as well as an exit;
• Exemption from “lock-in” period requirements when the investee company goes public; FVCIs are thus effectively allowed to exit the investment, immediately on the listing of the investee company;
• Exemption from “Takeover Code” (which mandates making of an open offer by the acquirer, on the acquisition of shares beyond prescribed threshold limits) in respect of shares sold by the FVCI to the promoters of the company, after the company goes public

Investments by the FVCI

With a view to promote innovation, enterprise and conversion of scientific technology and knowledge based ideas into commercial production, it is very important to promote venture capital activity in India.

A flourishing venture capital industry in India will fill the gap between the capital requirements of technology and knowledge based start-up enterprises and funding available from traditional institutional lenders such as banks.

Hence, following are the two ways which a Foreign Venture Capital Investor has:

• Investment by FVCI under Schedule I of Regulations

Under Schedule 1, an FVCI is allowed to invest under FDI scheme as non resident entities in other companies subject to FDI norms and FEMA provisions. An FCVI needs to determine before investing in an Indian Company whether the investment is under FDI scheme or under FCVI scheme and report accordingly

• Investment by FVCI under Schedule VI of Regulations

A SEBI registered Foreign Venture Capital Investor (FVCI) with specific approval from RBI under FEMA Regulations can invest in Indian Venture Capital Undertaking (IVCU) or Indian Venture Capital Fund (IVCF) or in a Scheme floated by such IVCFs subject to the condition that the VCF should also be registered with SEBI.

An Indian Venture capital undertaking [IVCU] is defined as a company

• incorporated in India
• whose shares are not listed on a recognized stock exchange in India
• which is not engaged in an activity under the negative list specified by SEBI.

In simple words, a Indian Venture capital Fund [IVCF] is defined as a fund established in the form of a trust, a company including a body corporate and registered under the Securities and Exchange Board of India (Venture Capital Fund) Regulations, 1996 which has a dedicated pool of capital raised in a manner specified under the said Regulations and which invests in Venture Capital Undertakings in accordance with the said Regulations.

• FVCIs can purchase equity / equity linked instruments / debt / debt instruments, debentures of an IVCU or of a VCF through initial public offer or private placement in units of schemes / funds set up by a VCF.
• At the time of granting approval, the Reserve Bank permits the FVCI to open a Foreign Currency Account and/or a Rupee Account with a designated branch of an AD Category – I bank.
• The purchase / sale of shares, debentures and units can be at a price that is mutually acceptable to the buyer and the seller. AD Category – I banks can offer forward cover to FVCIs to the extent of total inward remittance. In case the FVCI has made any remittance by liquidating some investments, original cost of the investments has to be deducted from the eligible cover to arrive at the actual cover that can be offered.

Conclusion

The ever growing Indian economy and the potential to grow further definitely makes India one of the most liked destination also strong fundamentals comprising of favourable demographic profile, human capital, trade openness, increasing urbanization and rising consumer spending has made India one of the fastest growing markets in the world. In case of further clarification, please contact Enterslice.

Further, you can read about Foreign Venture Capital Investors on the following blogs:

1. Approval for Registration of Foreign Venture Capital Investor

2.Procedure for Registration of Venture Capital Funds