The
Reserve Bank of India (RBI) allowed overseas investors to sell their stakes in
Indian start-ups to local companies, potentially giving foreign venture capital
(VC) funds an easier exit route. The regulator also allowed start-ups to file
reports over the Internet, and eased rules governing share transfer
transactions, according to a statement posted on RBI’s website.
More
options for VC funds to profit from their investments or exit struggling
companies will attract more overseas investors into Asia’s third-largest
economy that’s experiencing an Internet start-up boom. RBI governor Raghuram
Rajan’s move follows Prime Minister Narendra Modi’s decision to set up a Rs.10,000
crore ($1.5 billion) fund to encourage start-up businesses and government
pledges to offer tax breaks.
“This was
a big pain point for foreign VCs in India,” said Anil Joshi, founder of Unicorn
India Ventures. “If they are able to ease out that one problem, certainly it
will attract a lot of overseas VC money.”
The
central bank also said it would allow start-ups to access rupee loans under the
external commercial borrowing (ECB) framework from eligible lenders. RBI also
said that it would facilitate the issuance of innovative instruments such as
convertible notes by start-up enterprises in an effort to make it easier for
them to attract foreign direct investment. The changes will be finalized in
consultation with the government, said RBI.
The
changes will enable start-ups to receive foreign VC investment and also
transfer shares from foreign venture capital investors to other residents or
non-residents, RBI said in a statement issued outside the scheduled monetary
policy review.
The
central bank also said it would permit, in case of transfer of ownership of a
start-up enterprise, receipt of the consideration amount on a deferred basis up
to a period of 18 months.
RBI said
it would clarify certain other issues that are permissible under current rules.
These include the issue of shares without cash payment through sweat equity or
against any legitimate payment owed by the company. The issue of collection of
payments by start-up enterprises on behalf of their subsidiaries abroad would
also be clarified, RBI said.
The
proposals will help make both the investment and exit process smoother for
investors, according to Anand Lunia, founder and partner at early-stage VC fund
India Quotient.
The
burgeoning start-up industry in India has lured billions of dollars and raised
questions about whether valuations are becoming stretched. Much of the money is
coming from foreign investors such as SoftBank Group and Tiger Global
Management Llc.
In 2015,
VC funding touched $5.4 billion (across 473 VC deals), up from $2.3 billion
(across 307 deals) in 2014, according to data from VCCEdge, the financial
research platform of VCCircle.com.
Existing rules
Under
existing rules, shares held by foreign investors are subject to more
restrictions than those held by locals.
“This is
a reasonably good package,” said Harish Visweswara, a partner at consultant
Grant Thornton India Llp. Most of the changes involve “procedural
simplifications which would make life easier for entrepreneurs and investors”.
Certain
announcements such as those involving foreign loans and convertible notes are a
welcome move, experts said, as they will help boost investments.
“Proposals
like permitting start-ups to access foreign loans, issuance of convertible
notes will improve investor participation and also help start-ups raise capital
at low cost,” said Amarjeet Singh, partner, tax, at audit and consulting firm
KPMG.
According
to Lunia of India Quotient, there is significant demand for debt from
start-ups.
“After a
point, (promoters of) start-ups would not like to dilute too much equity to
raise funds. On the other hand, availing bank debt is a difficult proposition
for start-ups,” he said.
Convertible
notes carry a certain amount of interest and are convertible into equity shares
based on certain criteria.
“Most
angel or seed investments that we have seen outside of India typically happen
through convertible notes. It works well for early stage investors as it allows
investors to redeem their notes at a later date with a certain amount of return
in a worst case scenario,” said Nitin Bhatia, managing director at tech-focused
investment bank Signal Hill.
A lack of
tax breaks has also curbed the involvement of local investors and encouraged
entrepreneurs to domicile their companies in countries that offer lower levies.
In the
past decade, most of India’s best performing Internet start-ups have chosen to
establish themselves in countries such as Singapore, even though all of their
business is in India.
Union budget
“I can’t
say people won’t go to Singapore” because of the changes, Grant Thornton’s
Visweswara said, referring to RBI’s rules. “But I would say that this was one
of the steps that was required to encourage people to stay back.”
All eyes
are now on 29 February, when finance minister Arun Jaitley presents the budget.
Start-ups and investors are waiting to see if the government will ease taxes
relating to capital gains on start-up investments. Any easing of those
rules—for instance, exempting levies on gains made after holding for a year or
more—could have a “huge impact”, Joshi said.
If
Jaitley relaxes capital-gains tax rules “you will see a lot more money coming,
not only from India but also from outside India”, Joshi said.