Says present norms hamper valuation, FDI and VC deals; points to drop in flows this year.
The Department of Industrial Policy and Promotion (DIPP) plans to relax foreign direct investment (FDI) norms for convertible instruments, to encourage greater private equity (PE) participation and venture capital deals in the country.
DIPP Secretary R P Singh has written a letter each to Finance Secretary Ashok Chawla and Reserve Bank of India Governor D Subbarao seeking their views on the issue.
Under the present policy, the pricing of all the capital instruments that are issued to foreign investors must be decided upfront at the time of issue. However, companies argue that this would deprive them of getting a better valuation afterwards in case of better performance. This has led to widespread ambiguity among the industry and halted several potential investments.
DIPP says the precondition constrains flexibility by the industry. The department has also received several complaints from the industry to remove the stipulation as it was preventing FDI inflows into the country.
“Industry representatives have represented that this stipulation constrains their flexibility and prevents them from leveraging opportunities, if the company does well in future. Stipulating the condition of pricing fully convertible instruments upfront prevents them from getting a better valuation based on higher performance,” DIPP said in its letter.
DIPP has also argued that the stipulation also prevents venture capitalists from making a proper valuation, besides making FDI policy unfriendly for global investors. It also said India had received FDI worth $14.03 billion in the current financial year, compared to $19.33 billion during the corresponding period of 2009-10. On the contrary, countries such as Russia and China have attracted more investments in 2010-2011.
“Venture capitalists generally like to link the conversion ratio with the performance. This, while being a safeguard for them, is also an incentive to show higher performance by the recipient company. By insisting on fixing the conversion price upfront, we are depriving Indian entrepreneurs of a chance to get higher premium,” the DIPP secretary said in the letter.
The department also said it might look at fixing the minimum conversion price.
The provision to determine the pricing of capital instruments at the time of their issue became effective from April 1 last year, when Dipp issued a consolidated FDI Policy. This particular provision was recommended by the Department of Economic Affairs and the Reserve bank of India (RBI).
According to Yashojit Mitra, associate partner, Economic Laws Practice, the issue has given rise to adverse problems in the private equity (PE) space.
“Everybody in the PE industry is facing problems due to this stipulation. RBI has stipulated the prices of the underlying equity to be mandated, and this has opened a Pandora’s Box. Fixing the minimum conversion price would not be of much help but at least it would give some flexibility.”
