Investment conditions and restrictions for venture capital funds

Venture capital funds (VCFs) are contributing considerably to India’s economic growth. The amount of investment directed to venture capital has grown in recent years due to the pro-business environment and regulatory reforms in India, and the government is aiming for further reforms to attract more such investments.

Regulatory framework
VCFs are regulated by Securities and Exchange Board of India (Alternative Investment Funds) Regulations, 2012 (Regulations). A VCF is defined under the regulations as an alternative investment fund that invests primarily in unlisted securities of start-ups or early-stage venture capital undertakings mainly involved in new products or services, technology or intellectual property rights, or a new business model.

Conditions for investment in VCFs
A VCF can solicit or raise funds only through private placement. It may launch schemes subject to the filing of a placement memorandum with the Securities and Exchange Board of India (SEBI) and each scheme is required to have a minimum corpus of Rs200 million (US$2.9m).

Investment in a VCF is subject to the following conditions:

1. A VCF cannot accept investment of less than Rs10 million. In case investor is an employee or director of VCF or of the manager of VCF, minimum investment should be Rs2.5 million;
2. The manager or sponsor is required to have a continuing interest in the VCF of not less than 2.5 percent of the corpus or Rs50 million, whichever is lower, and such interest cannot be through the waiver of management fees;
3. The manager or sponsor has to disclose their investment in the VCF to the investors;
4. A scheme of VCF cannot have more than 1,000 investors;
5. The minimum tenor of a VCF is three years. Extension may be permitted up to two years subject to the approval of two-thirds of the unitholders by value of their investment; and
6. VCFs should be close-ended only.

Foreign investments in VCF
Foreign investments into VCFs are permitted under the automatic route. Downstream investment by a VCF will be considered as foreign investment if either the sponsor or the manager is not Indian “owned and controlled”. The extent of foreign investment in the corpus of the VCF will not be a factor to determine as to whether downstream investment of VCF concerned is a foreign investment or not.

Conditions for investment by VCF
A VCF should consider the following key conditions while making investments:

1. It can invest in overseas securities subject to the guidelines of SEBI and Reserve Bank of India;
2. It cannot invest more than 25 percent of the investable funds (corpus net of estimated expenditure for administration of the VCF) in one investee company;
3. It cannot invest in associates without prior approval of 75 percent of investors by value of their investment;
4. It should invest at least two-thirds of investable funds in unlisted equity shares or equity-linked instruments of a venture capital undertaking or in companies listed on a small and medium-size enterprise (SME) exchange or SME segment of an exchange;
5. It cannot invest more than one-third of investable funds in the following:

•    subscription of initial public offer of a venture capital undertaking;
•    debt or debt instruments of a venture capital undertaking in which the VCF has already made an investment by way of equity;
•    preferential allotment of equity shares or equity-linked instruments of a listed company subject to a lock-in period of one year;
•    equity shares or equity-linked instruments of a financially weak company or a sick industrial company whose shares are listed; or
•    special purpose vehicles created by the VCF for the purpose of facilitating investment.

Overseas investments by VCF
VCFs may invest in equity shares or equity-linked instruments, subject to an overall limit of US$500 million, only of offshore venture capital undertakings having an Indian connection and whose shares are not listed on any of the recognised stock exchanges in India or abroad.

Overseas investment will require prior approval from SEBI and investment cannot exceed 25 percent of the investable funds of the scheme of VCF. Further, VCFs cannot invest in a joint venture or wholly owned subsidiary while making overseas investment.

Conclusion
Considering the growth of VCFs in previous years and the government’s initiatives to further liberalise the regulatory environment, India may see a constant growth in investments in VCFs in the coming years.

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