Revisiting the Foreign Venture Capital Regime

In a previous post on this blog about four months ago, we had extolled the virtues of an economy possessing a favourable venture capital regime. We had also highlighted some of the progressive developments in the Indian venture capital market that were induced by favourable regulations issued by SEBI and RBI.

However, the perception of regulators in respect of venture capital firms (especially the foreign venture capital investors) has taken a drastic turn lately, and the picture is beginning to look somewhat gloomy. Over a week ago, we wrote about the possibility that the foreign venture capital route is likely to be restricted to a few sectors only, following pressure from the RBI. The fear on RBI’s part is likely to have been triggered due to the fact that foreign direct investments (FDI) is coming into certain sectors as foreign venture capital investment (FVCI) thereby not only taking advantage of the more benevolent FVCI regime but also overcoming some of the obstacles posed by the FDI regime. The bone of contention here is the real estate sector, where FDI is subject to greater regulation than in other sectors.

A recent column by Richie Sancheti and Vikram Shroff in the Economic Times notes:

“… RBI has been uncomfortable with FVCIs having low-capital base, circumventing takeover guidelines and round-tripping of investments, and has therefore also suggested that SEBI set up screening mechanism for all FVCI applications. In the interim, most of the applications have been kept on hold without any clarity on the time frame.

The intention behind introducing the FVCI regime in 2000 was to provide FVCIs a favourable environment with respect to their investments in India compared with foreign direct investment (FDI) and create a level-playing field between domestic and overseas venture funds.

FVCIs are accordingly entitled to certain benefits, including exemption from entry and exit pricing norms, exemption from any lock-up restriction, post-IPO (subject to certain conditions), and exemption from applicability of the takeover code in the event of sale of shares back to Indian promoters (and not generally). RBI seems to have developed some concerns on the nature of the applications received and investments under the FVCI regulations. …”

The column then goes on to discuss each of these concerns separately, and seeks to allay the fears of the regulator.

Ajay Shah deals with this issue from a broader perspective of financial market regulation and “rule of law”. He says:

“I am worried that there is a problem of rule of law here. What appears to be going on is that applications are not being cleared even though they are compatible with the existing policy framework. If the policy framework is a problem, it should be changed. But at all times, the letter of the law must define how government agencies operate. Similar problems seem to have arisen earlier with RBI’s treatment of external commercial borrowing (ECB) also.

Running any system of capital controls, in the modern world, is messy. There will inevitably be a arms race where the bureaucrats will come up with new controls and the private sector will use technological and financial sophistication to evade these controls. Good countries wake up and understand that this spy vs. spy contest is pointless, and shift over to full convertibility. While we are in the process of getting there, the least we should aspire to is to not do violence to the idea of rule of law.”

I couldn’t agree more. Even when capital controls operate in India as they do now, certainty of the law and clarity (to the extent possible) in its interpretation serve important roles in furthering economic development. The regulatory effort ought to be to preserve certainty and clarity, and to avoid ambivalence and nebulousness in policy for foreign investment.

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.


  • This is with reference to article titled “Foreign VCs may get less headroom” published in The Economic Times at page 1, on August 5, 2008.

    it has been stated that foreign investment in the form of venture capital is accorded special concessions not available to normal foreign direct investment, for instance, “exemption from sectoral FDI caps for investment in domestic venture capital funds”.

    Please note that in the Master Circular on Foreign Investment in India, circular no. 02/2008-08 dated July 1, 2008 (“Circular”) issued by the Reserve Bank of India, at page 51, it is clearly stated that “Offshore Venture Capital Funds/companies are allowed to invest in domestic venture capital undertaking as well as other companies through the automatic route, subject only to SEBI regulations and sector specific caps on FDI”.

    I request you kindly clarify the statement made in this article and also your post and let me know the relevant circular/guideline/notification in respect of the same.

  • Thanks for that comment and observation. I would agree based on the Master Circular you referred to that merely because a foreign investor invests through the venture capital route, it would not be in a position to overcome the sectoral caps on foreign investments. Unfortunately, I am unable to access online the Economic Times article of August 5, 2008 that you have referred to, but based on the portion that you have quoted in your comment, that goes against the above position reflected in the Master Circular.

    In my post, I was principally referring to the special treatment available in terms of relaxations on entry and exit pricing norms, lock-in restrictions and mandatory open offer under the takeover code, and not with respect to avoiding the sectoral caps on foreign investment.

  • can anyone please elaborate of the following issue:

    Foreign investors prefer which route for bringing in investments- FII (foreign institutional )route or the FVCI(foreign venture
    capital investors)?

    Further if someone can explain whicxh route is more tax efficient for the foreign investors?

  • The answer to this question depends upon a number of factors. But, primarily the FII route is used by foreign investors for portfolio investments such as buying and selling shares on the stock exchange, although FIIs can also invest in unlisted companies. There are limitations on the maximum amount of shares that an FII can buy in a company, which is 10%. However, the FVCI route is used for investments mainly in unlisted companies, as FVCIs are required to invest at least 66.66% of their corpus in unlisted securities and the balance in IPOs, etc. FVCI route is therefore not suitable for portfolio investment in listed companies. Likewise, there are differences in the tax treatment for FIIs and FVCIs and the optimality of taxation in either structure would also be determined on the basis of the double taxation avoidance treaty between India and the country through which the investor proposes to invest.

    Some details about FVCI regulations are contained in this article on ABA Net (, while some discussion about taxation is contained in this column in Mondaq (

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