According to the recently released report on private equity by McKinsey & Co, private equity investors invested more than $103 billion in India during the period 2001-14. This clearly establishes private equity as a stable source of equity capital and long-term institutional risk capital to various sectors.
However, the proverbial adage “the grass is always greener on the other side” may not hold true for foreign venture capital investors (FVCIs) registered with Sebi. Although Indian exchange control regulations purport to provide a favourable investment regime to FVCIs—such as exemption from entry and exit pricing restrictions prescribed by RBI and easy exit option on account of no lock-in on pre-issue share capital of a company in case of a future IPO etc—there exist practical roadblocks in the way of FVCIs seeking to make the most of this (apparently) favourable regime. It often has the effect of dampening their spirits.
Initially, FVCIs, once granted approval by RBI, could invest in any sector. However, the regime underwent a change in 2007, post which RBI started granting approvals to FVCIs to invest in only specified sectors. This again is a classic example of two regulators not working in tandem. According to Sebi regulations, an FVCI can invest in domestic unlisted companies and which is involved in the business of providing services, production, etc, except those not specifically permitted. The RBI move of restricting FVCIs to invest only in specific sectors needs to be liberalised. Such liberalisation will work towards the NDA government’s Make-in-India initiative by allowing FVCI investments in restricted sectors.
Further, according to an earlier regulation, a Sebi registered FVCI was allowed to invest in a domestic venture capital fund (VCF) registered under Sebi regulations without any approval being required. Accordingly, there was no distinction with respect to accepting foreign investment from an FVCI by a VCF, structured either as a company or as a trust. Given that now the Alternative Investment Funds Regulations are in place, there should be no reason why FVCIs should not be allowed to invest in other alternate investment funds, under the automatic route.
Then there is the issue under the Income-tax Act. Equity investments in the shares of an unlisted company are subject to meeting the fair market value determined in accordance with the rules made under the Income-tax Act. Since no statutory exception has been carved out in favour of FVCIs, an FVCI attempting to avail the benefit of free entry pricing available under the Indian exchange control regulations would still be under an obligation to pay tax on the difference between the fair market value and the negotiated purchase price, in case such purchase price is lower than the fair market value.
The merger control norms of the Competition Commission of India (CCI) are another area of concern for FVCIs. Domestic VCFs and foreign institutional investors are exempt from merger control scrutiny. However, ironically, unlike VCFs and FIIs/FPIs, FVCI investments have not been provided such an exemption benefit, and continue to be subject to merger control scrutiny by the CCI. Clearly, FVCIs, as an investor class, do not generally look to control the companies they invest in. Most private equity investors have clear time-periods in mind while investing, and it is common for FVCIs to make purely financial investments, as against entering into strategic partnerships with their respective portfolio companies. Against this background, placing FVCI investments under the CCI scrutiny may not merit justification.
Considering that the importance of private equity and venture capital cannot be undermined against the backdrop of what such funds bring to the table—and in view of their growing importance in India Inc’s growth story—the Indian private equity and venture capital association has been representing to the government for revamping the reforms for foreign venture capital investments route in India in order to make it more attractive for foreigners to invest in India.
In the current state of affairs, the allegedly ‘favourable’ investment regime promised to FVCIs is much like an optical illusion which, when pierced, leads to rather adverse, unsympathetic realities.
One can now hope that the level-playing field will be given to FVCIs for their investments in India.
(Prakriti Jaiswal, associate with J Sagar Associates, contributed to the article)
The author is partner with J Sagar Associates, Advocates and Solicitors. Views are personal