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Published : August 03, 2010 | Author : maneesh1982
Category : Tax Laws | Total Views : 13013 | Rating :

maneesh yadav, LL.M.

Regulatory Aspects of Venture Capital In India

Chris Bovaird has cited a practitioner’s definition of venture capital as follows:
...the provision of risk-bearing capital, usually in the form of a participation in equity, to companies with high growth potential. In addition, the venture capital company provides some value added in the form of management advice and contribution to overall strategy. The relatively high risks for the venture capitalists are compensated by the possibility of high return, usually through substantial capital gains in the medium term[1].

Venture Capital is money granted by qualified who advance and administer swiftly increasing companies that have the potential to enlarge as momentous economic contributors. It is the progression of investing private equity in companies to offer considerable potential to grow to a large extent and reward investors in market. Venture capital tenders institutional investors and high-net-worth individual’s high returns and burly diversification benefits from very low correlations with other asset classes.

Venture Capital firms characteristically supervise multiple funds formed over intervals of several years. Funds are illiquid but as companies in the portfolio go public or are sold, the investors comprehend their returns. A broad rule for the breakdown of returns among VC company investments is 40% will be complete losses, 30% will be "living dead," with the remaining 30% generating substantial returns on the original investment. The big winners yield 10 or more times the original investment. Venture capital has also been defined as investment in small or medium sizes unlisted companies with the investors participating, in some degree, in the management progress.[2]
The explanation of venture capital that commands the widest acceptability, is that it is

… a separate asset class, often labeled as private equity, Private equity investment sits at the furthest end of the risk-rewards spectrum from government bonds and can broadly describe equity investment in private companies not quoted on the stock market.[3]
ARD[4] (American Research and Development) Corporation, one of the few venture capital firms created after the war. Incorporated on June 6, 1946, under Massachusetts law, ARD was aimed at aiding ‘in the development of new or existing businesses into companies of stature and importance,’ as Doriot described in the company’s first annual report[5].

History of Venture Capital Funds in India
The Venture Capital takes part in a vital role in the development and growth of innovative entrepreneurships in India. Previously, venture capital funding was done by the financial institutions. These financial institutions promoted corporate bodies in the private sector with debt as a device of funding. In India, the call for Venture Capital was acknowledged in the 7th five year plan and long term fiscal policy of GOI[6]. Venture Capital financing actually originated in India, in 1988, w ith the formation of Technology Development and Information Company of India Ltd. (TDICI) - promoted by ICICI and UTI. The first private venture capital 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[7].

Regulatory framework of Venture Capital in India
Venture Capital in India governs by the SEBI[8] Act, 1992 and SEBI (Venture Capital Fund) Regulations, 1996. According to which, any company or trust proposing to carry on activity of a Venture Capital Fund[9] shall get a grant of certificate from SEBI[10]. However, registration of Foreign Venture Capital Investors (FVCI) is not obligatory under the FVCI regulations[11]. Venture Capital funds and Foreign Venture Capital Investors are also covered by Securities Contract (Regulation) Act, 1956, SEBI (Substantial Acquisition of Shares & Takeover) Regulations, 1997, SEBI (Disclosure of Investor Protection) Guidelines, 2000.

Constitution of Venture Capital Funds
There are three layers of structured or institutional venture capital funds i.e. venture capital funds set up by high net worth individual investors, venture capital subsidiaries of corporations and private venture capital firms/ funds. Venture funds in India can be divided on the basis of the type of promoters.

1. Venture Capital Funds promoted by the Central government controlled development financial institutions such as TDICI, by ICICI, Risk capital and Technology Finance Corporation Limited (RCTFC) by the Industrial Finance Corporation of India (IFCI) and Risk Capital Fund by IDBI.

2. It is promoted by the state government-controlled development finance institutions such as Andhra Pradesh Venture Capital Limited (APVCL) by Andhra Pradesh State Finance Corporation (APSFC) and Gujarat Venture Finance Company Limited (GVCFL) by Gujarat Industrial Investment Corporation (GIIC)

3. Also, promoted by Public Sector banks such as Canfina and SBI-Cap.

4. Venture Capital Funds promoted by the foreign banks or private sector companies and financial institutions such as Indus Venture Fund and Grindlay's India Development Fund[12].

Eligibility and Investment Criteria for Venture Capital Funds
For Venture Capital Funds it is required that Memorandum of Association or Trust Deed must have main objective to carry on action of Venture Capital Fund including prohibition by Memorandum of Association & Article of Association for making an invitation to the public to subscribe to its securities. Further, it is required that Director or Principal Officer or Employee or Trustee is not caught up in any litigation connected with the securities market and has not at any time been convicted of any offence involving moral turpitude or any economic offence. Also, in case of, body corporate, it must have been set up under Central or State legislations and applicant has not been refused certificate by SEBI[13].

A Venture Capital Funds may generate investment from any investor (Indian, Foreign or Non-resident Indian) by means of issue of units and no Venture Capital Fund shall admit any investment from any investor which is less than five Lakhs. Employees or principal officer or directors or trustee of the VCF or the employees of the fund manager or Asset Management Company (AMC) are only exempted. It is also mandatory that VCF shall have firm commitment of at least five Crores from the Investors before the start of functions by the VCF. Disclosure of investment strategy to SEBI before registration, no investment in associated companies and duration of the life cycle of the fund is compulsorily being done. It shall not invest more than twenty five percent of the funds in one Venture Capital Undertaking. Also, minimum 66.67% of the investible funds shall be utilized in unlisted equity shares or equity linked instruments of Venture Capital Undertaking.

It is also mandatory that not more than 33.33% of the investible funds may be invested by way of following as stated below:-
1. Subscription to IPO[14] of a Venture Capital Undertaking (VCU)
2. Debt or debt instrument of a VCU in which VCF has already made an investment by way of equity
3. Preferential allotment of equity shares of a listed company subject to lock in period of one year
4. The equity shares or equity linked instruments of a monetarily weak company or a sick industrial company whose shares are listed.
5. SPV (special purpose vehicles) which are created by VCF for the purpose of making possible investment.

RBI and Investment Criteria
A foreign venture capital investor proposing to carry on venture capital activity in India may register with the Securities and Exchange Board of India (“SEBI”), subject to fulfilling the eligibility criteria and other requirements contained in the SEBI Foreign Venture Capital Investor Regulations. The SEBI Foreign Venture Capital Investor Regulations prescribe the following investment guidelines, which can impact overall financing plans of foreign venture capital funds.

a) The foreign venture capital investor must disclose its investment strategy and life cycle to SEBI, and it must achieve the investment conditions by the end of its life cycle.

b) At least 66.67 per cent of the investible funds must be invested in unlisted equity shares or equity linked instruments.

c) Not more than 33.33 per cent of the investible funds may be invested by way of:
· Subscription to initial public offer of a venture capital undertaking, whose shares are proposed to be listed.
· Debt or debt instrument of a venture capital undertaking 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.
· The equity shares or equity linked instruments of a financially weak or a sick industrial company (as explained in the SEBI FVCI Regulations) whose shares are listed.

A foreign venture capital investor may invest its total corpus into one venture capital fund[15].

Tax Matters related to Venture Capital Funds
Indian Venture Capital Funds are allowed to tax payback under Section 10(23FB) of the Income Tax Act, 1961. Any income earned by an SEBI registered Venture Capital Fund (established either in the form of a trust or a company) set up to raise funds for investment in a Venture Capital Undertaking is exempt from tax[16]. It will also be extensive to domestic VCFs and VCCs which draw overseas venture capital investments provided these VCFs/VCCs be conventional to the guidelines pertinent for domestic VCFs/VCCs. On the other hand, if the Venture Capital Fund is prepared to forego the tax exemptions available under Section 10(23F) of the Income Tax Act, it would be within its rights to invest in any sector[17].

India legal system and industrial jurisprudence evolved venture capital financing as a ‘sanjivni’ to business ideas. Positioning of legal framework is to facilitate more and more invitation to new and dynamic ideas. Further, tax burden have also been reduced to invite youth participation in national progress. In the near future, venture capital would be the prime financing opportunity to the coming business fraternity.
[1] Dr. Neil Cross, quoted in Venture Capital Finance, Chris Bovaird, Pitman, London, 1990
[2] Asian Venture Capital Journal, Guide to Venture Capital in Asia, Hong Kong, 1992-1993. Also, S. Ramesh, Arun Gupta, Venture Capital And the Indian Financial Sector, p.no.48-49
[3] George Anson, ‘Venture Capital in Europe’, European Venture Capital Association Yearbook, London, 1992
[4] American Research and Development Corporation was a venture capital and private equity firm founded in 1946 by Georges Doriot, the "father of venture capitalism and is credited with the first major venture capital success story when its 1957 investment of $70,000 in Digital Equipment Corporation (DEC) would be valued at over $355 million after the company's initial public offering in 1968. Also, http://en.wikipedia.org/wiki/American_Research_and_Development_Corporation (Accessed on 05-07-2010)
[5] http://www.thehindubusinessline.com/2008/06/19/stories/2008061950360900.htm (Accessed on 06-02-2009)
[6] Gazette of India Notifications are published by department of publication and are printed by the Government of India Printing Presses regularly. This is an authorized legal document of Government of India containing the mode of operations under the law of the land. Also, http://egazette.nic.in (Accessed on 06-02-2009)
[7] http://www.indianmba.com/Faculty_Column/FC159/fc159.html
[8] The Securities and Exchange Board of India was established on April 12, 1992 in accordance with the provisions of the Securities and Exchange Board of India Act, 1992
[9] Venture capital is a type of private equity capital typically provided by outside investors to new businesses.
[10] Section-12 (1B) of the SEBI Act. Also, makes it compulsory for every domestic VCF to get certificate of registration from SEBI in conformity with the regulations.
[11] http://india-financing.com/The law of Venture capital in India.pdf (Accessed on 05-07-2010)
[12] http://www.indianmba.com/Faculty_Column/FC159/fc159.html (Accessed on 05-07-2010)
[13]Rule-4, SEBI (Venture Capital Funds) Regulations 1996
[14] IPO stands for Initial Public Offering and describes the process where a private entity offers its shares to the public for the first time.
[15] http://www.business-asia.net/pdf_pages/Venture_Financing/08mar_apr_venture_financing.pdf(Accessed on 13-07-2010)
[16] http://www.abanet.org/buslaw/committees/CL930000pub/newsletter/200603/singh.pdf (Accessed on 05-07-2010)
[17] http://www.delhilaw.firm.in/articlenews/venturefund-guideline.htm ( Accessed on 09-07-2010)

Authors contact info - articles The  author can be reached at: maneesh1982@legalserviceindia.com

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