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.
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.
“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.