Today The Economic Times headlined that the government is contemplating stricter norms which will mark the end of “joyride” for the fledgling private equity industry in India. Even though the headline ("Muzzling PEs, VCs"), sounded more like an over-enthusiastic sub-editor’s job to sensationalise a statement of a joint secretary in the finance ministry, the noise in the government circles about their fears of private equity and venture capital is getting louder.

The newspaper reported that the government and Securities Exchange Board of India are drafting new guidelines which will include barring private equity funds from making investments in listed companies (PIPE deals). The government also wants venture capital funds (official term for the entire industry including private equity) to invest only in “genuine new ventures” and not in established companies.

It further wants to treat domestic and foreign VC funds at par for taxation purposes, besides making it mandatory to register every fund in India if they intend to invest in the country.

Some of these steps such as banning funds from making PIPE deals and restricting funds from making growth capital investments sound like an over reaction of the government. Did the government official mean what he said?

However, the report quoted KP Krishnan, a Joint Secretray in Finance Ministry, as saying at the event which marked the inauguration of Venture Capital Association of India under the aegis of Assocham, an industry body: “It’s time to revisit the regulatory regime of venture funds. It’s important for us to know how many of them operate in India as well as the volume of the business they do.”

Reserve Bank of India and the government have been getting impatient about venture capital and private equity in India for a while. Their major grouse is that a lot of private equity money is getting into real estate. Apparently, RBI’s estimate is that private equity funds have put in more than Rs 1,000 crore into real estate in the last few months.

VC Circle’s estimates say about $1.7 billion in private equity has come into real estate from February 2008 to May 2008. The larger fund flow to real estate and the fear of a bubble in real estate business is what worrying RBI.

The fears about unregulated fundflow to real estate may be justified but an all encompassing licencing of venture capital and private equity business may not be prudent. India needs all kinds of capital, and that includes money for startups, growth capital for unlisted as well as listed firms, and even unrestricted buyouts and leveraged buyouts if need be.

But the plans to restrict funds to just startup investing activity sounds more like a misinterpretation of what Krishnan said at the event. Becasue you cannot have only startup VCs. We need funds for all stages of a life of a company - liek seed investing, venture capital, growth capital, private equity, and buyout. The official of Assocham said: “Without disturbing fund flows of venture capitalists (VCs) and private equities (PEs), the government is likely to regulate them with developing a new mechanism.”

It also said that the government’s move would “ensure equitable growth of all sectors and restrict specific sectors like realty from absorbing their investments for making quick money.”The Joint Secretary, however, did not specify any particular time frame and schedule to regulate the VCs and PEs and simply added that SEBI and the Finance Ministry are in the dialogue process to evolve the mechanism for fairly regulating the PEs and VCs.

And SEBI may also make it mandatory to register VCs and PEs with the regulator. Right now, there are 189 funds registered with SEBI (which includes foreign and Indian funds), while there are several other funds active in India through their investment advisors registered in India.

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