ICAI Bangalore
FEMA Framework – VC, PE and M&A
February 26, 2021
-- Amithraj AN
Amithraj AN
+ 91 98861 20086
2 Amithraj ANVC, PE and M&A
Contents
• Indian Fund – Entity Form
• Categories of AIF
• Investment Vehicle – FEMA Overview
• Non Convertible Debenture from FPIs
• Foreign Venture Capital Investor
• Case Studies in M&A – FEMA Aspects
Section 1
Indian Fund – Entity FormCategories of AIF
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Indian Fund – Entity Form
Trust Company LLP
• Significant corporate law
restrictions
• Challenges in raising funds
and retirement of investors
• Rarely used form for AIF/
AIF
• Lacks flexibility
• Almost all funds are set-up as
Trusts
• No corporate law restrictions
• Ease in raising funds and
retirement of investors
• Significant flexibility
• Deposit challenges for
optionally convertible debt
instruments and loans
• 95%+ of funds are structured
as Specific Trusts
• Many aspects similar to Trust
• RoC restrictions in setting-up
LLP as investment vehicles
not applicable to AIFs
• LLP will be a taxable entity,
unless it qualifies as AIF Cat I
or II fund
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AIF Categories
AIF Cat I
• Invest in start-ups or early
stage ventures or social
ventures or SMEs or
infrastructure or specified
sectors
• Venture capital funds, SME
funds, social venture funds,
infrastructure funds
• May be entitled for specific
benefits by Government or
Regulators
AIF Cat II
• Neither Category I nor
Category III AIFs
• No leverage or borrowing,
other than for operational
requirements
• Private equity and debt funds
• No specific incentives or
concessions are granted
AIF Cat III
• Employ complex or diverse
trading strategies
• May employ leverage
including through investment
in listed or unlisted
derivatives
• Hedge funds or funds
focusing on short-term
returns, open ended funds
• No specific incentives or
concessions are granted
Section 2
Investment Vehicle
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AIF/ REIT/ InvIT – Investment Vehicle
Investment Vehicle
NR Investors
Indian Investors
Eligible Investments
Eligible Investments
Eligible Investments
AMCManagement Services & Fees
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Investment Vehicle – IOCC/ FOCC
Investment in units of Investment Vehicle
• Investment in units of Investment Vehicle permitted under automatic route
• Swap of shares against allotment of units pemitted
Investment Vehicle – IOCC/ FOCC status
• IOCC/ FOCC status linked to Sponsor and Manager
• If Sponsor and Manager are Indian owned and controlled, investments by Investment Vehicle
regarded as resident investment
• No sectoral restrictions, pricing guidelines, etc.
• “Control” of the AIF should be in the hands of “sponsors” and “managers or investment managers”,
with the general exclusion to others
• Impact of affirmative/ veto rights
• Ownership linked to 50%+ ownership with resident citizens or non-residents
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Investment Vehicle – Manager
Company
• FDI is permitted 100%
• No complexities associated with the manager entity
LLP
• FDI is challenging in fund based activity for an LLP, as financial services is a regulated sector
• Differing views on permissibility of LLP with FDI as a fund manager
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Investment Vehicle – IOCC AIF
IOCC AIF
AIF
NR Investors
Indian Investors
Insurance Co
Media Co
Retail Co
Sponsor &Manager
Management Services & Fees
IOCC
Defence Co
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Investment Vehicle – Funding Instruments
Investment Vehicle
NR Investors
Indian Investors
Eligible Investments
Eligible Investments
Eligible Investments
• Equity shares
• CCPS
• CCD
• OCD/ OCRPS – Not considered as ECB
• NCD – Not considered as ECB
• Loans
• AIF is not permitted to extend loans – only debt
instruments are permitted
• REIT/ InvIT can extend loans
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Offshore Fund
Offshore Fund
Investors
Investors
Investors
Eligible Investments
Eligible Investments
Eligible Investments
AMCManagement Services & Fees
Investment Advisor
AdvisoryServices & Fees
India
Overseas
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AIF with Offshore Feeder Fund
AIF
Investors
Investors
Investors
Eligible Investments
Eligible Investments
Eligible Investments
AMCManagement Services & Fees
India
Overseas
Indian Investors
Offshore Fund
AMCManagement Services & Fees
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AIF & Offshore Fund – Parallel Investments
AIF
Investors
Investors
Investors
Eligible Investments
Eligible Investments
Eligible Investments
AMCManagement Services & Fees
India
Overseas
Indian Investors
Offshore Fund
AMCManagement Services & Fees
Section 3
Non Convertible Debentures from FPIs
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• Registered FPIs are permitted to subscribe to NCDs
• FPIs can subscribe to corporate bonds/ debentures with minimum maturity period of at-least 1
year (reduced from 3 years)
• Investment in corporate bonds with minimum residual maturity of < 1 year cannot exceed 30% of
the total portfolio of FPI in corporate bonds at all times (short-term investments)
• FPI/ related FPIs cannot subscribe to more than 50% of any corporate bond issue of
a single issuer
• There needs to minimum of 2 unrelated investor groups, with one investor group not subscribing to more
than 50% of the issue size
• In case the 50% criteria is not met, FPIs can consider investment under the Voluntary Retention
Route (VRR)
• VRR provides for a lock-in of capital in India for the FPI investors for a period of 3 years
• During the 3 year period, the FPI investor can invest the redemption proceeds in other NCD investments;
minimum 75% of the investable amount to be retained during the lock-in period
• FPIs cannot subscribe to partly paid-up NCDs
• Sectoral caps and Pricing guidelines – not applicable
• No investment concentration restrictions applicable on FPI investments in corporate bond
portfolio of a single company/ investee company (RBI Notification dated February 15, 2019)
NCD
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• FPIs can invest in Listed and Unlisted NCDs of Indian companies on repatriation basis
• Listed NCDs are to be listed on wholesale debt segment of the stock exchanges, within 15 days from
the date of allotment
• Credit rating is mandatory for issue of Listed NCDs
• No end-use restriction on investments in Listed NCDs
• In case of Unlisted NCDs, funds cannot be utilized for the following purposes:
• Real estate business
• Capital market
• Purchase of land
• ‘Real estate business’ means dealing in land and immovable property with a view to earning profit
therefrom and does not include development of townships, construction of residential /
commercial premises, roads or bridges, educational institutions, recreational facilities, city and
regional level infrastructure, townships. Further, earning of rent income on lease of the property,
not amounting to transfer, will not amount to real estate business
• Purchase of equity shares unlisted companies may not be regarded as investment in capital market
NCD
Section 4
Foreign Venture Capital Investor
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• Sectors for FVCI investment:
• Biotechnology
• IT related to hardware and software development
• Nanotechnology
• Seed research and development
• Research and development of new chemical entities in pharmaceutical sector
• Dairy industry, poultry industry
• Production of bio-fuels
• Hotel-cum-convention centres with seating capacity of more than three thousand
• Infrastructure sector
• Registered start-ups as per Department for Promotion of Industry and Internal Trade’s Notification
• Pricing regulations not applicable
• Possible to invest into OCD/ NCD, etc. without needing to comply with the ECB framework
Foreign Venture Capital Investor
Section 5
Case Studies in M&A
FEMA Aspects
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Pricing of Convertible Instruments
Facts
• Indian company proposes to allot CCPS to
non-resident investors
• Conversion ratio of CCPS linked to future
EBITDA of the company
• Conversion price or formula to be specified
upfront
FEMA pricing requirements
• Effective allotment price not to be lower than
the FMV at the time of issuance of CCPS
• Base effective price to be determined
• FMV at the time of issuance of CCPS to be
lower than the base effective price
Investors
Indian Company
CCPS
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Aggregation of Shareholding
Facts
• 50 resident shareholders in a target company
• Non resident investor buying out the entire
state
Commercial Requirement
• Speedy completion of share transfer and
documentation
Possible Solution
• Nominated resident buyer to acquire all the
shares from resident shareholder
• Post aggregating, such shareholder can
transfer the shares to non resident investor
through a single FC-TRS filing
• TCS requirement to be factored in
• Appropriate protection mechanism to be
considered
50 shareholders
Indian Company
Transfer
Investor
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Deferred Consideration
Issue
• Deferred consideration upto 25% is permitted
in respect of share transfer between resident
and non-residents
• Time limit for deferred consideration: 18
months
Commercial Requirement
• 30% amount for 24 months
Possible Solution
• Resident shareholder to continue to hold a
nominal stake of say 5%
• Deferred consideration amount to be loaded on
to the 5% tranche
• Appropriate protections to be put in place for
counter party risks
Indian Company
Transfer
NR InvestorIndian
Shareholders
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Differential Pricing – Equity & CCPS
Issue
• Non resident buyer acquiring shares in a Target
Company
• Liquidation preference at play in allocation of the
consideration
• Effective price for investors higher than resident
founders
• Investors holding CCPS and resident founders
holding equity shares
Possible Solutions
• Valuation of each class of shares along with
associated rights
• Conversion of CCPS held by the Investors into
equity shares in line with the payout amounts
Indian Company
NR InvestorIndian
Shareholders
Equity CCPS
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Differential Pricing – Swap & Cash Consideration
Issue
• FOCC Indian entity is the buyer
• Consideration discharged partly through swap of
shares and balance in cash
• Swap consideration: INR 100 per share
• Cash consideration: INR 80 per share
• Sellers include resident and non resident
shareholders
• Pricing requirements to be complied with
Possible Solutions
• Buy-back of portion of the shares meant for cash
consideration
• Averaging out the consideration between cash and
swap shares
• Reduction of allotment price in case of swap of
shares
Indian Target
Transfer + Swap
NR InvestorR + NR
Shareholders
Indian Acquirer
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Slump Sale between Two Indian Companies
Issue
• Two FOCC Indian entities involved in sale of
business from one to other
• DCF value of the business: 100
• Commercially agreed consideration: 70
Applicability of FEMA pricing requirements
• Pricing requirements applicable only in respect of
shares and capital instruments
• No pricing requirements for slump sale
transactions
Indian Seller
R + NR Shareholders
R + NR Shareholders
Indian Acquirer
Slump Sale
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FOCC & Debt Push Down Structure
Issue
• FOCC Indian company undertaking downstream
investment is required to bring in requisite funds
from aboard or use internal accruals
• Local leveraging is not permitted
• ECB proceeds are specifically prohibited from
investment into purchase of equity shares
Possible Solution
• FOCC Indian company to raise debt through
issuance of NCDs to FPI investors
• FOCC Indian company to acquire the target
company
• Post acquisition, both companies can be merged
Indian Target
Merger
NR Investor
Indian Acqn Co
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FOCC – Funding Instruments
• Equity shares
• CCPS
• CCD
• OCD/ OCRPS – Not considered as ECB
• Pricing requirement to be assessed at the time of
conversion separately
• NCD – Not considered as ECB
• Loans – Not considered as ECB Indian Target
NR Investor
Indian Acqn Co
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IOCC Structure
Issue
• Sectoral caps applicable in certain industries
• Indian founder intends to raise capital for
expansion of business
• FDI is the primary source
Possible Solution
• Subsidiarise the business below the HoldCo
• HoldCo shall operate in sectors under automatic
route
• As long as the HoldCo qualifies as IOCC,
downstream investment is not regarded as
indirect FDI
• Fund raise permissible upto 49.9% equity stake in
HoldCo
• Investor can put in additional funds through
NCDs under the FPI route
• NBFC issues to be considered
Indian HoldCo
NR InvestorIndian
Shareholders
> 50.1% < 49.9%
Op Co
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Fresh Lock-in
Facts
• Foreign investor holding shares in a real estate
SPV
• Real estate SPV is proposed to be merged into
another company also in real estate business
• Real estate investments are subject to a 3 year
lock-in or until completion of the project,
whichever is earlier
Issue
• Fresh lock-in of 3 years or not
• Intent seems to cover repatriation from India and
not particularly holding of instrument
• Scheme may specifically provide for recoding of
lock-in having been completed
Indian RE Co 1
R + NR Shareholders
NR Shareholders
Indian RE Co 2
Merger
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Inadequate Net-worth & ODI
Facts
• Indian company has raised CCDs from Investors
at par value
• Indian company proposing to undertaken an ODI
• ODI remittances restricted to 400% net-worth of
the Indian company
• CCD is excluded from net-worth for this purpose
Possible Solution
• Indian company to set-up a subsidiary and
capitalize the entity with equity shares/ CCPS
• Net-worth of the subsidiary should be sufficient
for the ODI
Indian Sub
R + NR Investor
Indian Parent
CCD
Equity
Foreign Sub
Equity + Debt
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Issue of Partly Paid Shares and Warrants
Partly paid equity shares
• Partly paid shares now FDI compliant
• Pricing to be determined upfront
• 25% of consideration to be paid upfront (balance within 12 months)
• Can be received after 12 months, if issue size > 500 cr and appoint monitoring agency
Warrants
• Warrants now FDI compliant
• Pricing of warrants and price/ conversion formula to be determined upfront
• 25% of consideration to be paid upfront (balance within 18 months)
• Price for conversion not to be lower than fair value at the time of issuance of warrants
• Investee company can receive more than pre-determined price
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Pricing of FDI Instruments with Optionality
• RBI has recently issued a Circular w.r.t ‘Put & Call options’ in Equity/ CCPS/ CCDs
• RBI was not comfortable with these options in SSA/ SHA – takes color of debt
• Docomo stake sale stuck before RBI on same aspect
• Optionality clause will oblige buy-back of securities from investor at the price prevailing/ value
determined at the time of exercise of option
• RBI has further specified that there shall not be an ‘assured price/ return’ for exit
• Is only buy-back by the Company permitted or purchase by Promoter also possible?
• For Listed Companies – at prevailing market prices
• For Unlisted Companies – As per RBI Pricing Norms
• Minimum lock-in – 1 year (few sectors may require a longer lock-in)
Thank You
Amithraj AN
+ 91 98861 20086
Views expressed in the presentation are personal