India’s thriving investment ecosystem has caught the eye of global investors, making it a lucrative destination for international investors. For non-residents, establishing a VC fund in India involves navigating a complex regulatory landscape governed by SEBI, FEMA, and taxation laws. The process demands meticulous planning and compliance. This article serves as a concise guide for non-residents, outlining the legally operational steps to set up a VC fund and capitalize on India’s entrepreneurial growth.
Important Legislations
It is important to understand the necessary regulations that apply to Foreign Venture Capital Investors. The following are the principal legislations that apply:
1. SEBI (Foreign Venture Capital Investors) Regulations, 2000 [“FVCI Regulations”]
2. SEBI (Alternative Investment Funds) Regulations, 2012 [“AIF Regulations”]
3. Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2000 [“FEM Regulations”]
4. SEBI (Intermediaries) Regulation, 2008 [“Intermediaries Regulations”]
Important Definitions
1. Foreign Venture Capital Investor (“FVCI”): Regulation 2(g) of FVCI Regulations provides – “An investor incorporated and established outside India, is registered under these Regulations and proposes to make investment in accordance with these Regulations.”
2. Venture Capital Fund (“VCF”): Regulation 2(l) of FVCI Regulations provides – “a fund registered under the Securities and Exchange Board of India (Venture Capital Funds) Regulations, 1996 or under the Securities and Exchange Board of India (Alternative Investment Funds) Regulations, 2012 in the sub-category of Venture Capital Fund under Category I Alternative Investment Fund.”
You can know more about Alternative Investment Funds here.
3. Venture Capital Undertaking (“VCU”): A VCU refers to a company that is eligible to receive VC funding.Regulation 2(m) of FVCI Regulations provide – “a domestic company:
- · not recognized on any stock exchange at the time of making of investment;
- engaged in business of providing services, production or manufacture of articles or things and does not include following activities;
- NBFCs, other than CICs in infrastructure sector, Asset Finance Companies (AFCs), and Infrastructure Finance Companies (IFCs) registered with RBI;
- Gold financing;
- Activities not permitted under industrial policy of GOI;
- Any other activity to be notified by Board from time to time.”
Thus, the definition of a VCU precludes certain businesses from receiving foreign venture capital investment.
Application Process
1. Application (Regulation 3): An application to the SEBI in Form A along with the application fee of USD 2,100 (as specified in Schedule II, Part A) payable through any of the modes provided under Schedule II, Part B.
2. Eligibility (Regulation 4): To apply for becoming an FVCI in India, the applicant must demonstrate a strong track record, professional competence, financial soundness, and integrity. They must obtain Reserve Bank of India approval for investments and belong to a recognized category (under AIF Regulations). Asset management entities or investment vehicles incorporated abroad must also meet eligibility criteria. The applicant should be authorized to invest in venture capital or Alternative Investment Funds and regulated by a foreign authority or provide a banker’s certificate verifying their credentials. Additionally, the applicant must not have previously been denied certification by SEBI. Lastly, the applicant should fulfil the fit and proper person criteria provided in Regulation 4A of FVCI Regulations r/w Schedule II of Intermediaries Regulations.
Intermediaries Regulations also provide that where any person has been declared as not ‘fit and proper person’, such a person cannot apply for any registration during the period provided in the said order or for a period of five years from the date of effect of the order.
3. Consideration of Application (Regulation 6): Application which is not complete in all aspects shall be rejected if the objections are not removed by the applicant within 30 (thirty) day notice period (extendable up to 90 days).
4. Grant of Certificate (Regulation 7): SEBI on being satisfied with the application and after receipt of registration fee of USD 8,500/- (as specified in Schedule II, Part A) grant the registration certificate in Form B.
5. Duties (Regulation 8, 12, 14 & 15): The following duties are provided:
- Abide by provisions of the Act;
- Appoint a domestic custodian for custody of securities (as per Regulation 14);
- Arrangement with a designated bank for operating a special non-resident rupee or foreign currency account;
- Any change in material particulars shall be informed to the Board;
- Maintenance of books of accounts, records and documents for a period of 8 years;
- Intimation to SEBI in writing about the place where the above-mentioned documents are kept
6. Investment Conditions and Restrictions (Regulation 11): All investments to be made by a FVCI shall be subject to the following conditions which are to be met by the investor by the end of its life cycle:
- Disclosure of investment strategy;
- Investment of total funds in one venture capital fund is permitted;
- Following conditions should be met:
- at least 66.67% investment in unlisted equity shares or equity linked instruments of a VCU;
- not more than 33.33% investment may be invested by way of subscription to an IPO of a VCU whose shares are proposed to be listed; debt or debt instrument of a VCU in which the FVCI has already made an investment by way of equity;
- preferential allotment of equity shares of a listed company subject to lock in period of one year;
- disclosure of the duration of life cycle of the fund;
- SPVs created for facilitating investment in accordance with FVCI Regulations.
FEMA Regulations
Schedule 6 of FEMA Regulations provide that:
1. Any FVCI may purchase equity or equity linked instruments or debt instruments for Indian Company in the following sectors:
- Biotechnology;
- IT related to hardware and software development;
- Nanotechnology;
- Seed research and development;
- Research and development of new chemical entities in pharmaceutical sector;
- Dairy industry;
- Poultry industry;
- Production of bio-fuels;
- Hotel-cum-convention centres with seating capacity of more than three thousand;
- Infrastructure sector (Includes infrastructure under the External Commercial Borrowing guidelines / policies notified under the extant FEMA Regulations).
2. Any FVCI may purchase equity or equity linked instruments or debt instruments in startups, irrespective of the sector.
3. Units of a VCF or a Category I AIF or units of a Scheme or of a fund set up by a VCF or by a Cat-I AIF.
Schedule 6 also provides guidelines for maintenance of accounts by registered FVCI, transfer of investments, and reporting.
Conclusion
Setting up a VCF in India as a non-resident offers a unique opportunity to tap into one of the world’s fastest-growing startup ecosystems. As the article above displays the complexities of the industry, it is important that foreign investors do careful planning, due diligence, and expert guidance for successfully establishing a fund that fosters innovation and drives growth.