INVESTMENT MANAGEMENT DEPARTMENT
IMD/NS/ 22479 /04
October 04, 2004
India Value Fund Trustee Company Private Ltd.
12 Technopolis Knowledge park,
Mahakali Caves Road,
Andheri (E)
Mumbai-400 093
Dear Sir,
Sub : Interpretive letter under SEBI (Informal Guidance) Scheme, 2003.
Vide your letters dated 19.03.2004, 21.04.2004, 11.06.204 and 02.07.2004 wherein you have submitted that:
1) IVF is a private trust (under the Indian Trusts Act, 1882), formed vide Trust Deed dated June 2, 2000, which is registered under the Registration Act, 1908 and a venture capital fund (VCF) registered with SEBI.
2) As per the Contribution Agreement with the investors, the original amount committed by investors of the Fund, was Rs. 95.5 Crores, which has now been increased to Rs. 108.06 Crores.
3) The actual receipt of funds from various investors can take some time (generally 1-3 months).Therefore, the draw-downs for a prospective investment are initiated after obtaining approvals from the investment management committee, but before finalization of a deal with the VCU, including conducting due diligence reviews etc. As and when the funds are received from the Investors, they are deposited into short-term deposits with the HDFC Bank, pending the short time lag before getting deployed as investments.
4) IVF had entered into an agreement with QCIL on August 21, 2001 to invest in the equity share capital of QCIL, an unlisted Indian company. IVF had paid a sum of Rs.15 crores to QCIL by way of share application money. Pursuant to a Supplemental Agreement, IVF had a right to acquire shares of QCIL. However, if certain targets were not met by QCIL by September 30, 2003, IVF had the option not to acquire the shares, in which case the unadjusted share application money would be refunded with some return.
5) In accordance with the Supplemental Agreement, IVF decided to withdraw its investment to the extent of Rs. 13.6 crores since QCIL had not met the specified targets. Accordingly, the said sum of Rs. 13.6 crores was refunded to IVF and a return of Rs. 6.99 crores on the said sum of Rs. 13.6 crores was also paid.
6) For the balance Rs. 1.4 crores, equity shares have been issued to IVF.
7) In view of the amounts advanced towards subscription of the equity shares, IVF, through its trustee was also represented on the Board of Directors of QCIL and enjoyed certain other rights and privileges.
On the above factual position, you have asked for an interpretive letter from SEBI with regard to Reg. 12 (d) of SEBI (Venture Capital Funds) Regulations, 1996 (the ‘VCF Regulations’) on the following two issues:
1) Whether the amount received from investors, which are lying temporarily with HDFC Bank as short term deposits pending disbursements, would be akin to cash in hand and should the same be treated as amounts not yet invested and accordingly excluded for the purpose of arriving at the percentage of investment in debt or equity for the purpose of regulation.
2) IVF had placed Rs. 15 crores with Quality Care India Ltd. (QCIL) towards share subscription money, convertible into equity shares as per the terms of the shareholders agreement. What would be the character of investment in QCIL, for the purpose of Regulation 12(d).
Our views on your request for informal guidance are given as follows –
Both the issues arise in the context of reg. 12(d) of the VCF Regulations, which at the relevant point of time, inter alia laid down investment restrictions for VCFs as follows:
(i) At least 75% of the ‘investible funds’ shall be invested in ‘unlisted equity shares or equity linked instruments.’
(ii) Not more than 25% of the investible funds may be invested in IPO of a VCU (subject to 1 year lock in)
or debt or debt instrument of a VCU in which equity has already been made by the VCF.
Issue 1) – Nature of the short term deposits with HDFC Bank
Regulation 2(hh) defines ‘investible funds’ as “corpus of fund net of expenditure for administration and management of the fund”. We take the view that funds received from investors and parked in short term deposits pending deployment shall be excluded from this definition.
Issue 2) – Nature of investment as ‘share application money’ with QCIL
The object of specifying a minimum limit of equity investment in reg. 12(d) was to ensure that the VCF assumes the risk associated with equity in respect of a startup business to the extent mentioned in that regulation. Certain facilities which are not available to normal investment activities, including income tax exemptions, are provided to VCFs conditional upon fulfillment of this requirement. This requirement goes to the root of the definition of VCFs itself.
In the present case, IVF had retained its investment in QCIL in the form of ‘share application money’ for a long period of time and made the allotment of shares conditional upon QCIL meeting certain specified targets by 30.9.2003. It had thereby insulated itself from the risk that is usually associated with equity investment, thereby defeating the purpose of reg.12(d).
The correct accounting treatment in respect of share application money is analysed as below:
· Section 211 of the Companies Act, 1956 provides that the balance-sheet of a company shall give a true and fair view of the state of affairs of the company and shall be in the form (either horizontal or vertical) as set out in Part I of Schedule VI.
· The broad heads under “Liabilities” therein are (i) Share Capital, (ii) Reserves and Surplus, (iii) Secured Loans, (iv) Unsecured Loans and (v) Current Liabilities and Provisions. The item of ‘share application money’ does not appear in the sub-heads under any of these heads.
· Any subscription received by a company against issue of share capital can be regarded as “subscribed share capital” only when the share capital is actually subscribed and allotted as well. Until the allotment is made, any subscription cannot be included in the amount of subscribed share capital. [ICAI Compendium of Opinions, Vol. XII, pp. 121 to 123]. Share application money, therefore, cannot be treated as ‘Share Capital”.
· Share application money only in respect of invalid or revoked applications and excess application money received due to over-subscription, however, may be treated as “Current Liabilities”. The instant case does not satisfy any of the above, hence cannot be treated as “Current Liabilities” Share
application money, therefore, can neither be categorized as “Share Capital’ nor “Current Liabilities”.
· The ICAI Compendium of Opinions, [Vol. XV, (1996 Edn.) pp. 34 to 36], opines that the “share application money pending allotment” should be shown in the balance-sheet under a separate heading between “Share Capital” and “Reserves and Surplus”.
· Share application money is also not an instrument, much less an Equity linked instrument.
In view of the object and purpose of regulation 12(d) and the correct accounting treatment as well as the opinion of ICAI in respect of share application money, it is opined that such money advanced by IVF to QCIL cannot be treated as investment in equity shares. It may be noted that in interpretation of such regulatory provisions, the substance rather than the form of transactions is relevant.
In view of the above, without going into the question of legality of the transaction, it is opined that the share application money advanced by IVF to QCIL does not have the character of equity investment for the purpose of regulation 12(d).
This letter is based on the representation made to the Division of Funds in your letters. Different facts or conditions might require a different result. This letter expresses the Division’s position on enforcement action only. It does not express decision of the Board on the Questions presented.
Yours faithfully
N. Sunil