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            In its sixth bi-monthly monetary policy statement, the central bank has eased stake sale rules, making exits easier

            Start-up companies, which are struggling to get overseas funds or are looking at new forms of funds, might soon get not only foreign funds but could also issue convertible notes to attract foreign direct investment. Start-up community members, companies and investors, said this would enable impending transactions to conclude as well as enable foreign venture capital (VC) funds - on the edge of entering India - to make formal entry announcements soon.

            The Reserve Bank of India (RBI) in its sixth bi-monthly monetary policy statement had proposed steps towards ease of doing business for start-ups by easier access to foreign capital and also through smoother transfer of ownership.

            For easing cross-border transaction, RBI has proposed (in consultation with the government of India) that in the case of transfer of ownership of a start-up, permitting receipt of the consideration amount on a deferred basis could be done. It also proposes to enable escrow arrangement or indemnity arrangement up to a period of 18 months.

            Harish H V, partner, Grant Thornton India, said these would remove procedural hassles and enable India to have the same environment for the investor community as prevalent in other parts of the world. "We look forward to further relaxations around convertible notes as promised," he added.

            The proposals also include permitting start-up enterprises to access rupee loans under the external commercial borrowing (ECB) framework with relaxations in respect of eligible lenders. It is also looking at issuance of innovative foreign direct investment (FDI) instruments like convertible notes by start-up enterprises. Further, it is looking into the proposal of issue of shares without cash payment through sweat equity or against any legitimate payment owed by the company, remittance of which does not require any permission under the Foreign Exchange Management Act (FEMA).

            Amarjeet Singh, partner - Tax, KPMG in India, said, "The amendment makes investment process more structured. The proposal means that an escrow arrangement would be there for 18 months as against six months. Deferred payments for transfer of ownership of start-up will also be allowed. These relaxations will allow investor to close deals at right price."

            Bharat Banka, founder and ex-CEO of Aditya Birla Private Equity, said the proposal if implemented, will allow more secondary market transactions in the start-up space. He added that under the ECB, having optionally convertible instruments will provide access to more funds.

            Start-up community and venture capitalists have welcomed RBI suggestions. Apart from the fact that it could make up for the trend of slacking funding, it also gives VCs an option to buy out underperforming assets.

            "There is this concept of turnaround funds in the US," said Yogendra Vasupal, founder and CEO, Stayzilla. "They can make an entry into Indian markets." The mandate for these funds is simple. They identify companies, which have reached their growth potential and are struggling to monetise the market due to legacy costs, buy out the founder and change the management team. "Sometimes, founders have emotional attachment to the verticals they may have gotten into, which don't work in the longer term. The funds come with the new ideas and change the way the company functions and push it back into the black," Vasupal sad.

            In a very subtle way, this is already happening in India, he explained. Vasupal suggested that Housing.com, for example, has had its entire management team changed after SoftBank invested further capital.

            Several of the real estate tech company's founders have left and, sources said most of their stake was absorbed by the Japan-based fund. "There will be more OLX-type deals that will happen if the regulations are finally relaxed," he said.

            Not only does it help turnaround funds, it helps VC firms find companies at lower valuations. The RBI said the aim was to enable start-up enterprises, irrespective of the sector they are engaged in, to receive foreign venture capital investment and also explicitly enabling transfer of shares from foreign venture capital investors to other residents or non-residents.

            "The new suggested guideline means that a VC firm can look at a segment where the company shows promise but it is struggling in the short-term. The 18-month window means the VC funds can regulate the flow of funds based on concrete milestones," said Ben Mathias, India Head, Vertex Ventures. The guidelines, he said, also made exits easier, which has been a stumbling block. "Good exits mean investment opportunities have increased. It will invite bigger funds to invest in the country giving a boost to the ecosystem," Mathias added.

            This article was published in the Business Standard, to read please click here.

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