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FVCI Licensing and Pitfalls

20 July, 2009
Foreign investors invest in India primarily via two routes – Foreign Direct Investment (FDI), and Venture Capital (VC) Investment.  India has attracted foreign investments through Foreign Venture Capital Investments (FVCI) route of Rs 23,047 crores compared to Domestic Venture Capital Investments (DVCI) of Rs 14,531 crores for the financial year 2008-09, according to the website of SEBI, the capital markets regulator. 
Recently, considering the chunk of FVCI concentrating in certain sectors regulators have become stringent to grant the FVCI registration.  In this article, we try and outline key issues pertaining to FVCI approval from Reserve Bank of India’s (RBI) perspective.
The journey of FVCI regulations in India 
Venture Capital (VC) finance is an important source of funding seed capital for start-up ventures and technology projects.  A committee on Development of SME in 1973 for the first time highlighted the need for introduction of VC in India.   
The formalization of VCs began in 1995 whereby the Government framed guidelines for Overseas Venture Capital Investments (OVCI) in India.  In 2000, pursuant to K B Chandrasekhar Committee recommendations, the OVCI guidelines were withdrawn and SEBI was made a nodal regulator for VCFs to provide a uniform, hassle free, single window regulations.   
SEBI (FVCI) Regulations, 2000 requires FVCI to make minimum investment of 67.77 % of investible funds in unlisted Indian Venture Capital Undertaking (IVCU) and balance 33.33 % in listed securities or debt instruments, primarily with a view to foster investments in unlisted start-ups. IVCU should be a company not engaged in an activity under the negative list specified by SEBI.
The FVCI Edge 
Venture capitalists invest at an early stage to enable companies to meet their long term funding requirements. Since the pricing at investment stage is not necessarily in sync with the book value of assets, RBI guidelines (ie the pricing guidelines generally applicable to a foreign investor) relaxes this condition for an FVCI on purchase and sale of shares.
FVCI’s key role is to provide initial capital and it generally does not get involved in day to day management of companies. Unless these funds are unlocked, these funds cannot be used for other start-ups. Considering this, SEBI provides following two relaxations :-
No lock-in for shares held by FVCI post listing of shares so long as FVCI has stayed invested at least for 12 months before the company files Draft Red Herring Prospectus.
If FVCI decides to stay invested even after listing, it can sell its stake to promoter without trigging ‘open offer’ under the takeover code.
Besides an attempt to provide funds for new businesses, it is also recognized by Government that FVCI only financially nurtures business venture and does not undertake management functions.  Hence, additional relaxations are available as under:-
No approval is required even if investments are made in ‘same’ field in India – Press Note 1 of 2005 restriction applicable to other investors.Restrictions applicable to a promoter under SEBI (Disclosure & Investors Protection) Guidelines, 2000 are not applicable to FVCI.
FVCI is permitted to make investments in DVCF under the automatic route subject to certain conditions.
RBI Concerns
It appears that RBI is granting FVCI approval after its concerns relating to investments in Real Estate sector and thin capitalization are met. 

Real Estate
In 2004, FVCI regulations were amended to permit investments in companies engaged in Real Estate sector.  Vide Press Note No. 2 (2005) foreign investors are allowed to invest through FDI route in townships, housing, built-up infrastructure and construction-development projects subject to fulfillment of certain conditions. 
Given the above, RBI wants to direct foreign investors to invest in Real Estate sector through FDI route and not to enjoy the advantages of investing through FVCI regime.  
In order to mitigate the delay in obtaining the FVCI approval, the foreign investors should, at the time of registration, make clear and appropriate disclosures of its investment strategy and in addition, also explicitly state that it is not intending to invest in Real Estate sector. 

Thin Capitalization
Till recent past, RBI, on a reference by SEBI, did not clear FVCI applications for want of cash flows and capitalization of FVCI Company.  Recently, SEBI has relaxed this norm vide Circular No 1/ 2009 dated July 3, 2009 which requires FVCI to obtain only ‘firm commitment’ from its investors for a contribution of an amount of atleast USD 1 million at time of the registrations.  It, therefore, appears that FVCI now only need to produce documentary evidence of ‘firm commitment’ as against actual capitalization of the company. 
New areas of concern 
Though FVCI approvals are nowadays being considered positively by RBI, it is learnt that RBI wants to link the FVCI approval with nine sectors listed under section 10 (23 FB) of the Income-tax Act, 1961. It would be important to mention that DVCF are not restricted to make investments outside these nine sectors but FVCI are restricted to make investments outside nine sectors thereby making FVCI route unattractive. 
Pranay Bhatia, Partner and Rachana Kapadia, Associate, Economic Laws Practice 


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FVCI Licensing and Pitfalls

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