6.0 MOBILISATION OF GLOBAL AND DOMESTIC RESOURCE

6.1 Foreign Venture Capital Investors(FVCIs)

6.1.1 At present, offshore investors make investment in VCU either by investing in domestic venture capital funds by seeking one time approval from FIPB through FDI route directly. However, this requires FIPB approval for every single investment. Further, for every investment and disinvestment, RBI approvals are required in respect of pricing of securities. The Government of India guidelines provide for one time FIPB approval in the case of venture capital fund with 100% investment by offshore investors, but in practice, requirement of taking approval for pricing of securities from RBI remains for every investment and disinvestment. Foreign investors find the requirements of taking FIPB/RBI approvals very cumbersome and time consuming.

6.1.2 Most of the offshore investors are incorporated in tax havens particularly Mauritius to have the benefit of double tax treaty and they do not have an incidence of tax in India. These investors feel that if making investment in India is made hassle free and automatic in a transparent manner with proper tax exemptions, there would be no need for them to adopt Mauritius route and avoid several operational problems. FVCIs therefore shall be provided tax exemptions. This provision will put all FVCIs, whether investing through Mauritius route or not, on the same footing.

6.1.3 Realising the importance of venture capital investments for the development of industry and business in India, it is necessary that inflow of such investments are encouraged and facilitated. In case of FIIs there is already a hassle free and automatic route for investment and repatriation without specific FIPB/RBI approval for investments and disinvestments. Once registered with SEBI, FIIs can freely make investments. This has brought positive investment and the net investment are around US$10 billions. It would therefore, be desirable that atleast at par with FIIs. FVCIs are allowed the facility of registration with SEBI and once registered they should have the same facility of hassle free investments without any requirement of approvals from FIPB/RBI. This would also provide authentic data and disclosures as regards their commitments and investments in VCU in India. Presently, as per Annexure III of the Industrial Policy 1991, there are already several sectors which are eligible for the investment under automatic approval route varying from 50% to 100% of the paid up capital of the companies. In case of NRIs and OCBs this limit is 100%. Keeping this in view and venture capital being a thrust area for attracting risk finance for development of business and industry, 100% inflow of funds of the foreign venture capital investors should be allowed through automatic approval route without requiring either FIPB/RBI approval once registered with SEBI. Appropriate regulatory requirements in respect of FVCIs could be incorporated under SEBI venture capital funds regulations. Alternatively, FVCIs should be allowed to invest within overall ceiling of 50% of the paid up capital of the investee company under automatic route. However, the ceiling of 50% would get substituted by higher ceilings of 51%, 74% and 100% in respect of the sectors as provided in annexure III of the Statement of Industrial Policy and would get decreased accordingly wherever Government of India has prescribed lower ceiling as in the case of insurance, banking sector etc. This proposal is consistent with the existing policy of Government of India as regards automatic approvals.

6.1.4 The hassle free entry of such FVCIs on the pattern of FIIs is even more necessary because of the following factors :

1. Venture capital is a high risk area. In out of 10 projects, 8 either fails or yield negligible returns. It is therefore in the interest of the country that FVCIs bear such a risk.
2. For venture capital activity, high capitalisation of venture capital companies is essential to withstand the losses in 80% of the projects. In India, we do not have such strong companies.
3. The FVCIs are also more experienced in providing the needed managerial expertise and other supports.

6.1.5 Further, the FVCI bringing in foreign currency should be permitted to retain the same in foreign exchange either with the Bank in India or outside till it is actually invested. Further, as permitted in the case of FIIs they may be permitted to take forward cover to protect against the currency, price fluctuation risk.

6.1.6 Recommendations

In view of the above background, following recommendations are proposed :

1. SEBI regulations should be amended to include provisions for registration and regulation of Foreign Venture Capital Investor(FVCI) on the pattern of FIIs and once registered, should be extended .the same facility of hassle free investment and disinvestment without any approval from FIPB/RBI.
2. Foreign VC Investor (FVCI), registered with SEBI would be eligible to make venture capital investments under automatic route without any ceiling and any requirement of FIPB or RBI approval or alternatively, in the overall ceiling of 50% in any sector under automatic route without FIPB/RBI approval provided the overall ceiling would automatically get substituted by higher ceiling of 51%,74% and 100% as prescribed under Annexure III of Statement of Industrial Policy or will get reduced in accordance with the ceilings for investment prescribed by Government of India in certain specified sectors like banking, insurance etc.
3. The FVCI should be permitted to park their foreign remittances in foreign exchange in a bank in India or outside till actually invested in VCUs and they should also be permitted to obtain forward cover as permitted to FIIs.
4. The Government may consider providing a tax exemption to registered FVCI to attract large pool of risk capital directly into India.

6.2 Augmenting the Domestic pool of Resources

6.2.1 The present pool of domestic venture capital and commitments made by FVCIs is around US$ 1.3 billion. This pool has been predominantly contributed by foreign funds to the extent of 80%. The domestic pool of venture capital is very limited. The acute need for venture capital in India is for small and medium industries which could preferably be financed by domestic venture capital funds, as the foreign funds, seek to invest in relatively larger enterprises and the return expectations are also high. The main sources of contribution for domestic venture capital funds are from financial institutions, banks, high networth individuals, etc. The venture capital activity needs to be deep rooted to promote a small and medium scale industries promoted by professionally qualified entrepreneurs in hi-tech, research oriented sectors. It is therefore necessary to augment the pool of resources for domestic venture capital funds.

6.2.2 The investment horizon of a venture capital fund is for a longer duration ranging from five to ten years and the funds are contributed mainly by the institutional investors and high networth individuals. Typically, the institutional investors include Banks, financial institutions, Insurance Companies, Pension Funds, Private Trusts, Endowments and angel investors which in case of India are yet not active into venture capital industry. The expected role of banks, mutual funds and insurance companies in promotion of venture capital activity in India is discussed hereunder :

6.2.3 Banks: RBI had recently allowed banks to invest in Venture Capital funds with a provision that this investment could be treated as priority sector lending. In order to encourage the banks to provide venture capital to start up industries, the RBI should treat venture financing by banks under the priority sectors lending to small scale industries. The investments made by Banks in venture Capital Funds/Undertakings directly or through subsidiaries, should not be counted for the purpose of 5% exposure to the capital market. Further, Banks should be encouraged to extend line of credit to Venture Capital Funds.

6.2.4 Mutual Funds: The Mutual Fund industry is fast becoming a channel for routing private savings into capital market. Given that an appropriate regulatory framework for Mutual Funds is in place, it would be desirable that the mutual funds are permitted to invest upto 10% of their corpus in SEBI registered Venture Funds. Within this ceiling, individual Mutual Funds may have their own prudential limits. This would also give the opportunity to retail investors to participate in high growth enterprises through the institutional mechanism of mutual funds. Further, Mutual Funds can set up a dedicated fund for investment in VCF / VCU.

6.2.5 Insurance Companies: Insurance companies typically accumulate large pools of capital which is available for investment on a long-term horizon. If such funds are deployed in venture capital industry, these may not only generate good return to the insurance company, at the same time, would provide significant resources to the venture capital industry. Insurance companies may be permitted to invest in SEBI registered Venture capital Funds within certain ceilings.

6.2.6 It is seen in many developed and developing countries that the entry of institutional players not only boosted resource mobilisation for venture capital activity but also over a period of time, these institutional investors become expert assessors of the investment activities of Funds and provides appropriate business guidance, as happened in USA. Thus, these investors not only provide large resources for venture capital activity, but also help in developing appropriate system for monitoring the investment by VCF.

6.2.7 RECOMMENDATION

(a) In the light of the above it is recommended that the mutual fund, banks and insurance companies should be permitted to invest in SEBI registered venture capital funds.