The 170 venture capital funds registered with the Securities and Exchange Board of India (Sebi) may have to decline attractive deals overseas because of the 10% limit set on such investments by the capital markets regulator.
While most investors have welcomed the regulator’s move to allow investments overseas, they see the new guidelines as too restrictive to allow for significant involvement in overseas deals.
The guidelines, issued on 9 August, allow Sebi-registered funds, domestic and foreign, to make equity-related investments abroad into companies that have a back office in India. Each can spend only 10% of its available corpus after expenses, and altogether they cannot invest more than $500 million (Rs2,035 crore). Also, approval
for an investment will expire after six months.
Conservative cap: Sebi chairman M. Damodaran. Registration with the capital market regulator remains an unattractive option for VC funds.
Nitin Deshmukh, head of private equity group at Kotak Mahindra Bank Ltd, had a specific transaction in mind in energy-related technology when he wrote to the ministry of finance, Sebi and the Reserve Bank of India in January. While he, like other venture capitalists, is pleased with any steps Sebi takes in this direction, the deal ran out of time and would not have met the restrictions in the recently released guidelines anyway.
He says he will run into this problem given his sector focus.
“Life sciences and biotechnology are extremely capital intensive,” he says. “Many funds have to be incorporated outside India to raise money in the US or Europe. Good opportunities in the space are still outside India.”
Some venture capitalists and legal experts say Sebi was unexpectedly conservative in imposing the 10% cap and the stipulation that the target should have a back-office operation in India. India’s rising foreign exchange reserves caused many to expect a higher limit.
Siddharth Shah, head of private equity at Mumbai-based law firm Nishith Desai Associates, says that the back-office stipulation will “essentially discourage VC investment in those businesses that will ultimately benefit India,” such as those foreign businesses with majority of suppliers in India.
Sebi declined to comment for this story.
Investing abroad has become increasingly important to venture capitalists for various reasons. The global markets have become more integrated, Shah says. Also, the investment structures have become more sophisticated where there may be a need to create an offshore holding company.
Overall, registration with Sebi, despite certain benefits—for instance, registered venture capitalists do not have to remain locked-in for a year when their investee companies go public—remains a largely unattractive option.
The removal of the tax “pass-through” for many sectors in the 2007 Union Budget made matters worse.
One of the few strong reasons to be registered is the ability to hold foreign securities, but the 10% cap restricts that as well.
Yet, many expect loosening of the restrictions, particularly the 10% cap, within 12-18 months. Somasekhar Sundaresan, partner at law firm J. Sagar Associates, said the guidelines resemble the spirit of the initial guidelines on foreign institutional investment in debt, specifically the limit and time frame to act within the limits, and may evolve along similar lines.