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ICAI Bangalore

FEMA Framework – VC, PE and M&A

February 26, 2021

-- Amithraj AN

Amithraj AN

+ 91 98861 20086

[email protected]

mailto:[email protected]

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


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


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


AIF/ REIT/ InvIT – Investment Vehicle

Investment Vehicle

NR Investors

Indian Investors

Eligible Investments



AMCManagement Services & Fees


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


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


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


Investment Vehicle – Funding Instruments

Investment Vehicle

NR Investors

Indian Investors




• 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


Offshore Fund

Offshore Fund

Investors

Investors

Investors





Investment Advisor

AdvisoryServices & Fees

India

Overseas


AIF with Offshore Feeder Fund

AIF

Investors

Investors

Investors





India

Overseas

Indian Investors

Offshore Fund



AIF & Offshore Fund – Parallel Investments

AIF

Investors

Investors

Investors





India

Overseas

Indian Investors

Offshore Fund


Section 3

Non Convertible Debentures from FPIs


• 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


• 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


• 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


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


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


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


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


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


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


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


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


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


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


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


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


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

[email protected]

Views expressed in the presentation are personal

mailto:[email protected]

ICAI Bangalorebangaloreicai.org/assets/uploads/newsletters/5839ed89... · 2021. 3. 1. · ICAI...

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