The road to foreign investment for private equity in India is open, but not smooth. There are sectoral caps, tax hurdles, restrictions on debt instruments, and till very recently, the bugbear of Press Note 18. There are expectations for speedier processes, quick returns and preferential treatment. Private equity players have been demanding certain safeguards, in order to provide protection from the vulnerability of being randomly subjected to the standard FDI Regulations, SEBI Takeover Code provisions, notifications under Securities Contract Regulation Act, on put options and some recent court rulings.
The entry and proliferation of private equity (PE) investments in India is not a new phenomenon, having been around for the last decade, playing a significant role in taking forward Indian entrepreneurial initiatives. PE is not specifically defined, nor subjected to any specific regulatory norms. In practice, in the Indian context, PEs cover a wide range of investment options including leveraged buyouts, distressed debt buyouts, mezzanine loans being some examples. But the absence of proper regulation has given rise to certain interpretational issues, sometimes confusing, the public perception being that PE activity is synonymous with venture capital (VC).
In many economies there is a conscious distinction observed between the two, the dividing lines based on the target being a listed or unlisted company, duration and quantum of investment and so on. A Reserve Bank Occasional Paper of 2009 specifically acknowledges the ambiguity of the various concepts of alternative investment channels, to conclude that VC is a subset of private equity, usually funding start up activity. The dilemma in pigeon holing PEs on the regulatory front is partially attributable to the absence of clarity in activities specific to PEs and whether all PE players would actually welcome being regulated.
In the 1980s, certain guidelines were issued for setting up of Venture Capital Funds. But these were restricted to banks and financial institutions and did not go very far. Thereafter on FDI, SEBI registered VCs were exempted from Press Note 18 and investment in NBFCs, though subject to restrictions.
Clearly, the need of a policy for PEs is urgently warranted, as well as for those operating in capital markets, primary or secondary, whether registered under the SEBI Foreign Venture Capital Investor (FVCI) Regulations.The cause has been taken up by various industry representative bodies. While India needs PE Investment for its growth, the recommendations for regulating the PE space may not remain insulated from abuse and misuse.
How does one categorise a PE? It’s not possible from the main objects of the MOA as they are worded. One way to view this is to rule out the activities PEs don’t undertake. For one, PEs are not plain vanilla funders, growing organically with the investee, eventually aiming at a long term takeover holding on to their shares for three to five years and exit by a private sale or IPO. PE financing is also usually specific to a purpose-working capital, further acquisitions. But it is not possible for a regulator to keep track or rely on such parameters. Therefore, in order to be regulated, PEs will necessarily have to submit to certain classifications and be subjected to disclosures and compliances.
There have been some adjudications on PE and off shore investments and terms and conditions of PE investment companies contracts with the investee company leading to interpretations that potentially threaten both. Pipe Transactions run the risk of triggering the Takeover Code, though the proposal to raise the trigger to 25% may ease some deals. The recommendation for doing away with public offers may not entirely work, but some exemptions such as, not being clubbed as ‘promoters’ should be allowed. The risk in providing such a blanket exemption is that all acquirers, PE or otherwise, will try to find a way into the PE slot, and this may result in virtually nullifying the Takeover Code. The over-arching provisions in PE contracts in terms of drag along and veto rights, restrictions on material changes, have been subjected to challenge in the Courts. In the 2010 SAT decision (Subhkam Ventures Pvt Ltd vs. SEBI), the rights of VC investor, and whether the protective provisions in the shareholder’s agreement such as, maintaining of status quo till actual infusion of funds by the PE, or pertaining to material changes in the duration of the investment, were held as not amounting to ‘control’ within the meaning of the SEBI Takeover Code and thereby Regulation 12 of the SEBI Takeover Code was not triggered being transitional provisions. SAT’s interpretation distinguishes proactive and reactive power thereby sending out a positive signal. One may have a better idea tomorrow, after the Supreme Court hearing.
On the other hand, the demand for clear tax pass throughs for all sectors, not just the ones permitted under section 10(23FB) of the Income Tax Act is something which merits consideration, but will be an uphill effort in the current fiscal and judicial climate, with the Vodafone and Hassan Ali Judgments under the scanner.
Kumkum Sen is a partner at Bharucha & Partners Delhi Office and can be reached at kumkum.sen@bharucha.in