AVenture Capital Fund (VCF) is a privately pooled investment vehicle. It can be established or incorporated in the form of a trust, a company, a limited liability partnership, or a body corporate, which collects funds from investors, for investing in accordance with a defined investment policy for their benefit.
Current scenario in India. As per the report of Bain and Company “India Private Equity Report 2018”, last year was a good time for private equity in India as the country witnessed the highest investment of Private Equity (PE) /Venture Capital (VC) on record, i.e., amount of around US$26 billion.
The Securities and Exchange Board of India (SEBI) regulates both domestic and offshore funds using various rules. Domestic VC funds come under SEBI (Alternate Investment Fund) Regulations and offshore VC funds come under SEBI (FVCI) Regulations, 2000.
Instruments. Some of the preferred instruments for a VC fund outside equity: (a) compulsorily convertible preference shares are one such type of instrument as they carry a preferential right over dividend and gives investors a preferential right to recover ther nvestment in case the company is wound-up; (b) compulsorily convertible debentures are another investment instrument that may be considered. It is a debt instrument compulsorily convertible into equity after a specified time; (c) convertible notes as an investment option is permitted for start-up companies with effect from 10 January 2017. A foreign investor is permitted to invest in convertible notes up to Rs2 million or more in a single tranche (a start-up company issues convertible notes to acknowledge receipt of money initially as debt, which is repayable at the option of the holder, or which is convertible into such number of equity shares of such company, within a period not exceeding five years from the date of issue of the convertible notes, upon occurrence of specified events as per the other terms and conditions agreed to and indicated in the instrument).
Documentation. Typically, a VC fund enters into various documents in connection with its investment, including (a) term sheet, which initially captures a capital financing, covering various important aspects, such as valuation of the company, the constitution of the board, the right to veto, exit rights, future funding, right to financial information etc., (b) share subscription agreement to provide for the issue of shares to the investor for subscription money, determined as per the valuation of the company. It provides the purpose for which the money may be used, representations and warranties by the founder pertaining to the start-up, provides a safeguard against any liability that the investor may face due to legal, regulatory or tax related liabilities of the start-up, etc. (c) shareholders’ agreement to provide for the structure of the board of directors, the appointment of the investor’s directors on the board, liability of the founder to provide the investor with financial reports from time to time, pre-emptive right, right of first refusal, the exit route available to the investors, etc.
Exit options/routes available to investors are as set out below. One of the key aspects for a VC fund in connection with its investment is the right to exit the portfolio company. Typically, the exit options include: (a) initial public offering; (b) buyback of shares; (c) redemption of fully paid-up preference shares/debentures; (d) registration rights that allow an investor to register its securities for sale in case the company lists its securities on a foreign stock exchange; (e) tag along rights where an investor can sell its share on the same terms and conditions as the shareholders exiting the company to a third party; (f) drag along rights that allow an investor to compel the other shareholders to sell their shares on the same terms and conditions as the investor to a third party; (g) put option that gives an investor the right to sell shares back to the other shareholders at a predetermined price/terms and conditions; and (h) call option that allows an investor to purchase the shares of another shareholder at a predetermined price/terms and conditions as specified under the shareholders agreement.
Judicial pronouncements. With their recent judicial pronouncements, Indian courts are likely to instil more confidence among investors, creating a favourable climate for investments. In a recent judgment, the Delhi High Court upheld an international arbitral award passed in favour of a foreign investor, and against the promoters, of an India company for having concealed information about proceedings against them by the American food and drug department while selling their shares. In another judgment on NTT Docomo v Tata Sons, the court upheld the arbitral award in favour of Docomo. With the decision, the court clearly brought out the need to create a favourable environment for foreign investment by holding the Indian parties liable to their commitments under the contracts, not allowing them to take defence of the foreign exchange laws.
Economic growth in any country depends on the consistent expansion of business and an environment to nurture investor confidence. Confidence is assured when investors can exit the companies after accruing profits and without suffering any loss due to wilful default or misrepresentation of the other shareholders or promoters. With laudable judicial precedents and liberal laws, India is likely to achieve high investment and business growth in the coming years.
Ravi Singhania is the managing partner and Arjun Anand is a partner at Singhania & Partners