Foreign Investment

Raising Funds in India: Financing Options for Foreign Business

India is one of the fastest-growing economies in the world. To ease doing business in India, the Indian government introduced the Invest India initiative. The purpose of this initiative was to attract foreign business to India by providing subsidies and helping foreign organizations set up their subsidiaries in India. The two easiest ways for a foreign business to do business in India are: i) Setting up a subsidiary in India by registering as a private limited company or; ii) setting up a branch/project/liaison office in India. In these two entry strategies, no government permission is required.

India has also become the global competitor of foreign direct investment. Businesses have management consultants who deal with the funding sources so that the companies can carry out operations in a precise manner. Generally, the two main pillars for the success of a business enterprise are the availability of resources and viable funding options. Not just the funding options but the mode of funding is also important. The financing option is decided after assessing the cost-benefit ratio. Mainly there are two financing options: equity financing and debt financing. So let’s understand the different financing options available to foreign businesses in India.

Equity Financing

Raising funds in India by way of Equity financing can be done either by private placement of stock with the investors or by offering stocks to the public. This financing option mainly caters to the short-term cash requirement of companies by selling the company’s stocks along with the ownership rights.

Debt Financing

Whereas raising funds in India by way of debt financing refers to borrowing funds. In this financing option, funds are borrowed to meet the working capital requirement by selling debt instruments to individuals or institutional investors. The individuals and the institutional investors become the company’s creditors who are obliged to repay the original debt along with any accruing interest in a time-bound manner. However, unlike equity financing, no ownership or control rights are transferred to the holders in debt financing.

Hybrid Financing Option

In India, the demand for hybrid financing options is increasing. The hybrid financing option offers better potential for risk mitigation. Investors generally prefer to combine the features of both equities as well as debt financing options. However, identifying the hybrid financing option can be a tough task sometimes. Currently, hybrid instruments are governed under the External Commercial Borrowing Policy.

What are the debt financing options available in India?

Onshore Debt Financing options

In this Financing option, foreign investors provide capital to Indian debt issuers through organizations such as non-banking financial companies, alternative investment funds, asset reconstruction companies (ARC), etc. These organizations function as intermediaries who receive funds from foreign investors and lend the proceeds to the borrowers. Some of these intermediaries are at par with the foreign financing options in terms of taxation and serve as a good alternative route to invest in offshore investors, including global debt funds.

1. Non-banking financial companies (NBFCs)

These are Indian companies registered as per the RBI Act and are usually engaged in retail and corporate lending. The foreign investor can choose among various options available for investment through NBFCs depending on short-term as well as long-term goals. The financing options available via NBFC are:

• Captive NBFC

This type of NBFC requires either acquiring or registering an NBFC in India and using it for on-lending purposes. This strategy is common among investors looking for long-term growth. The downside of this type of financing option is that it is not tax efficient and does not yield a return in the short term.

• On-lending NBFC

This type of NBFC requires using existing NBFC as an intermediary entity for on-lending purposes. The perk of this financing option is that it yields both short-term as well as long-term growth. It is tax efficient and as NBFCs are taxed only on margin.

• Securitization

In this type of NBFC, the NBFC generates loans and securities and converts them to marketable securities. In this financing option, the securitization trust issues a pass-through certificate to foreign investors directly. The perk of this financing option is that it is tax efficient and provides foreign investors exposure to Indian markets with easy repatriation options. It is also one of the most preferred options.

2. Alternative Investment Funds (AIFs)

AIFs are investment funds registered with SEBI. They are privately pooled investment vehicles that collect funds from high-net-worth individuals and invest them as per the defined policy. AIFs invest in securities through debenture instruments and not by way of loans. It comes with flexibility regarding debt investment from the Indian regulatory perspective. 

3. Asset Reconstruction Companies (ARC)

ARC are Indian vehicles registered with RBI under the SARFAESI Act, 2002. ARC acquire non-performing loans. So this financing option is opted for by distressed banks or financial institutions and provides for the acquisition of bad assets or non-performing assets by ARCs in return for security receipts that are acquired by foreign investors. These vehicles help revive distressed companies. To facilitate the growth of ARCs, various SOPs like simpler registration charges, reduced stamp duty, tax benefits, etc have been provided.

4. Venture Debt

This type of financing option acts as a bridge between equity financing and debt financing. It is a medium-term debt instrument that requires investment by venture debt funds with valuation linked to the next round of portfolio funding. It mainly serves the debt requirements of a start-up in its initial phase.

Offshore debt financing options

Under this financing option, the debt investors make direct funding to the final borrowers. The perk of this financing option is that it is not only tax efficient but also allows investors to retain control over the enforcement of rights. It mitigates the currency exchange risk incurred due to currency fluctuations in international financial transactions. Offshore financing options are highly regulated in India and have to comply with the guidelines issued by SEBI and RBI. The offshore debt financing option available to foreign investors in India is as follows:

Foreign Direct Investment in compulsorily convertible debentures (CCD)

Foreign investors are allowed to invest in CCDs, issued by Indian companies by way of FDI. It is a non-repatriable investment meaning thereby that foreign investors are not permitted to repatriate funds back from India. The CCDs must be converted into equity shares. FDI in equity shares is allowed in fully and compulsorily convertible debentures, fully and compulsorily convertible preference shares and share warrants or any other sector other than the prohibited sectors. This financing option is good for long-term investment, especially for those investors who intend to convert their loan into ownership rights in the future.

• Foreign Venture Capital Investment

It is a rupee-denominated lending. Under this financing option, the foreign venture capital investors (FVCI) are registered with SEBI. FVCIs can also invest in debt instruments of Indian companies engaged in sectors such as infrastructure, pharmaceuticals, nanotechnology and information technology, etc. In the infrastructure sector, foreign venture capital investment is most preferred as the investors have the option to invest directly in optionally convertible debt instruments. No pricing norms are applicable on FVCIs either at the time of entry or exit. These investments can be made utilizing optionally convertible debentures, compulsorily convertible debentures and non-convertible debentures. Registered FVCIs are accorded the status of qualified institutional buyers (QIB) under the International Centre for Dispute Resolution (ICDR) Regulations. FVCIs are also eligible to subscribe to securities at an Initial Public Offering (IPO) through the book-building route.

• Foreign Portfolio Investment

Under this financing option, the SEBI registered foreign portfolio investors (FPIs) can directly acquire listed or unlisted rupee-denominated Non-Convertible Debentures issued by Indian corporations. However, this option has become unviable as the new regulatory changes have restricted each FPI not to invest more than 50% of each issue of NCD. 

• External Commercial Borrowings (ECB)

ECBs are borrowings or loans given by foreign entities to a company having its existence in India. Any foreign business setting up its subsidiary in India will be able to avail of ECB. In India, ECBs are regulated by the Ministry of Finance and the Reserve Bank of India. ECBs are available in both Indian Rupees as well as in foreign currency. To be an eligible borrower, one should be a direct foreign equity holder with a minimum of 25% of direct holding or an indirect equity holder with a minimum of 51% of indirect holding. For a company to obtain ECB, it should be a part of a common foreign parent company.

• Non-convertible Debentures (NCDs)

Another important source of funding for foreign business is the corporate debt market. Both secured and unsecured NCDs are available with a minimum residual maturity of one year, subject to the conditions laid down by the law. To invest in listed or unlisted NCDs, foreign shareholders have to register as foreign portfolio investor (FPI) with the Securities Exchange Board of India (SEBI)^[1]. Registration as an FPI is completed within a few weeks.

• Masala bonds

It is a rupee-denominated bond issued to international investors for raising funds in the international market. It is issued by Indian entities. Foreign investors who are willing to invest in India invest in masala bonds. In the case of these bonds, all transactions, including buying of bonds, interest payments, and repayment, are done in Indian currency. These bonds are lucrative financing option for foreign investors as it offers a 2-3% higher rate of interest compared to the standard London Inter-Bank Offer Rate (LIBOR).

Conclusion

At last, it can be said that India is a fast-evolving nation and has a diversified consumer market with variations in the needs and preferences of the consumers. Indian economy is booming and there are various opportunities for foreign businesses to invest in India. The above discussion highlights the various financing options available to foreign investors in India. Different financing options are available for different financial needs therefore, it can be said that foreign businesses can easily raise funds in India. 

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