VCF Regulation in India by SEBI

Every now and then the much avoided debate on regulation of venture capital funds (“VCFs”) rears its head in Regulatory and Government circles. Though it is much avoided it has to be crushed now and then with some application of mind. The foremost issue is of course, whether a compulsory regulation of all VCFs required?. The second and a little more serious debate is the issue of many domestic funds are using the definition of “associates” as a loophole to make cross investments in their group companies. Does this require to be regulated at all? Also, we find that every time the market takes a dip or there is out flight of FII money there is a cry in parliament for all VCF investment data. SEBI is perpetually under pressure to report how much money has been invested into India by VCFs, which is a rather redundant exercise of reporting numbers for the nation’s capital markets Regulator.


Since Section 12(1B) of the Securities and exchange Board of India Act, 1992 (“SEBI Act”) inter alia provides that, “no person shall sponsor or cause to be sponsored or carry on or cause to be carried on any venture capital funds…..unless he obtains a certificate of registration from the Board in accordance with the regulations”, the question is; Is SEBI required to regulate all VCFs who although are not doing any fund activity inside India but are structuring their inward investments in the form of private equity (in compliance with the FDI guidelines)?

Defining ‘Fund Activity’ and Exclusion of ‘Private Equity’ from ‘fund activity’:

a. The distinction between ‘venture capital’ activity and ‘venture capital fund’ activity needs to be clearly made in the VCF Regulations. Presently the SEBI Act requirements are mandatory and require registration of all VCFs, however, only fund registration is required, and there is no requirement of registration of a venture capitalist (either domestic or foreign) if that venture capitalist is not doing any fund activity.

b. The essential element of a fund activity would be pooling in of contributions from investors and further investing these amounts into Venture Capital Undertakings (“VCUs”). As most foreign funds structure their investments as private equity (i.e. collect money from select investors outside India and invest in Indian companies upon conducting adequate due diligence and are in compliance with FDI guidelines) there cannot be said to be any fund activity within India as these foreign funds adopt a single entry route.


c. As mentioned above, the SEBI Act mandates that VCF activity be regulated by SEBI. However, the VCF Regulations do not define what is VCF activity, and hence two possible interpretations may be given to the applicability of VCF Regulations:

 First Interpretation: is that any VCF, irrespective of the nature of activity that is being carried on within India is required to be regulated in terms of section 12 (1B) of the SEBI Act. This interpretation will be of a very wide import which will hinder the present (reasonably vibrant) private equity market.

 Second Interpretation: is that registration under the VCF Regulations is optional as only those VCFs are required to be registered who seek tax benefits and the benefit of being a Qualified Institutional Buyer under the Disclosure and Investor Protection Guidelines, 2000 (now redundant as they are redrafted as SEBI ICDR Regulations 2009). This interpretation will also lead to concerns, as in making registration optional, all those VCFs who are not doing merely private equity business, but also fund activities will opt not to get registered. This will, simply put, lead to unregulated fund activity which is not allowed by the SEBI Act. None of the investment restrictions as provided in the VCF Regulations will apply and neither will the negative list (although if foreign inflows are being used for investment the FDI guidelines will still have to be complied with).

d. Thus, in line with the requirement of section 12(1B) of the SEBI Act which requires SEBI to register VCFs and also in line with the needs of the private equity investments which do not require SEBI’s supervision, the current VCF Regulations must define a VCF to be a fund that carries on venture capital ‘fund’ activity within India. And ‘fund activity’ should be defined to mean raising of capital for investments in Unlisted Indian Companies (VCUs) except investments in the nature of private equity. Private Equity investments can further be defined as investment activity which is in compliance with FDI guidelines and for which there is a single entry point within India and should exclude (for clarity) foreign funds raising money from Indian investors and Indian funds raising money from foreign investors (as these two exceptions to the exception need to be within the ambit of the VCF regulations). Any other fund activity (other than private equity) should be compulsorily registered and regulated by SEBI under the VCF Regulations. As a consequence of such limited compulsory registration of funds, all investment restrictions as well as the benefits currently available will apply.

Cross Investments in Associates

Presently cross investments in associates is prohibited and an associate company under the present VCF regulations is narrowly defined to mean a company which is a director or trustee or sponsor or settler of the venture capital fund or asset management company holds either individually or collectively, equity shares in excess of 15 percent of the paid up equity share capital or venture capital undertaking.

Although currently, domestic, unregistered funds are being set up which invite moneys from entities/ persons and make cross investments into group companies/ ventures which are technically not ‘associates’ and help channel money into venture capital undertakings This route is being used to bypass other legitimate means of raising capital, such as, vide the company law route of preferential allotment or and IPO or an FPO for which a SEBI approved prospectus is required and certain minimal checks are provided to the investors. In these kinds of investments (through a offer document) the investors at least have ownership of share capital of the underlying company. Allowing these funds, which make intra associate investments without being under the regulator’s purview, to raise capital from the public should be discouraged and it is submitted that the definition of ‘associate company’ be made tighter by introducing the concept of indirect as well as direct shareholding of at least 15%. By allowing the unregistered and unregulated ‘fund route’ to raise capital, the regulated channel of raising moneys from the public through an offer document is being subverted by many domestic funds.

If the alternative is to take a more lenient view in the case of intra group investment, then a much higher threshold limit for individual contributions into the fund should be provided to protect small domestic investors.

Regarding the frequent debate on data gathering, since currency inflow data is required, suitable tie ups with RBI may be explored as presently all foreign inflows are reported vide form FC – GPR at two stages, namely at the time of inward remittance and at the time of issue of shares.

Although by amendment to the VCF Regulations a reporting requirement can easily be mandated for all registered funds, it will just duplicate paper. In any case event if a reporting requirement is mandated for private equity investments, the only way to confirm the veracity of these figures will be from RBI again. Hence, instead of making VCFs report the figures and then verify with RBI it will be easier to forge a tie up mechanism with RBI and obtain the investment figures of FVCIs, VCFs and other Private Equity.


In the final analysis, yes, there is a need to regulate VCF Activity and impose the enumerated investment conditions and restrictions as well as the negative list. In the event the investment conditions and restrictions which predominantly mandate investments in security instruments of a VCU are done away with, it will enable funds to directly invest in assets like land and manufacturing units ( as per the FDI guidelines) and manage these assets, and this will put the investors money at risk as the objective of a fund is to invest in VCUs, which have better expertise and ability to invest in assets and generate income.