11 May

Legal Compliances for Venture Capitalists (VCs) and Private Equity (PE) Investors before Investing Money: Lawyers Advice on Foreign Investments in India | | FDI Attorney in Delhi NCR | FDI Attorney in India | India Business Entry

in Corporate Lawyer, E Commerce, Foreign Direct Investment FDI, STARTUPS IN INDIA, Uncategorized

The business scenario in today’s time is dependent on investments or what is known as fund raising especially for new startups and small businesses. This increasing culture of investments has led a rapid growth of Private equity investment in India. Public Equity is an alternate investment option used by companies that are not public or listed on the stock exchange. It used by High Net Worth individuals or firms to purchase shares or interest in private companies or public companies with an aim to make them private and delist from the public stock exchanges. Usually small or new companies which high growth prospective are targeted.

There are broadly two types of Private Equity (PE) Investments:

Leveraged Buy-Outs: Acquiring controlling stakes in mature and stable cash flow companies.
Venture Capital Funds: Acquiring a minor stake holding in startup companies usually in high growth sectors like technology, healthcare, etc.

An investor of Private Equity (PE) can opt for one of the following three options:
• Equity Shares
• Compulsorily Convertible Preference Shares
• Compulsorily Convertible Debentures

Further, as per the FDI (Foreign Direct Investment) Policies, any instrument apart from the above, which are not compulsorily convertible to equity shares shall be treated as debt and would be governed by the External Commercial borrowing norms.

With Private Equity growing rapidly and more and more international investors being interested in investing in Indian Companies, it is important to look at the laws and regulations that govern such transactions:

Companies Act, 2013: As per Section 42 of the Companies Act, 2013 any offer made to people exceeding 200 persons cannot be categorized as Private Offer and the Company has to fulfill all the requirements of a public offer. Further, as the Private Equity Managers play a key role in growth of the company by playing an active managerial role, section 149(12) of the Act makes the non-executive directors liable for the acts of the company and presumes that they have the knowledge about such acts during their time on the board.

Securities and Exchange Board of India (Foreign Venture Capital Investors) Regulations, 2000: A foreign Venture Capital (VC) investor who proposes to make any investment on venture capital activities in India has to registered with SEBI (Securities and Exchange Board of India). Registration has to be granted to the investor only after they fulfill all the eligibility conditions laid down under the Regulation. An important advantage for investor registered under the regulation is that at the time of Initial Public Offer of an investee company, such registered investor shall not be bound by the one year lock in period in respect of the pre-issued share capital held by it.

SEBI (Alternative Investment Funds) Regulations, 2012: Nowadays, investment in various companies are routed through Alternate Investment Funds which was established for the sole purpose of making such investments. Therefore, the given regulation was formed to govern such Funds. The regulation lays down that no entity can function as an Alternative Investment Fund unless registered with SEBI. It also limits the number of investors to not more than 1000 and the amount of investments to less than 1 Crore.

Foreign Exchange Management (Transfer and Issue of Security by a Person Resident Outside India) Regulations, 2017: The regulation has for the very first time introduced the definition of the term the “foreign investment” and categorized it into “foreign direct investment” and “foreign portfolio investment”. This categorization has had deep impact on the foreign exchange regime in India, by making it from investor-specific regime to investment specific regime.

The regulation prescribes the procedure for a foreign Venture Capital (VC) investor to make investments in India. The investor has to apply to RBI (Reserve Bank of India), through SEBI for permission to invest in an Indian Venture Capital Fund scheme. The consideration amount for investment can be paid out of inward remittances from abroad through normal banking channels. Based on the approval of the Reserve Bank of India (RBI), the investor has a right to maintain a foreign currency or Indian rupee account with an Indian Bank which is authorized to do so. The money in such accounts can be utilized for the purpose of investment.

Competition Act, 2002: The Act requires the companies to notify Competition Commission of India (CCI) to review the any merger, acquisition or any kind of a combination which excess a predetermined assets or turnover limit. CCI (Procedure in regard to the Transaction of Business relating to Combinations) Regulations, 2011 was notified in order to identify transactions not expected to pose competition issues and hence, need not notify the CCI of such transactions. By virtue of the regulation, any private equity investment to acquire less than 25% of the shares or voting rights of target company, are exempted from the obligation of sending a notice provided it is made solely as an investment and does not lead to acquisition of control. This exemption comes in handy for financial investors that make frequent investments. However, such exemption is not applicable to Private Equity transactions where there is an overlap between the activities of the target company and controlled portfolio companies of acquirer.

Income Tax Act, 1961: Any income earned from Private Equity Investment that is from the sale of securities generally falls under the category of “Capital Gains” and not “business income.” However, there has always been a confusion in the mind of investors in regard to the categorization. A series circulars issued by the Income Tax Authority has given a clarity. According to these circulars, income earned from the sale of unlisted shares would be categorized as Capital Gains unless
1) The tax officer is not satisfied with the genuineness of the transaction.
2) Where there is transfer of control and management of the company along with the shares.
3) Where the question of lifting of the corporate veil arises. Under such conditions, the income of sale of shares would be considered as Business Income.

Further, income from a Venture Capital (VC) Corporation or Fund which was set up for raising funds for investment in venture capital is exempted from tax, provided it is registered with SEBI and in compliance with the criteria laid down the Government of India and SEBI. Nevertheless, tax has to be paid by the shareholders of such fund and the withdrawers of such funds.

Quarter of a century has passed since India opened up its economy, and India has seen a tremendous growth in the economy. However, with this growing economy and more foreign investors trying to invest in India, it is of utmost importance that the international investors are well guarded by the legal framework. Therefore, in order to encourage more investment from foreign entities, India has to ensure a robust legal environment to protect the investment and promote the economy in India. Further, new rules and regulations should be laid down to provide new opportunities and new ways of deal structuring to make the investment process more friendly and easy.
Authored By: Adv. Anant Sharma & Ananya Jain

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Legal Compliances for Venture Capitalists (VCs) and Private Equity (PE) Investors before Investing Money: Lawyers Advice on Foreign Investments in India | | FDI Attorney in Delhi NCR | FDI Attorney in India | India Business Entry

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