Venture Capital Fund in India

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VENTURE CAPITAL REGULATION IN INDIA

A Paper Submitted to Mr. M Carling as part of Credit

Course on Comparative Venture Capital

Thinlay Chukki


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VENTURE CAPITAL REGULATION IN INDIA

Venture Capital market in India is of recent phenomenon in comparison with the US

Venture Capital market. The government backed venture capital firms1 were established in the

1980s which marked the beginning of the venture capital market in India. Since then the market

has seen upward development with increase in number of venture capital firms and increase in

investment. 2 It has also attracted foreign investment in large scale with Over 44 US-based

VC firms sought to invest heavily in start-ups and early-stage companies in India with an

average of US $100 million each.3

The legal framework in India regulating the Venture Capital is considered, interestingly,

not conducive to the growth of venture capital market.4 In India the venture capital market is

regulated by the Securities Exchange Board of India (Venture Capital) Regulations, 1996 for

domestic venture capital company and by the Securities Exchange Board of India (Foreign

Venture Capital Investor) Regulations, 2000 for foreign investors. This researcher shall analyze

the regulation regulating the domestic venture capital market.

With the establishment of various government-backed venture capital firms5 in 1980s

the then Controller of Capital Issues issued guidelines stipulating the framework for

establishment and operation of funds/companies in 1988.6 As India embraced liberalization,

privatization and globalization in 1990s, it witnessed drastic changes in the governance patterns

and higher activities in the venture capital market. Securities Exchange Board of India

(hereinafter referred to SEBI) was established to regulate the securities market in India in 1992

through the SEBI Act, 1992. It has framed various regulations to regulate the market and the

1For example Risk Capital and Technology Finance Corporation (RCTFC) and Industrial Development

Bank of India's (IDBI) venture capital fund.2

Mike Wright, Andy Lockett, Sarika Pruthi , Internationalization of Western Venture Capitalists intoEmerging Markets: Risk Assessment and Information in India, Small Business Economics, Vol. 19, No. 1

(Aug., 2002), pp. 13-29, retrieved fromhttp://www.jstor.org/stable/40229217 on 18/4/20123Dr. Alok Aggarwal, Is the Venture Capital Market in India Getting Overheated?, retrieved from

http://www.venturewoods.org/wp-content/EvalueserveIndianVCMarketAugust06.pdfon 18/4/20124

Supra note 25

Supra note 16Sudip Bhattacharyya, Venture Capital Financing, Economic and Political Weekly, Vol. 24, No. 47 (Nov.

25, 1989), pp. M157-M159. Retrieved fromhttp://www.jstor.org/stable/4395620on 19/4/2012
http://www.jstor.org/stable/40229217http://www.jstor.org/stable/40229217http://www.jstor.org/stable/40229217http://www.venturewoods.org/wp-content/EvalueserveIndianVCMarketAugust06.pdfhttp://www.venturewoods.org/wp-content/EvalueserveIndianVCMarketAugust06.pdfhttp://www.jstor.org/stable/4395620http://www.jstor.org/stable/4395620http://www.jstor.org/stable/4395620http://www.jstor.org/stable/4395620http://www.venturewoods.org/wp-content/EvalueserveIndianVCMarketAugust06.pdfhttp://www.jstor.org/stable/40229217


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SEBI (Venture Capital) Regulations, 1996 (hereinafter referred to as The Regulation) was

framed to regulate the domestic venture capital market in India. The Act has undergone

amendments in 2000, 2004, 2006, and April 2010, in addition to the numerous administrative

circulars of SEBI. Two advisory committees were also appointed in 2000 and 2003 to identify

critical areas of regulatory support.

The Regulation defines a venture capital fund (herein after referred to as VCF) whereby it

can only be formed as a:

Trust, registered under Indian Trusts Act, 1882 or

Company, registered under Companies Act, 1956 or

A body corporate, set up or established under the laws of the central or state legislature7

In all forms, the main objective of the entity should be to engage in venture capital

investment and the trust deed or the memorandum of articles should explicitly state this as its

main objective.8 Therefore, in India the VCF cannot be formed as a Partnership Firm which is

the most popular form of VCF in other jurisdiction.

The VCF can invest only in Venture Capital Undertaking. Venture capital undertaking is a

domestic company whose shares are not listed on a recognized stock exchange in India. It should

not be involved in such activities or sectors which are specified in the negative list by the Board

with the approval of the Central Government in the Third Schedule of the Regulation.9

The Negative List contains the following items:

1. Non-banking financial services excluding those Non-Banking Financial Companieswhich are registered with Reserve Bank of India and have been categorized as

Equipment Leasing or Hire Purchase Companies.

2. Gold financing excluding those Companies which are engaged in gold financing forjewellery

.

3. Activities not permitted under industrial policy of Government of India.

7Regulation 2(m) of SEBI (Venture Capital) Regulation, 1996

8Regulation 4 of SEBI (Venture Capital) Regulation, 1996

9Regulation 2(n) of SEBI (Venture Capital) Regulation, 1996


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4. Any other activity which may be specified by the Board in consultation withGovernment of India from time to time.10

Therefore, a VCF cannot invest in any Venture Capital undertaking involved in the above

mentioned activities or companies. Prior to the Venture Capital Amendment Regulation 2000

even Real Estates were put under the Negative List. This Negative List restricts the options of

the VCFs.

Any VCF to start its operation has to get registered with the SEBI by filing the Form A along

with the registration fees mentioned in the Schedule. Separate eligibility conditions have been

specified for each form of VCF whether company, trust or body corporate.

Once the VCF is registered it can invite contribution to the pool either through private

placement or through an agreement with investors for contribution or subscription. The

minimum pool size for each investor is fixed at INR 5 lakh.11 This qualification is not applicable

to employees and the principal employees or the principal officer or directors of the venture

capital fund, or directors of the Trustee Company or trustees where the venture capital fund has

been established as a trust and the employees of the fund manager or Asset Management

Company.

For the purpose generating the pool of fund for investment, a placement memorandum or

contribution or subscription agreement with the investors needs to be issued, a copy of which

should be filed with SEBI. The document shall contain information like, the details of the

trustees, fund managers, fund size, duration of the fund, and manner of subscription, investment

strategies, and tax implications to the investors.

The regulation specifically states the maximum limit for the VCF while making investment

decisions. It shall not invest in the associated companies. It can invest only upto 25% in any one

VCU. At least 66.67% of the investible funds shall be invested in unlisted equity shares or equity

linked instruments of venture capital undertaking. It also makes restriction on investment in

certain kinds of companies. Therefore there is lack of flexibility to the VCF in making its

investment decisions.

Though it is accepted that the venture capital market is of recent phenomenon compared to

other jurisdictions, it is necessary that the VCFs should be given sufficient flexibility in making

10Third Schedule, SEBI (Venture Capital) Regulation, 1996

11Regulation 11(c) of SEBI (Venture Capital) Regulation, 1996


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the investment decisions. The protection to the investors is necessary but it should not curb the

freedom of the investors to take higher risk and earn higher profit in the name of protection.

Bibliography:

1. Dr. Alok Aggarwal, Is the Venture Capital Market in India GettingOverheated?

2. Mike Wright, Andy Lockett, Sarika Pruthi , Internationalization of WesternVenture Capitalists into Emerging Markets: Risk Assessment and

Information in India, Small Business Economics, Vol. 19, No. 1 (Aug.,

2002

3. SEBI (Venture Capital) Regulation, 19964. Sudip Bhattacharyya, Venture Capital Financing, Economic and Political

Weekly, Vol. 24, No. 47 (Nov. 25, 1989)

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