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Legal Aspects of Foreign Venture Capital Investor (FVCI) And Their Relation with Startups

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In a competitive market economy, the liquidity to run a business efficiently and effectively is the prime management requirement for any new venture. Such business has the option to raise money from banks through debts that require severe and stringent norms with high-interest rates and repayment policy. Even capital raised through open market operations comes with great risk. A business is new in the market is not trusted because of a lack of experience. To solve such issues Investors as a venture capitalist and Angel Investors are specialized in making such risky investments. This establishes a startup culture, Venture Capitalist is the prime liquidity provider for the new and inexperienced business. Startups attracting foreign venture capital investors adds an advantage to their growth. Just as for a miner a gold is his ultimate possession such as for a startup attracting investments through FVCI into their venture. FVCI are basically foreign incorporated firms that target growth sectors in underdeveloped and developing economies because of having higher growth prospects. For the proper and legitimate functioning of FVCI the Security and Exchange Board of India (SEBI) has placed Regulations for the functioning and procedures for FVCI firms in India which are discussed below.


Also Read: Latest Judgments from SARFAESI Act and  Insolvency & Bankruptcy Code

Who are Foreign Venture Capital Investors?

The SEBI (Foreign Portfolio Investors) Regulations, 2019 and its regulation 2(j) define FVCI as:

“Foreign Venture Capital Investor” means an investor incorporated and established outside India, is registered under these Regulations and proposes to make an investment in accordance with these Regulations.

So, to be an FCVI it has two criteria:

  1. It is incorporated and established outside India.
  2. Has a purpose to make an investment in accordance with the regulation

The FVCI investing in a startup is called Venture Capital Undertakings as described in Regulation 2(m) and only the following kinds of entities in which FVCI can invest:

  1. Which is not listed on a recognized stock exchange in India at the time of making an investment; and
  2. Which is engaged in the business for providing services, production or manufacture of article or things and does not include following activities or sectors:
  3. non-banking financial companies, other than Core Investment Companies (CICs) in the infrastructure sector, Asset Finance Companies (AFCs), and Infrastructure Finance Companies (IFCs) registered with Reserve Bank of India;
  4. gold financing;
  5. activities not permitted under industrial policy of Government of India;

An FVCI is similar to that of an Angel Investor with a difference being that an Angel Investor is not a registered entity whereas FVCI or Venture Capital Investors are registered incorporated entities which are specialized in making an investment in dynamic business ideas in the market. The similarity between the two is that both invest in high-risk ventures which have huge chances of losing in the market.


Also Read: Understanding The Difference Between Asset Sale and Slump Sale

What Startups can gain from FVCI investment?

The startup can advance hugely by receiving investment from an FVCI. Some of the primary advantages that it can immediately receive from such investment are:

  1. Ventures Capitalist are specialist in making an investment, these are incorporated with the intention and purpose to invest in unique and emerging business ideas, FVCI can be helpful for the startup in gaining market expertise for their specialization in the certain market field.
  2. FVCI can have a better capital infusion as compared to other foreign investors, because of their investment being in foreign currency which makes a huge difference when receiving funds in Indian Rupees. The FVCI are professionals and if they are in an investment into a venture, they are serious in their profit-making expectations.
  3. The Startup can have better expansion and recognition in the market or achievement in raising funds and having a foreign collaborator assisting, thereby providing them liquidity and expertise in the market, thus, increasing the chances of growth and optimism for the startup.

What are the laws and regulations the FVCI must be compliant with?

FVCI are regulated by SEBI through its SEBI (Foreign Venture Capital Investment) Regulation, 2000 and by RBI through FEMA (Transfer of Issue of Securities by a Person Resident outside India) Regulations, 2017

  1. Regulations framed by the SEBI:

  • It is a Registering Authority for any FVCI.

SEBI acts as the registering authority for an FVCI expanding its investing scope into India. Under Chapter II from Regulation 3 to 10 deals with the Registration of Foreign Venture Capital Investors, whereby, the process of application, the eligibility criteria and the conditions for the process of grant of registration certificate has been enumerated. The SEBI Board has the sole power to examine and grant a certificate to an FVCI. The following are the disclosures for an FVCI:

  1. the applicants track record and professional soundness and experience the incorporation type of the FVCI has.
  2. whether it is incorporated as a partnership, pension fund or mutual fund or any kind of fund registered by law.
  3. whether it is an asset management company or any form of investment vehicle incorporated outside India.
  4. with which foreign regulatory authority the FVCI comes under where it is incorporated and its promoters track record

  • Frame the guidelines of Investments.

As per Regulation 11 the SEBI has framed the following guidelines as the method of investment it must follow:

(a) it shall disclose to the Board its investment strategy.

(b) it can invest its total funds committed in one venture capital fund or in an alternative investment fund.

(c) it shall make investments as enumerated below:

  • at least 66.67% of the investible funds shall be invested in unlisted equity shares or equity-linked instruments of venture capital undertaking or investee company as defined in clause (o) of sub-regulation (1) of regulation 2 of Securities and Exchange Board of India (Alternative Investment Funds) Regulation, 2012;
  • 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 or investee company as defined in clause (o) of sub-regulation (1) of regulation 2 of Securities and Exchange Board of India (Alternative Investment Funds) Regulation, 2012 whose shares are proposed to be listed;
  • debt or debt instrument of a venture capital undertaking or investee company as defined in clause (o) of sub-regulation (1) of regulation 2 of Securities and Exchange Board of India (Alternative Investment Funds) Regulation, 2012 in which the foreign venture capital investor has already made an investment by way of equity;
  • preferential allotment of equity shares of a listed company subject to a lock-in period of one year.
  • it shall disclose the duration of the life cycle of the fund;

  • As a penal authority

The Board has the power to inspect the Books of Accounts of the FVCI and whether it is working according to the conditions with which it is incorporated and functioning according to its investing activities. SEBI also acts as an investigative and penal authority in case of illegal or activities that lead to non-compliance with the rules and regulations. The SEBI has the power to impose penalties and can also cancel the registration of FVCI.

  • Regulations placed by the RBI.

The RBI also acts as the authority which checks the inflow of foreign fund in India through FEMA (Transfer of Issue of Securities by a Person Resident outside India) Regulations, 2017. The RBI has enumerated Schedule 7 on Investment by a Foreign Venture Capital Investor (FVCI) under the said regulation. The following are the set of regulations it has issued for FVCI.


Also Read: How Venture Capitalist Can Be Best Investment for Startups?: An Indian Policy Analysis.

  1. Checks the flow of capital into the market through FEMA Regulation.

The RBI has categories the type of security through which the person resident out of India for making internal remittance into a startup. The Indian company of any sector not being a listed company in any stock exchange in India can issue any security to the FVCI subject to such sectoral caps and entry routes the conditions are applicable. The mode of payment of such remittance shall be paid as inward remittance from abroad through banking channels or out of funds held in a foreign currency account and/or a Special Non-Resident Rupee (SNRR) account maintained in accordance with the Foreign Exchange Management (Deposit) Regulations, 2016.

  • The kinds of companies that it can invest.

As per the FDI policy, FCV Investments can contribute up to 100% of the capital to an Indian company engaged in any activity mentioned in Schedule 6 of Notification No. FEMA 20/2000.

The following are the sectors where FVCI Investments are allowed:

  • Biotechnology
  • Nanotechnology
  • Seed research and development
  • Research and development of new chemical entities in the pharmaceutical sector
  • Dairy industry
  • Poultry industry
  • Production of biofuels
  • Hotel-cum-convention centers with a seating capacity of more than three thousand.IIT-related to hardware and software development

Infrastructure sector. The term ‘Infrastructure Sector’ has the same meaning as given in the Harmonised Master List of Infrastructure sub-sectors approved by the Government of India vide Notification F. No. 13/06/2009-INF dated March 27, 2012, as amended/ updated.

  • Pricing Guidelines

 A pricing guideline has been provided under Rule 11 of the FEMA Regulation. According to the said regulation the price of the capital instrument issued by the Indian Company not listed in the stock markets to a person resident outside of India shall not be less than the valuation done as per any internationally accepted pricing methodology for valuation on an arm’s length basis duly certified by a Chartered Accountant or a Securities and Exchange Board of India registered Merchant Banker or a practicing Cost Accountant, in case of an unlisted Indian Company. So, a startup can issues capital instruments to a foreign collaborator at any premium value it quotes provided that, it shall not be lower than the policy as the pricing guidelines suggest.

Conclusion

Thus, a Foreign Venture Capital Investment gives an advantage for the business of the startup. The FVCI investing has to be complied with all legal and regulatory guidelines in place to assist in supporting new ventures in India. Though from the market liberalization policy adopted by India, she has attracted many foreign investors into investing in different and emerging sectors in India. The Government through its Regulators has framed proper policy in attracting foreign investment into new and developing ventures that to be targeted to be benefited from such investments. Indian economic growth story has been benefited hugely from the policy and investment from the foreign collaborators in Indian Startups.


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Sources:

  1. https://www.sebi.gov.in/legal/regulations/sep-2000/sebi-foreign-venture-capital-investors-regulations-2000-last-amended-on-march-6-2017-_34636.html
  2. https://www.rbi.org.in/SCRIPTS/NotificationUser.aspx?Id=11161

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