India: Legislative Updates Proposed Reforms to Access to Capital Markets for Knowledge-based Technology Companies

Francisco A. Laguna 

This week, TransLegal continues our series on recent legislative changes in India, focusing on a proposal by the Securities & Exchange Board of India (“SEBI”) that could ultimately affect an Indian company’s ability to raise capital and provide possible exit strategies for early stage investors.

 

Numerous Indian start-ups have innovative business models that seek to create or expand business opportunities or increase efficiency for existing business activities, including software development and e-commerce companies. These companies tend to be run by professional management, have low asset bases, long gestation period and limited founding member equity participation.

 

SEBI refers to these companies as “Knowledge-based Technology Companies”. SEBI understands that the laws currently applicable to these start-ups, including those governing small and medium enterprises (“SME”) do not allow them to raise capital effectively. To address this issue, SEBI proposes to amend the listing rules to enable these Knowledge-based Technology Companies to raise capital from India’s public markets.

 

SEBI Proposal

 

Parliament of India Photo Credit: Wikimedia Commons

Parliament of India
Photo Credit: Wikimedia Commons

The SEBI proposal would introduce the following changes.

 

Knowledge-based Technology Companies would be permitted to raise capital on the Institutional Trading Platform (“ITP”) through initial public offerings, provided that no person or persons acting in concert hold over 25% of the share capital.

 

Investors would be limited to qualified institutional buyers (“QIBs”) and non-institutional investors (“NIIs”). Retail investors will not be permitted to purchase shares of Knowledge-based Technology Companies at the IPO stage. The definition of a QIB would be expanded to include NBFCs and family offices / trusts, provided they are registered as alternate investment funds ( AIFs), as well as any entity registered with the SEBI with a net worth of more than INR 500 Crores.

 

75 % of the IPO must be reserved for QIBs. Allotments would be on a discretionary basis, provided no QIB is allotted more than 5 % of the issue. Allotments for NIIs would be proportional and spill-over from the NII portion would be allowed.

 

Investment in this segment would be treated as unlisted for Category I and II AIFs to allow them to satisfy their investment limits in unlisted securities.

 

The minimum application size will be INR 10 lakhs and the offer must be subscribed by no less than 500 allottees.

The issuer would need to remain listed on this restricted segment of the exchange for at least 1 year after the IPO, at which point it can apply for listing on the national exchanges, provided they satisfy applicable listing criteria.

National Stock Exchange of India  Photo Credit: Wikimedia Commons

National Stock Exchange of India
Photo Credit: Wikimedia Commons

The entire pre-issue capital must be locked-in for 6 months, with no separate lock-ins for promoters.

The issuer will be required to file a draft IPO document with SEBI for comments. However, rules for Knowledge-based Technology Companies would be slightly more flexible, as described below.

The main purpose of the IPO can include general corporate purposes and the disclosures may be restricted to broad objectives.

IPO disclosures related to the determination of the issue price falls within the discretion of issuers; however, the offering may not include income or other financial projections.

The issuer has discretion to include disclosures related to group companies, litigations (other than criminal cases, regulatory and tax matters) and creditors (though complete details to be made available on the website) based on whether such disclosures are material for purposes of determining whether to invest in the company.

Eligible Companies

Given the range of business activities available to start-up Knowledge-based Technology Companies, the SEBI should promote a broad definition for eligible companies to allow as many entities to participate in this approach to raising capital.

Promoter Requirements

Presidential Standard of India  Photo Credit: Wikimedia Commons

Presidential Standard of India
Photo Credit: Wikimedia Commons

As indicated above, the founders of Knowledge-based Technology Companies typically end up as minority shareholders. Consequently, they need promoters. The SEBI recognizes this reality, and its proposal provides more flexible rules for post-issue lock-in requirements than those generally applicable to listed companies., The SEBI Proposal is silent on the criteria for determining promoters or whether the issuer will be permitted to list without a named promoter.

Although founders are often minority shareholders, most Indian start-ups have more than 1 founder. These founders tend to be unrelated parties, except for their joint operational control which results from the fact that each is a shareholder. If these founders are deemed to be”persons acting in concert”, their combined holdings would likely exceed 25%, which would disqualify the company from this participating in this avenue to raise capital. SEBI has yet to issue any proposed guidance on this issue.

SEBI’s final qualification criteria and related definitions will determine the program’s success. If this issue is not appropriately addressed, the program will have limited practical effects.

Minimum Subscribers

Considering that retail investors will not be permitted to invest in the IPOs of the Knowledge-based Technology Companies, it is unclear why SEBI has imposed a minimum 500 subscriber requirement. Since most QIBs are often unwilling to assume limited positions, most issuers may not be able to meet this threshold for practical reasons.

Importance for Private Equity

SEBI’s proposal would result in a change in access to India’s public capital markets, which is likely to have long-term effects on the country’s venture capital and private equity industry. SEBI’s proposed reforms would allow Knowledge-based Technology Companies and other Indian start-ups much necessary access to institutional and other qualified investors.

Call TransLegal with your questions concerning Indian laws and regulations and how they may impact your proposed FDI projects.

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India: Legislative Updates

Francisco A. Laguna

 This week, TransLegal begins a series on recent legislative changes in India. In the following posts, we will analyze some of the more significant ones for foreign investors.

 Capital Markets

 The Securities Exchange Board of India (“SEBI”) has revised insider trading regulations. The new rules, contained in the Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations, 2015, enter into force 16 May 2015. One major change introduced by the new rules is that people not in the brokerage sector cannot obtain from an insider, directly or indirectly, any unpublished, price-sensitive information related to a company listed, or proposed to be listed, on an exchange. Insiders are defined as people who have been associated for the prior 6 months with a company that is listed, or proposed to be listed, on an exchange, and who are is in possession of the company’s unpublished, price-sensitive information.

Citizenship Law

The Parliament issued the Citizenship (Amendment) Bill, 2015, which purports to grant the same rights and privileges to persons of Indian Origin as well as Indian citizens living abroad.

Coal Mines Bill

Parliament of India Photo credit: Wikimedia Commons

Parliament of India
Photo credit: Wikimedia Commons

The Lower House of Parliament, the Lok Sabha, approved the Coal Mines (Special Provisions) Bill, 2015. The law seeks to make the process of granting coal mine leases more transparent. The Upper House, the Rajya Sabha, has yet to pass the law. The leasing process has been criticized for lack of transparency and corruption.

Foreign Direct Investment – Generally

The Department of Industrial Policy and Promotion (“DIPP”) is proposing to raise the FDI threshold from 12,000 million rupees to 30,000 million rupees. The Government may increase the threshold at which Cabinet approval for foreign investments becomes necessary, making India a more attractive venue for FDI. The goal is to attract foreign investments, particularly in infrastructure and manufacturing sectors. Currently, investments exceeding the 12,000 million limit require the approval of the Cabinet Committee on Economic Affairs.

TransLegal has advised clients on foreign direct investment regulations in the food & beverage as well as the hospitality sectors.

Foreign Direct Investment – Housing Sector

The Government has relaxed the rules related to repatriating FDI in the housing sector. In December 2014, the Government implemented these new rules by decreasing the required built-up area and capital needs. In March 2015, the DIPP clarified that the existing three-year lock-in will no longer apply, and under normal circumstances, an investor can exit on an automatic basis upon completion of the project or after the construction of basic infrastructure, such as roads, water supply and drainage. The Foreign Investment Promotion Board (“FIPB”) can approve earlier exits on a case by case basis.

The minimum built-up area requirement for development projects has been reduced from 50,000 square meters to 20,000 square meters, and minimum capital investment by foreign companies has been decreased substantially from US$ 10 million to US$ 5 million. In addition, the government has introduced an exemption to the minimum floor area and the capital requirements when an investor / joint venture company commits at least 30 % of the total project cost to low-cost housing.

 Foreign Direct Investment – Insurance and Pension Sectors

 In March 2015, the Indian Parliament passed the Insurance Laws (Amendment) Bill, 2015. The bill raises the foreign direct investment (“FDI”) cap in insurance companies from 26% to 49%. This increased FDI cap directly increases the allowable FDI in the pension sector: the Pension Fund Regulatory and Development Authority Act ties FDI limits in the pension sector to those in the insurance sector. This increase presents important opportunities for foreign companies in both sectors.

National Stock Exchange of India Photo credit: Wikimedia Commons

National Stock Exchange of India
Photo credit: Wikimedia Commons

Import / Export Documentary Requirements 

In March 2015, the Directorate General of Foreign Trade (“DGFT”) issued a notification drastically reduced the mandatory documents required for importing and exporting goods to three (3) documents. For imports, the mandatory documents are: bill of lading / airway bill; commercial invoice / packing list; and bill of entry. For exports, the mandatory documents are: bill of lading / airway bill; commercial invoice / packing list; and shipping bill / bill of export.

Intellectual Property

India’s IP Office now allows electronic filing for new applications for design & geographical indications. Previously, e-filing was only available for trademarks and patent applications.

Labor Law

 The 2015 Union Budget proposes the following amendments to applicable labor laws. First, the government seeks to provide increased flexibility for employee contributions to the Employee Provident Fund (“EPF”). Employees would be allowed to choose to participate in the EPF or a New Pension Scheme (to be developed). The proposal also provides that employees with incomes below certain monthly thresholds would have the option not to contribute to the EPF, without affecting or reducing the employer’s mandated contribution. In addition, the amendments would allow employers to offer employees participation in the Employee State Insurance (“ESI”) or a different health insurance product duly approved by the Insurance Regulatory Development Authority (“IRDA”).

Money Laundering

Presidential Standard of India Photo credit: Wikimedia Commons

Presidential Standard of India
Photo credit: Wikimedia Commons

Amendments to existing laws have been proposed to prevent money laundering. Two independent laws have been submitted to address unaccounted-for monies held offshore and dubious domestic transactions. Persons found to violate the law will be subject to prosecution and steep penalties. To implement these measures, amendments have been proposed to the Prevention of Money Laundering Act (“PMLA”), 2002 and the Foreign Exchange Management Act (“FEMA”). Under the proposed amendments, concealment of income and assets and evasion of tax related to foreign assets will be subject to prison sentences of up to 10 years. Each transaction in violation of the law will be treated separately, and offenders will not be allowed to reach an out-of-court resolution through the Settlement Commission. Those found guilty of tax evasion will be subject to penalties of 300% the tax that would have been paid on the concealed income and assets.

Call TransLegal with your questions concerning Indian laws and regulations and how they may impact your proposed FDI projects.