A brief insight of Foreign Investment in India and a guide to Start Ups in cross border fund raising

India's dream to achieve the five trillion economy has cheered the India Startups to reach out to external investors to boost the efficiency of the operations because India needs capital, there are investors also, not in India obviously, some distant foreign investor. Now the question is how to bring the capital to India? There are many aspects which are covered under this subject and obviously not under this write-up. The author has restricted the write up to briefing on how to bring capital into India.

What are the forms in which capital can be brought into India?

1. Equity
2. Debts
3. Hybrid (Equity + Debts)

Under each form there are several options like

1. Equity Shares.
2. Compulsory convertible preference shares.
3. Compulsory Convertible Debenture.
4. Partly paid-up shares.
5. Share warrants.
6. Convertible Note for Start-ups.

Whether do we need government approval to bring capital?

There are two routes in which capital can be brought into India. Automatic Route and Approval route. Under Automatic route 100% FDI  is permitted. The areas where 100% is permitted under automatic route are as given below:-

• Agriculture & animal husbandry
• Almost all forms of manufacturing and service industries
• Mining.
• Coal & lignite
• Electricity generation, transmission, distribution & trading (not in atomic plants)
• E-commerce activities (B to B and market place model of e-commerce)
• Single Brand Product Retail Trading [100% under automatic route vide Press Note 1 of 2018]
• Pharma – Greenfield projects
• Development of townships, housing, built-up infrastructure & construction-development projects
• Industrial parks
• Petroleum & natural gas sector
• Cash & carry wholesale trading/ wholesale Trading (including sourcing from MSEs).
• Airports – Greenfield projects

Further, there are some sectoral restriction, meaning in these areas FDI is prohibited:

• Lottery business including Government/ private lottery, online lotteries.
• Gambling & betting including casinos.
• Business of chit fund.
• Nidhi company.
• Trading in Transferable Development Rights (TDRs).
• Manufacturing of cigars, cheroots, cigarillos & cigarettes, of tobacco or of tobacco substitutes.
• Real estate business or construction of farm house (except certain carve outs)
• Activities/ sectors not opened to private sector investment including atomic energy and railway transport (other than mass rapid transport systems).

Is there any compliance 'before and after' bringing capital to India?

Before bringing the capital: if the sector requires any prior permission of central government then an application to be made and approval to be obtained for the same and for capital infusion under automatic route there is no prior compliances as such required.

The revolutionary steps taken by the India government to promote easy of doing business has reduced much of compliances. However, few compliances when an investee company brings capital into India (After compliance), which cannot be ignored. Failing which will lead to a huge penalty and compounding of fees. Depending upon the capital instrument and size of capital investment compliance form shall be decided.

There are two easy mode that foreigner can bring/invest capital in India.

1. Green field Investment where an investor sets up a new Joint Venture or a Wholly Owned Subsidiary. (fresh issue of shares)
2. Brown field Investment which is related to investing in existing Start-Ups.

In other words, a foreign investor or an Indian investee can plan for any of the three modes given below:

1. Float a new company which is a Wholly Owned Subsidiary of a foreign company.
2. Be an equity investor in Startup Private Limited Company or an LLP
3. Start a Joint Venture with an Indian Partner.

Let us decipher all three options available:

1. Float a new Private Limited company:

It's an easy and fast route for foreigner to invest in India, a prospective foreign investor has to start wholly-owned subsidiary in India and bring the capital to India. Although it is the simplest and fastest route, the investor has to understand and comply with all the applicable laws and regulation post-incorporation.  On the other hand when an investor joins hands with the Indian startups he will be relaxed to that extent of regular compliances. 

2. Be an Equity Investor in Indian Start Ups:

This method of capital pooling is more suitable for those who have an identified a like -minded foreign investor and willing to have a long-term collaboration with the company, a win-win situation.

As an Indian investee you have to offer equity for capital investment and that % of equity control will be given to the foreigner.

So before going for this method Indian investee has to decide about the collaboration 's strength and weakness thoroughly because you will be offering equity which means you are giving control. 

3. Start a Joint Venture:

When the Indian Start-Ups requires capital for short term projects or a limited scope projects like development of a product etc., and profit-sharing agreement and repatriation of capital is too stringent it is always wise to float a Joint Venture. There are several types/formats under which a joint venture can be floated in India. Most suitable format for short term or a limited scope venture is Limited Liability Partnership Firm (LLP) as per the author's view. 

Most importantly Indian investee has to decide few things before offering for /accepting the investment:

1. Whether the relation with investor is long term or short term?
2. Is investment is required for a specific project to take up or it is for the overall objective of the company?
3. Whether Indian Startups willing to give control?
4. What are the profit-sharing clauses and how repatriation is done?

Needless to say, the investment should be a win-win for both the parties, while emphasizing the wining negotiation we have to take into account for some of the compliance and regulatory matters. For accepting any foreign investment, regulatory framework is given under FEMA. Generally depending upon the size and format of investment compliances are decided.

It is always wise that an investee company in India chalk out his needs such as the investment size , profit sharing clauses, his willingness and stand on control over the business,  terms of relationship with the investor, etc.,, and then consult a professional for drafting agreement and suitable route to bring the  capital which is compliant in all respect.    

The author can also be reached at dhruvakalamanji@gmail.com