Venture Capital Fund

Venture capital means risk capital. It refers to capital investment, both equity and debt, which carries substantial risk and uncertainties. Venture capital means different to different people. It is impossible to come across one single definition of the concept. The European Venture Capital Association describes it as risk finance for entrepreneurial growth oriented companies. It is investment for the medium or long term return seeking to maximize medium or long term for both parties. It is a partnership with the entrepreneur in which the investor can add value to the company because of his knowledge, experience and contact base.1 In India, the need for Venture Capital was recognised in 1973 and a committee on Development of small and medium enterprises highlighted the need to faster Venture Capital as a source of funding new entrepreneurs and technology. Venture Capital activity in India in the past was done by the developmental financial institutions like IDBI, ICICI and State Financial Corporations. These institutions promoted entities in the private sector with debt as an instrument of funding. For a long time funds raised from public were used as a source of Venture Capital.2 VC financing really started in India in 1988 with the formation of Technology Development and Information Company of India Ltd. (TDICI) - promoted by ICICI and UTI. The first private VC fund was sponsored by Credit Capital Finance Corporation (CFC) and promoted by Bank of India, Asian Development Bank and the Commonwealth Development Corporation viz. Credit Capital Venture Fund.3 At the same time Gujarat Venture Finance Ltd. and APIDC Venture Capital Ltd. were started by state level financial institutions. Sources of these funds were the financial institutions, foreign institutional investors or pension funds and high net-worth individuals.4

D. Aruna Kumar,

The Venture Capital Funds in India

Available at:
2 id 3 id 4 id

http://www.indianmba.com/faculty_column/fc159/fc159.html (Last

Visited : 27/6/2011)

REGULATORY FRAMEWORK Venture Capital Funds (VCF) are regulated by the SEBI (Venture Capital Fund) Regulations, 1996. The regulation clearly states that any company or trust proposing to carry on activity of a VCF shall get a grant of certificate from SEBI. Section 12 (1B) of the SEBI Act also makes it mandatory for every domestic VCF to obtain certificate of registration from SEBI in accordance with the regulations. Hence there is no way that an Indian Venture Capital Fund can exist outside SEBI Regulations. Domestic Venture Capital Regulatory Framework The venture capital fund regulations by the Securities and Exchange Board of India are a comprehensive set of laws to be followed by the venture capital funds in India. From the registration of venture capital funds to the action to be taken in case of default, the regulation has been divided in VI chapters. Registration Of Venture Capital Funds A Venture capital fund can either be a fund established as a trust under the Indian trust act or a company as defined under Companies act 1956. The regulations provided for the registration of a company or a trust which either was functioning as a venture capital fund before the commencement of this act or proposed to do so after the commencement of this act. A company or trust (which functioned as a venture capital fund before the commencement of these regulations) shall cease to function as a venture capital fund if it does not apply to SEBI for registration within 3 months from the commencement of the regulations.5 Procedure to be followed for registration:
i) ii)

An application for grant of certificate to be made to SEBI in Form A along with a fee of Rs 25,000.The fee shall be paid through a draft. There are certain conditions which must be fulfilled before the certificate of registration is granted by SEBI:6 a. In case of a company, the MOA of the company shall have the business of venture capital fund as its main object, and invitation to public shall be expressly barred by the MOA and AOA, in addition to this, any officer of the

5 Section 3(2), SEBI (Venture Capital Funds) Regulations,1996

6 Section 17, SEBI (Venture Capital Funds) Regulation,1996 2

company shall be involved in any litigation connected to the security market or should not have been convicted of an economic offence. b. In case of a trust, the trust is in form of a deed and has been duly registered under the Indian registration act. Carrying the business of venture capital fund is its primary objective. Any trustee of the trust is not involved in a litigation connected to security market and has not been convicted of any economic offence. c. In case of a body corporate, it should be formed under the laws of central or state legislature and it is permitted to venture in the field of venture capital funds.
iii)

The application for registration shall be complete in all respect. If SEBI discovers anything in the application that renders it incomplete, it shall give the applicant a time of thirty days to remove the loophole, failing which the application can be rejected by the board.

iv)

SEBI after finding

the applicant to be eligible, shall inform the applicant

about it, after receiving the information the applicant shall tender to SEBI the registration fee which is Rs 5 lacs, after receiving which SEBI shall issue the Certificate of registration. Conditions and Restrictions on Investments The regulation has applied a lot of condition and restriction to the amount of investment to be made in and by the venture capital fund in India. An investment in the venture capital fund can be made by any person whether Indian, Foreigner or NRI, but no investment which is less than Rs five lacs can be allowed in the venture capital fund. This however does not apply to investment made by the employees, directors or the principal officers of the company or by the trustee where the venture capital fund is a trust. The investment strategy at the time of registration shall be disclosed by the venture capital fund. The venture capital fund shall also disclose the duration of its life cycle. Not more than 25% of the fund shall be invested in a single venture capital undertaking .Investment to be made in the following manner: i) At least 66.67% of the fund to be invested shall be invested in unlisted equity shares or other instruments linked to equity shares of the venture capital undertaking.
ii)

Not more than 33.33% of the investible fund shall be invested by the way of IPO of a venture capital undertaking whose shares are proposed to be listed, the debt
3

instrument of the venture capital undertaking in which the venture capital fund has already invested, preferential allotment of equity shares of a listed company, equity shares or equity linked instrument of a financially weak company and SPV's7 which have been created by the venture capital fund. No venture capital fund shall get its units listed on any recognized stock exchange till the expiry of thee years from the date when they were issued to the investors by the venture capital fund. The venture capital funds shall also not invite any member of the public by way of advertisement to subscribe to its units. The venture capital fund may receive investments only through private placements of its units. Placement Memorandum or Subscription Agreement Every venture capital fund shall issue a placement memorandum which contains all the terms and conditions relating to the scheme through which money is proposed to be raised from the investors. The venture capital fund may also enter into a subscription agreement with the investors which would specify the terms and conditions of the scheme through which money is proposed to be raised. The venture capital fund shall submit a copy of such placement memorandum or subscription agreement with SEBI along with the report of the money actually raised through such agreement or memorandum. The placement memorandum or the subscription agreement shall contain the details of the trustee and the trust as well as the details of the directors and the principal officers of the venture capital fund. It shall also state the minimum amount of money to be raised to start the venture capital fund and the minimum share to be invested in every scheme of the venture capital funds. Tax implications which would be applied to the investors shall also be stated. The manner of subscription to the units of the fund, the period of maturity of the fund if any and the manner in which the fund would be wound up shall also be stated. Every venture capital fund shall maintain a book of record for a period of eight years which would generate the true picture of the venture capital fund. 8 SEBI at any time can call for information regarding the working of the venture capital fund, the information shall be submitted to SEBI in the specified time period.9

7 Special Purpose Vehicles which are created by a venture capital fund for the purpose of facilitating or
promoting investment in accordance with these Regulations. Section 12(e) SEBI (Venture Capital Funds) Regulation,1996

8 Section 20, SEBI (Venture Capital Funds) Regulation,1996 9 Section 21, SEBI (Venture Capital Funds) Regulation,1996 4

Investigation SEBI on receiving a complaint from the investors or suo motu appoint one or more person as investigating officer, who would undertake investigation in relation to the maintenance of the account books of the venture capital fund, compliance of the regulation and the affairs of venture capital funds.10 A notice of at least ten days shall be given before the investigation is carried on though if SEBI deems it to be in interest of the investors it may not serve a notice at all. It shall be the duty of every officer of the venture capital fund to cooperate with the investigation officers, they shall be provided with all the documents, books etc which are in the custody of the officers of the venture capital fund. The investigation officer shall also be furnished with any statement he demands for. After the completion of investigation the investigation officer shall submit his report to SEBI. The board after considering the investigation and giving the venture capital fund to be heard may direct the venture capital fund not to launch new schemes or prohibiting the concerned person from disposing off the property of the venture capital fund or to refund to any investor any amount of money or asset. Action In Case Of Default Any venture capital fund that fails to act in accordance with the regulations, or fails to furnish reports of the affairs of the venture capital fund to SEBI or furnishes report that is not true, does not cooperate in any enquiry instituted by SEBI or fails to act on the complaints made by the investors or does not give a satisfactory reply in this regard to SEBI, shall be dealt with in manner provided in SEBI (intermediaries) regulations, 200811.

FVCI REGULATORY FRAMEWORK Although foreign private equity players and offshore venture capital funds may invest in India directly, as per the FDI Policy, there are certain benefits that may be availed by such funds if they follow a process of registration with the Indian securities regulator, SEBI.

10 Section 25, SEBI (Venture Capital Funds) Regulation,1996 11 Section 30, SEBI (Venture Capital Funds) Regulation,1996 5

An FVCI is an investor incorporated or established outside India which proposes to make investments either in DVCF's or VCU's
12

in India (defined to mean a domestic unlisted

Indian Company) and which is registered under the FVCI Regulations. The Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2000 enable a FVCI to avail of certain benefits/flexibilities while making investments in India. SEBI Registration: Under Regulation 3 of FVCI Regulations, a foreign investor may seek registration with SEBI, as a foreign venture capital investor, by making an application in Form A and paying the requisite fee13. In considering an FVCI application, SEBI does review the applicant's track record, professional competence, financial soundness, experience, general reputation, whether the applicant is regulated by an appropriate foreign regulatory authority or is an income tax payer, amongst other factors. While SEBI may be considered as the primary regulator and the registering authority, for FVCI's, SEBI seeks approval from RBI before registering any FVCI. Although, certain restrictions are placed on the manner in which an FVCI may use its funds, it has the option of using all of its funds to invest in a DVCF, which can in turn invest up to two-thirds of its funds in unlisted companies. While the FDI Policy does not apply to FVCIs, an investment by an FVCI in a listed company or in a special purpose vehicle (an SPV) that does not fall under the definition of a VCU or a VCF would qualify as an investment under the FDI Policy, which would be subject to the sectoral caps and other limitations on investment that apply under the FDI Policy for such investments, unless special permission is obtained for investing beyond the sectoral caps or waiving any of the other limitations under the FDI Policy. As per SEBI records14 on March 31, 2010 there are 144 funds registered with SEBI as FVCI's. 140 of these FVCI are from Mauritius and 2 each from Singapore and Cyprus,

12 Under the Venture Capital Funds Regulations, 1996 that govern the functioning of domestic venture capital fund, a VCU means a domestic company (i) whose shares are not listed on a recognized stock exchange in India; and (b) which is engaged in the business of providing services, production or manufacture of articles or things and does not include such activities or sectors which are specified by the Federal Government. The current list includes Non Banking Financial Services, Gold Financing etc 13 Currently an application fee of US $2,500 and final registration fee of US $10,000 is payable for registration as a Foreign Venture Capital Investor 14 http://www.sebi.gov.in/Index.jsp?contentDisp=SubSection&sec_ id=5&sub_sec_id=5

respectively. This trend reflects the benefits available under the DTAA that India has signed with these three countries. Benefits of an FVCI Registration: Registering as an FVCI though not compulsory, it allows funds to avail of several benefits, as against making a vanilla FDI investment in India. These benefits, as mentioned earlier, are covered in the Regulation 5(1) of the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2000. Some of these benefits are stated hereunder: a) No entry/exit pricing restriction: The entry/exit pricing restrictions, as applicable to FDI investment, are not applicable to FVCI's. FVCI's are exempt from the usual practice of valuing the shares on the basis of their listed price or on the basis of DCF Method (in the case of an unlisted company) in any investment or M&A transaction. This exemption also helps when an FVCI is looking to exit its investment from an unlisted company. In such a situation, instead of paying a price based on the net asset value of the investee company, it could pay the negotiated price. b) Post IPO limited lock-in: As per the SEBI (Issue of Capital & Disclosure Requirements) Regulations, 2009 (ICDR Regulations) a one year lock-in period is applicable to all pre-IPO15 investors in any company which makes an initial public offering. The shares acquired by a FVCI in an unlisted company are not subject to the one year lock-in period upon the IPO of the shares of the company16. In the case of FVCI's, they are locked in only for a period of one year from the date of their investment in the portfolio company and not from the date of the IPO. Thus, the FVCI would have the flexibility of an exit from its investment in a company after its listing, more than most other investors. d) Investment flexibility: FVCI's may, subject to limited restrictions/approvals, purchase equity/equity linked instruments/debt/debt instruments, debentures of an Indian VCU or of a VCF via an IPO or Private Placement or in units of schemes/funds set up by a VCF. e) Open Offer exemption: A FVCI may transfer shares, pursuant to an agreement, to the promoters without triggering open offer requirements. This exemption is available under Regulation 3(1)(ia) of Takeover Code. Pursuant to the exemption the provisions of the Takeover Code do not apply to shares transferred from an FVCI to the promoters of the
15 Initial Public Offering, by an unlisted company. 16 The ICDR Regulations prescribe that the entire pre-issue share capital of a company undertaking an IPO owned by a promoter is to be locked-in for a period of at least one year. A minimum thereafter has to be kept locked-in for two more years.

company, or to the company itself, if effected in accordance with a pre-existing agreement between the FVCI and such promoters. This ensures that in the event the promoters/company decide to buy back shares from the FVCI, they will not be required to comply with the public offering requirements of the Takeover Code, which would otherwise require that an offer be made to the other shareholders of the company for up to twenty percent (20%) of the outstanding share capital. f) Sectoral restriction exception: FVCI's have exemptions from prior approval in case of investment in same sector. Generally, non-resident investments are subject to a condition that subsequent investments in the same sector require Government's approval. g) Pass through status: FVCI's get a pass through status, and qualify for exemption under section 10(23FB) of the Indian Income Tax Act, 1961 (Income Tax Act). Though the FVCI is exempt, the LP's17 would be subject to tax. While considering the various tax advantages, it is also important to take into account the various business organizations available in India in which a fund may invest. In addition to the above, FVCI's are required to submit periodic information to SEBI and also maintain books of account, records and documents for a period of 8 years. SEBI also has a right of inspection on FVCI's. FVCI's are also covered by provisions of FEMA and money laundering laws.
Qualified Institutional Buyers Qualified Institutional Buyers are those that fall under a special category and are receive less protection from issuers as compared to other public investors due to their financial sophistication. Also, the Securities and Exchange Board of India has specified in the ICDR Regulations (Issue of Capital and Disclosure Requirements, 2009) to include Public Financial Institutions, Banks, Mutual Funds, VCFs, FVCIs, FIIs, Multilateral Development Financial Institutions, Insurance Companies, State Industrial Development Corporations, Provident Funds/ Pension Funds with minimum corpus of Rs.25 crore and National Investment Fund set up by Government of India and thus are generally pooled investment vehicles which undertake investment on behalf of a large body of stakeholders.

FVCI's are treated as Qualified Institutional Buyers (QIB's) under the ICDR Guidelines and are entitled to all benefits available to such QIB's. As a result, they are eligible to participate

17 Limited Partners or investors in the fund.

in the primary issuance process, meaning that they would be able to subscribe for the securities in an IPO under the typical book-building process.