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INDIA PRIVATE EQUITY AND VENTURE CAPITAL LANDSCAPE 2016-17 ACCESSIBLE I RESPONSIVE I ADAPTABLE

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  • INDIA PRIVATE EQUITY AND VENTURE CAPITAL

    LANDSCAPE 2016-17

    ACCESSIBLE I RESPONSIVE I ADAPTABLE

  • INDIA PRIVATE EQUITY AND VENTURE CAPITAL LANDSCAPE 2016-17

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    NOTE FROM RAJESH BEGUR 05

    PE & VC 2016: THE YEAR IN FOCUS

    INVESTMENT TRENDS: SECTORAL AND QUANTITATIVE ANALYSIS 07

    REPRESENTATIVE DEALS OF 2016 16

    DEVELOPMENTS IN THE REGULATORY LANDSCAPE 19

    PE & VC SECTOR : KEY ISSUES, IN PERSPECTIVE

    I. FUNDRAISING FOR STARTUPS: IS YOUR HOUSE IN ORDER? 34

    II. LISTING VENUE FOR STARTUPS: ISSUES AND WAY FORWARD 36

    III. FIVE EXIT CHALLENGES FOR VC AND PE INVESTORS 38

    IV. KEY ASPECTS OF INTELLECTUAL PROPERTY RIGHTS FOR STARTUP'S 40

    V. EMPLOYEE STOCK OPTIONS IN STARTUPS: ALL YOU NEED TO KNOW 42

    VI. OPTION CONTRACTS: ENFORCEABILITY ISSUES 44

    VII. NON-CONVERTIBLE DEBENTURES: ISSUES IN PRIVATE PLACEMENT 46

    VIII. REAL ESTATE INVESTMENT TRUSTS (REITS) REGULATORY & TAXATION ASPECTS 48

    IX. BRIEF OVERVIEW OF AIF REGULATIONS 52

    X. IS DUMPING OF FOREIGN CAPITAL TO OFFER DISCOUNTS “ANTI COMPETITIVE”? 54

    XI. PHARMACY - LEGAL SANCTITY? 57

    INVESTOR SPEAK 61

    SECTOR VIEWS & WISH-LIST FOR 2017 67

    PE & VC SECTOR VIEW - 2017 68

    POLICY & REGULATORY WISHLIST FOR 2017 72

    TABLE OF CONTENTS

  • RAJESH N. BEGUR

    FOUNDER & MANAGING PARTNERARA LAW

    INDIA PRIVATE EQUITY AND VENTURE CAPITAL LANDSCAPE 2016-17

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    “2016 HAS BEEN AN EVENTFUL YEAR WITH ANUNPRECEDENTED NUMBER OF EVENTS FROM BREXIT TOTRUMP’S VICTORY TO INDIA’S DEMONETIZATION. THESE

    EVENTSHAVE CONTRIBUTED TO MARKET VOLATILITY AND ITS IMPACTHAS BEEN SEEN ACROSS ALL ASSET CLASSES,

    MAKING THEINVESTING ENVIRONMENT MORE CHALLENGING. GIVEN THECHALLENGES AND RISKS THAT

    EMERGE FROM 2016 ANDMOVE INTO 2017 THERE CAN BE NO BETTER TIME TOCAPITALIZE ON THE VALUE BASED INVESTMENT WHICH ISWHAT PE & VC IS ALL ABOUT!”

  • 2016

    Private equity deal volume and valueduring Q3 CY2016 declined 45%and 63% respectively, compared toQ3 FY2015, which is evident fromthe statistics provided under thesection on Investments by PE & VCin 2016. The sharp decline ininvestments can be attributed to thedeclining interest of investors inonline and e-commerce businessmodels, unstable valuations, lessthan expected improvement in easeof doing business and a challengingenvironment for exits due to lowervaluations.

    RAJESH N. BEGUR

    FOUNDER & MANAGING PARTNERARA LAW

    INDIA PRIVATE EQUITY AND VENTURE CAPITAL LANDSCAPE 2016-17

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    has been an eventful year with an unprecedented number ofevents from Brexit to Trump’s victoryto India’s demonetization. Theseevents have contributed to marketvolatility and its impact has beenseen across all the asset classes,making the investing environmentmore challenging.

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    India was ranked 130 amongst 189 countries, on the World Bank’s DoingBusiness index for 2017, as against 134 in 2015. India does not have the luxuryto grow at this pace as this would certainly take a century for India to be at parwith developed nations. To foster a vibrant investment environment, both thecentral, state and local authorities will have to implement big bang reforms forfacilitating ease of doing business in India.

    To attract more FDI in PE & VC space and otherwise, policymakers have over ayear made several attempts to address the concerns of startups and PE/VCinvestors, including relaxing conditions for foreign investments in trading infood products, investment in financial sector, defence sector and alternativeinvestment funds. Additionally, despite a number of positive steps undertakenby the government such as ‘Make in India’, ‘Digital India’, ‘Start up India’, ‘SkillIndia’ and so on, it has not been successful in increasing investor confidence.We have attempted to list out some of the ‘Significant Legal Developments inthe PE & VC sector’.

    It is imperative that the Government bring about path breaking big bangreforms. The forthcoming budget could be a precursor to achieving theobjective including the implementation of the most awaited goods and servicestax (GST), the land acquisition bill, the tax regime rationalization and labourreforms. A select list of “Policy & Regulatory Wish-list for 2017” has beenhighlighted that requires immediate attention to ignite the investment cycle.

    Renegotiated tax treaties by India with Countries like Mauritius, Singapore andCyprus, where the Capital Gains for investments after March 31, 2017 wouldbe taxed in India, would have far reaching effects on fund structuring fromthese jurisdictions. Further, other changes in domestic tax laws with theintroduction of Indirect transfer taxation, GAAR and Place of EffectiveManagement would create uncertainty on the taxation front for offshore fundsinvesting in India.

    Other changes in domestic tax laws with introduction of Indirect transfertaxation, GAAR and Place of Effective Management would create uncertaintyon the taxation front for offshore funds investing in India.

    Given the above challenges and risks there can be no better time to capitalizeon the value based investment which is what PE/VC is all about! Some of theinteresting sectors to look out for in 2017 include consumer and technology,fintech, health care, IT & ITES.

    It is with great pleasure that we, along with our partners, present this PE & VCHandbook titled ‘INDIA PRIVATE EQUITY LANDSCAPE 2016-17’. I would like tothank our clients for their active and candid participation in sharing their insightsfor this book.

  • PE & VC 2016: THE YEAR IN FOCUSINVESTMENT TRENDS: SECTORAL AND QUANTITATIVE ANALYSIS

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    Private Equity and Venture Capital investments into India have declined by almost 50% in2016 to US$10.34bn (based on data till mid-December 2016) after showing an all-timehigh of US$21.93bn in 2015. The decline was not only visible in the deal value, but alsoin the total volume of deals both in the PE and VC space. The e-commerce sector,specifically, witnessed a sharp fall in investments mainly due to a decrease in the valuationof companies.

    PE & VC INVESTMENTS IN INDIA - 2016

    Source: VCCEdge

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    In terms of deal volume based on type of deal, 2016 witnessed a smaller number of dealshappening in both the PE and VC space. However, angel and early stage investments wereaffected much less than other types of investments. These trends clearly suggest thatinvestors wrote smaller cheques this year.

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    Similarly, PE and VC investments in 2016 totalled US$4991mn and US$2567mn,respectively: a drop of more than 50% in total deal value compared to 2015.

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    On a quarterly basis, there was a trend of falling PE investment activity. While Q1 2016 sawa total of US$4.1bn in investments (143 deals), the total investment activity decreased toUS$3.0bn in Q3 2016. A similar trend was also seen in big deals (US$100mn and above)during the course of the year. In fact, October and November 2016 witnessed investmentsof US$1.19bn (decline of 27% over the previous year) and US$0.9bn (decline of 50% overthe previous year). At the current pace, the 4th quarter is expected to close with US$3bn(143 deals).

    Source: VCCEdge; Volume of deals extrapolated for Nov-Dec 2016 period, Value of deals extrapolated for Dec 2016

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    IT & ITES, consumer discretionary, industrials and financials attracted the highest amountof investment throughout the year. On the other hand, sectors like real estate andinfrastructure showed encouraging signs of deal activity in the year 2016. The real estatesector, in the first nine months of 2016, saw commitments of $4.2bn, an increase of20% from the same period last year, according to a report by Cushman & Wakefield andthe Global Real Estate Institute.1 The potential to list under real estate investment trusts(REITs) led to a growing interest in leased office assets in an otherwise residential sectordominated asset class.

    1 http://www.livemint.com/Companies/cXQlCRxeyGse1nVSiEcQpI/PE-investments-in-real-estate-set-to-touch-72-billion-in-2.html

    The value ofinvestment in IT & ITES wasUS$3.2bn across 715 deals.

    Share of the sector intotal PE investment inthe year has beenmaintained ataround 30%

    Source: VCCEdge

    The value ofinvestment inconsumerdiscretionary wasUS$1.5bn across 210 deals.

    Share of the sector intotal PE investment inthe year was around15%.

    Source: VCCEdge

    The total value of PEinvestment in BFSIsector in the 2016was US$2.6bn, agrowth of around40%

    The sector is expectedto continue to attractinvestment in thenext year.

    Source: VCCEdge

    Private equity (PE)investment in realestate is estimated totouch $7.2bn in2016, up 53% from2015.

    Status as onSeptember 2016:• Total investment: $4.2bn• Domestic Funds: $2.9bn; Foreign Investors: $1.15bnResidential to Commercial Ratio = 54% to 46%

    Source: Cushman & Wakefield and the Global Real EstateInstitute

    TRENDS IN PE INVESTMENTS BY SECTOR

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    The private equity exits began on a slow note in 2016. The first quarter of the year sawa total deal value of US$265mn (59 deals). Though the total deal value picked up pacein the second quarter (US$1.3bn), the total number of deals (58 deals) remainedsubdued. The same trend was visible in the July-September period when number ofprivate equity exits hit the lowest in the past 17 quarters but a few big-ticket deals donethrough the strategic route inflated the quantum of the transactions which hit a highof US$2.08bn.

    Though the year started with M&A being the preferred route for exit, the July-Septemberquarter witnessed higher exits through the IPO route. The private equity backed IPO tallytouched 12 till September 2016, which is the highest in the past five years. Some of thePE players who diluted their holdings through IPOs include marquee names like SequoiaCapital, Helion Venture Partners and Sarva Capital (Earlier known as Lok Capital II LLC).

    Source: VCCEdge

    PE EXITS IN INDIA - 2016

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    START-UP FUNDING

    Investment in start-ups also saw a significant change in the current year as compared tothe previous year. In terms of statistics, the number of deals fell by (28%) and value ofdeals fell by (44%).

    Though, the first quarter saw investors backing startups (number. of deals were morethan that in Q1 2015), both deal value and volume dropped significantly across all theremaining three quarters of the current year. The size of deals also got significantlysmaller as angel and early stage funding were much higher than late stage funding.

    Source: VCCEdge

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    Source: VCCEdge

    In terms of segment funding, fintech lead in terms of number of deals, followed byhealthtech. Overall, the highest amount of funding continues to be attracted byconsumer technology start-ups, though the investors have become more selective intheir investment decisions.

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    The year 2016 saw some very interesting deals taking place in the PE & VC sector. However, investorsremained cautious of the valuations at which the deals were being closed. ARA LAW, an expert in thesector, managed to close a series of deals in an otherwise dull environment. Some of the publishabledeals that ARA LAW has represented include:

    REPRESENTATIVE DEALS OF 2016

    Investor(s)� Kalaari Capital Partners III, LLC;� GVK Davix Technologies Private Limited

    Target CompanyRKSV Securities India Private Limited

    DescriptionThe deal involved investment by KalaariCapital Partners III, LLC and GVK DavixTechnologies Private Limited in RKSVSecurities India Private Limited wherein theproprietary and commodity tradingbusinesses of the Company were hived offfrom the Target Company, as a part of therestructuring of the Target Company so as toremain in compliance with FDI norms.

    Round of InvestmentSeries A

    Investor(s)� Kalaari Capital Partners III, LLC;� SIDBI Venture Capital LimitedTarget Company� Holachef Hospitality Private Limited

    DescriptionThe deal involved investments by SIDBIVenture Capital Limited and furtherinvestment by Kalaari Capital Partners III, LLCin Holachef Hospitality Private Limited.Round of InvestmentSeries B1

    Investor(s)� Malabar India Fund Limited and � Malabar Value FundTarget CompanyNeuland Health Science Private Limited

    DescriptionThe deal involved investment by Malabar IndiaFund Limited and Malabar Value Fund inNeuland Health Science Private Limited by wayof share purchase, which contained structuringchallenges and finalization of definitivedocuments within exacting timelines.Round of InvestmentSecondary sale of shares

    Investor(s)� JungleVentures

    Target CompanyPaysense Pte Limited and its Indian Subsidiary

    DescriptionThis deal involved investment by Jungle Ventures IIInvestment Holding Pte. Ltd along with otherinvestors in Paysense Pte. Ltd., a private limitedcompany incorporated in Singapore with a subsidiaryin India engaged in the business of developingsoftware and activities for payment, lending andcredit solutions to customers through anonline/android based platform wherein FDIallowance as well as local regulatory aspects of theIndian subsidiary were deeply analyzed.

    Round of InvestmentSeries A

    � Represented by ARA LAW

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    Investor(s)� Kalaari Capital Partners III, LLC;� India Quotient 2Target CompanyHolachef Hospitality Private Limited

    DescriptionThe deal involved investment by KalaariCapital Partners III, LLC and India Quotient 2in Holachef Hospitality Private Limited, apopular online restaurant engaged inpreparation of meals and delivery of thesame through its mobile application andwebsite wherein regulatory concerns wereanalyzed in relation to the e-tail storetrading third party food products throughan inventory.Round of InvestmentSeries B

    Investor(s)� Greenvisor CapitalTarget CompanyGet Simpl Technologies Private Limited

    DescriptionInvestment by Greenvisor Capital in relationto its pre-series A round of investment inthe Target Company. This transactioninvolved prolonged negotiations andfinalization of definitive documents andclosing within exacting timelines.Round of InvestmentPre-series A round

    Investor(s)� Ventureast Life Fund III & � Ventureast Trustee Company Pvt. Ltd.Target CompanyEMBL Retail, Inc. (a US company) and itsIndian Subsidiary.

    DescriptionThe deal involved investment by Ventureastin the US Holding Company and in theIndian Subsidiary through a domesticinvestment vehicle wherein a treasury poolwas created by the Holding Company so asto accommodate the exit by Ventureastfrom the Indian Subsidiary at the same exitprice as that of the exit from the USHolding Company.Round of InvestmentSeries seed

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    The year 2016 saw may legal developments brought about by SEBI, RBI and DIPP with respect to the PE& VC sector. Below are the month-wise relevant updates starting January 2016 till November 2016.

    JANUARY

    2016Increase in Liberalised Remittance Scheme (LRS) Limits

    FEBRUARY

    2016E- Reporting under FDI Scheme

    The LRS limit has been revised up to USD2,50,000/- per Financial Year (April-March) for anypermitted current or capital account transaction ora combination of both. The LRS allows residents toacquire and hold shares, debt instruments or other

    assets outside India without prior approval of theRBI. With the improvement of the forex situationin India such an increase will open gateways formore investments outside India.Source: RBI - FED Master Direction No.7/2015-16

    W.E.F February 8, 2016 the physical filing of formsARF, FC-GPR and FC-TRS will be discontinued andforms submitted in online mode only through e-Biz portal will be accepted.This will make the reporting of transactions under

    the FDI faster, convenient and more efficient for theinvestors. Also going forward in the long run, it willbe a more efficient mode of preserving all recordsand filings by the authorities.Source: RBI- A.P. (DIR Series) Circular No.40

    • A Start-up in India with an overseas subsidiary ispermitted to open a foreign currency accountabroad to pool the foreign exchange earningsout of the exports/sales made by the concernedstart-up.

    • The overseas subsidiary of the start-up is alsopermitted to pool its receivables arising from thetransactions with the residents in India as well asthe transactions with the non-residents abroad

    into the said foreign currency account openedabroad in the name of the start-up.

    • A start-up is also permitted to avail of the facilityfor realising the receivables of its overseassubsidiary or making the above repatriationthrough Online Payment Gateway ServiceProviders for value not exceeding USD 10,000.

    Source: RBI- A.P. (DIR Series) Circular No. 51

    Regulatory relaxations for start-ups [relating to acceptance of payments]

    DEVELOPMENTS IN THEREGULATORY LANDSCAPE

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    Following issues related to issue of shares withoutcash payment by the investor were clarified:• Issue of shares without cash payment through

    sweat equity: Indian companies may issue sweatequity, subject to conditions of the schemedrawn in terms of applicable laws mentioned.

    • Issue of shares against legitimate payment owed:Indian companies may issue equity shares against

    any other funds payable by the investee company(e.g. payments for use or acquisition ofintellectual property rights, for import of goods,payment of dividends, interest payments,consultancy fees, etc.), remittance of which doesnot require prior permission of the Governmentof India or RBI.

    Source: RBI- A.P. (DIR Series) Circular No. 52

    Regulatory relaxations for start-ups [relating to issue of shares]

    SEBI ICDR Regulations have been amended toprovide for exit offers by promoters to shareholderswho have voted against the resolution for change inobjects or variation in terms of a contract, referredto in the prospectus of the issuer. Eligibilityrequirement, exit price, manner of exit, etc. havebeen provided for. This amendment takes care of the interests of the

    investors and makes sure they have a way out if theresolution voted for is against their best interests. Inthis way, the investors are not stuck in the Companywhich is managed against their wishes. Consideringthat easy exit options have always been one of themajor requirements for the investors, thisamendment will give a boost to the investors’ rights.Source: RBI- A.P. (DIR Series) Circular No. 52

    Exit option to Dissenting Shareholders

    FDI up to 49% under automatic route has beenpermitted. Please note that additionally suchinvestment in Pension Sector is regulated by PFRDAAct, 2013 and therefore the FDI in this sector is

    subject to fulfilment of the conditions laid downby the same.

    Source: DIPP Press Note 2

    E- Reporting under FDI Scheme

    The limits for investment by FPIs in CentralGovernment Securities and state developmentloans have been increased from an aggregate ofINR 1865 Billion to INR 2005 Billion from April 04,2016 and INR 2140 Billion from July 05, 2016.The limits for the long term investors remaining

    unutilized at the end of half year ending Sept 30,2016 will be released for investment under theopen category in October, 2016.

    Source: RBI- A.P. (DIR Series) Circular No. 55; SEBIIMD/FPIC/CIR/P/2016/45

    As per the current guidelines, 100% FDI ispermitted under automatic route for market placemodel. However, it has been clarified that no FDIis permitted in inventory based model. The

    guidelines have also, in a consolidated manner,reiterated the recent amendments made in the E-Commerce sector last year including (i) FDI up to100% under automatic route is permitted in B2B

    Investment by Foreign Portfolio Investors (FPI) in Government Securities

    FDI in E-Commerce (Guidelines)

    MARCH

    2016

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    model; (ii) No FDI permitted under B2C modelexcept as provided.DIPP further clarified that the e-commercemarketplace may provide support services to sellersin warehousing and logistics. This move has alsobrought a long overdue clarity on the definition ofthe term ‘marketplace format’. Such a move by theFDI is sure to lure in foreign investors.The significance of these guidelines lies in theimpact of the restriction of not effecting more than25% of the sales from any single vendor and its

    group companies and the obligation to maintain alevel playing field with regard to pricing ofgoods/services, on the current business modeladopted by the e-commerce companies. Anothercritical condition introduced seems to be regardingmarket competition, where the Guidelines simplystate that "E-Commerce entities providingmarketplace will not directly or indirectly influencethe sale price of goods and services and shallmaintain level playing field."Source: DIPP Press No. 3

    • Companies in infrastructure sector, Non-BankingFinancial Companies - Infrastructure FinanceCompanies (NBFC-IFCs), NBFCs-Asset FinanceCompanies (NBFC-AFCs), Holding Companiesand Core Investment Companies (CICs) will alsobe eligible to raise ECB under Track I withminimum average maturity period of 5 years,subject to 100 per cent hedging.

    • NBFCs-IFCs and NBFCs-AFCs will be allowed toraise ECB only for financing infrastructure.

    Holding Companies and CICs shall use ECBproceeds only for on-lending to infrastructureSpecial Purpose Vehicles.

    • Companies in infrastructure sector, HoldingCompanies and CICs will continue to have thefacility of raising ECB under Track II of the ECBframework.

    • The individual limit of borrowing of USD 750 Mshall be applicable.

    Source: RBI- A.P. (DIR Series) Circular No. 56

    Relaxation of ECB norms for Infrastructure Sector

    Limit on foreign investment in insurance sectorincreased from 26 to 49 percent under theautomatic route. It will help this sector in beingable to raise more capital from overseas. As the

    sector expands, it will also lead to an increase inthe number of jobs in the sector.

    Source: RBI- A.P. (DIR Series) Circular No. 58

    Increase in FDI limits in Insurance Sector

    Clarified that keeping deposits with an Indiancompany by persons’ resident outside India, inaccordance with section 160 of the Companies Act,2013, is a current account (payment) transaction

    and, as such, does not require any approval fromRBI.

    Source: A.P. (DIR Series) Circular No.59

    • Self-certification of APRs is sufficient in case ofresident individuals;

    • In case multiple resident parties have invested inthe same overseas JV / WOS, the obligation to

    Acceptance of deposits by Indian companies from a person residentoutside India for nomination as Director

    Overseas Direct Investment – Clarification and relaxations on submission of Annual Performance Report (APR)

    APRIL

    2016

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    submit APR shall lie with the investor havingmaximum stake in the JV / WOS, unless mutuallyagreed.

    • An APR in Form ODI Part II in respect of each JV

    / WOS outside India and other reports ordocuments to be submitted to AD by 31st ofDecember each year.

    Source: A.P. (DIR Series) Circular No.61

    • A new reporting format has also beenintroduced for Venture Capital Fund (VCF) /Alternate Investment Fund (AIF), PortfolioInvestment and overseas investment by MutualFunds.

    • Any post investment changes subsequent to theallotment of the UIN are required to be reportedas indicated in the operational instructions onsubmission of Form ODI Part I

    • Self-certification by the resident individualconcerned may be accepted.

    • Online OID application has been revamped tofurther reduce the traditional paper based filingsystem.

    • The rationalised and revised Form ODI will beapplicable now.

    Source: A.P. (DIR Series) Circular No.62

    Overseas Direct Investment – Rationalization of reporting obligations

    In order to streamline procedures for issuance ofdebt securities on private placement basis andenhance transparency to discover prices, aframework for issuance of debt securities on

    private placement basis through an electronic bookmechanism has been laid down.

    Source: SEBI CIR/IMD/DF1/48/2016

    Electronic book mechanism for issuance of debt securities on privateplacement basis

    IDF-NBFCs were allowed to raise resources throughissue of bonds of a minimum of five-year maturity.Now IDF-NBFCs are allowed to raise funds throughshorter tenor bonds and commercial papers (CPs)

    from the domestic market to the extent of 10% oftheir total outstanding borrowings.

    Source: DNBR(PD).CC. No.079/03.10.001/2015-16

    Relaxation for investment norms for Infrastructure Debt Fund-Non-Banking Financial Companies (IDF-NBFCs)

    Amongst other amendments,• An amendment by way of insertion of a new

    revised Schedule 6 dealing with the manner ofinvestment by FVCIs has been introduced.

    • “Start-Ups” have been included as a separate

    category. ‘Startup’ has been defined to mean anentity, incorporated or registered in India not priorto five years, with an annual turnover notexceeding INR 25 Crores in any preceding financialyear, working towards innovation, development,

    Foreign Exchange Management (Transfer or Issue of Security by a PersonResident outside India) (Third Amendment) Regulations, 2016

    Foreign investment in the units of InvestmentVehicles registered and regulated by SEBI or anyother competent authority (REITs, InvITs, AIFs) has

    been allowed subject to conditions provided in thecircular.Source: A.P. (DIR Series) Circular No.63

    Foreign Investment in units issued by Real Estate Investment Trusts,Infrastructure Investment Trusts and Alternative Investment Funds

    governed by SEBI regulations

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    deployment or commercialization of newproducts, processes or services driven bytechnology or intellectual property, provided that

    such entity is not formed by splitting up, orreconstruction of a business already in existence.

    Source:Notification No. FEMA.363/ 2016-RB

    Amongst other amendments,• No tax on income from start-ups: a 100%

    deduction of profits for 3 out of 5 years for start-ups, during April, 2016 to March 2019, withcertain riders will be available. To promoteinnovation, a special patent regime with a 10%rate of tax on income from worldwide, toprevent the exploitation of patents developedand registered in India was proposed.

    • While listed companies do not attract LTCGbeyond a holding period of 12 months, unlistedcompanies (read start-ups and privately held)companies attract 20% till a holding period of 3years. The Finance Minister has now reduced theholding period from three to two years to getbenefits of long term Capital Gain regime in caseof unlisted companies.

    • NBFCs- deduction to the extent of 5% of itsincome in respect of provision for bad and

    doubtful debts.• To get more investment in Asset Reconstruction

    Companies (ARCs), which play a very importantrole in resolution of bad debts, a complete passthrough income-tax to securitization trustsincluding trusts of ARCs has been proposed. Theincome will be taxed in the hands of the investorsinstead of the trust.

    • The Prime Minister had in his Start-up India planmentioned that 1-day incorporation via a mobileapp would be possible. This is an importantproposal and would be a big boost for aspiringentrepreneurs, if it can be pulled off. As of now,it takes anywhere between 15 and 30 days for acompany to get incorporated.

    • “Make in India” initiatives: measures aimed atincreasing ease of doing business andencouraging manufacturing in India.

    Start Up India Plan

    Earlier Limit: FDI limit increased to 100% of paidup capital of ARC (FDI +FII/FPI) –automatic up to49%.

    Revised Limit: FDI limit increased to 100% underautomatic route.Source: DIPP Press Note 4

    FDI in Asset Reconstruction Companies (ARCs)

    Higher FDI limits as under, to entities which havean established track record of running a Credit

    Information Bureau in a well regulatedenvironment:

    Investment in Credit Information Companies (CICs)

    The revised DTAA provides for changes in the taxregime including, inter alia, change of basis to“source” instead of “residence” and hence thisamendment effectively takes away the capital gainsexemptions that were available by investing

    through the Mauritius route.The Protocol will be effective for investments madeon or after April 01. 2017. Similar amendments inIndo-Singapore DTAA are also expected soon.Source: Press Release dated May 10, 2016 by CBDT

    Amendment to Indo-Mauritius DTAA

    MAY

    2016

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    • up to 49% if their ownership is not welldiversified (i.e., one or more shareholders eachhold more than 10% of voting rights in thecompany)

    • up to 100% if their ownership is well diversifiedor if their ownership is not well diversified, atleast 50% of the directors of the investee CIC inIndia are Indian nationals/ Non-Resident Indians/Persons of Indian Origin subject to the conditionthat one third of the directors are Indiannationals resident in India.

    • The investor company should preferably be alisted company on a recognized stock exchange.

    FII/FPI investment would be permitted subject tothe conditions (i) a single entity should directly orindirectly hold below 10% equity; (b) anyacquisition in excess of 1% will have to be reportedto RBI as a mandatory requirement; (c) FIIs/FPIsinvesting in CICs shall not seek a representation on

    the Board of Directors based upon theirshareholding.In case the investor in a Credit InformationCompany in India is a wholly owned subsidiary(directly or indirectly) of an investment holdingcompany, the above conditions will be applied tothe operating group company that is engaged incredit information business and has undertaken toprovide technical know-how to the CreditInformation Company in India.Please Note: As per Consolidated FDI Policy of June2016, FDI up to 100% under automatic route isapplicable to CICs. This is subject to otherconditions including (i) regulatory clearance fromRBI, (ii) conditions on FII/FPI investment asmentioned above and (iii) compliance with CreditInformation Companies (Regulation) Act, 2005

    Source: DBR.CID.BC. No.98/20.16.042/2015-16

    The Insolvency and Bankruptcy Code 2016, animportant reform to make it easier to do businessin India, was passed this year. With this, investors

    will find it simpler to wind up non-performingbusinesses quickly and easily.

    Insolvency and Bankruptcy Code 2016

    The amendment provides that in a transactioninvolving purchase of shares of an Indian companyby a non-resident buyer from a resident seller, orvice versa, the consideration may be paid on adeferred basis subject to the following conditions:• The deferred component of consideration must

    not exceed 25% of the total consideration• Such deferred payment must be made within a

    maximum period of 18 months from the date ofthe share transfer agreement

    Such deferred consideration may be structuredeither through an escrow arrangement or througha seller indemnity (in a case where the entirepurchase consideration has been paid up-front).Any deferred consideration mechanism which doesnot meet the restrictions as to the amount (i.e. upto 25% of the total consideration) or duration (i.e.no longer than 18 months) would continue torequire the approval of the RBI.Source: Notification No.FEMA.368/2016-RBI

    Deferred Consideration in Cross-Border Share Purchase Transactions Allowed

    Restriction may be imposed when there arecircumstances leading to a systemic crisis or eventthat severely constricts market liquidity or theefficient functioning of markets such as liquidityissues, operational issues, market failures andexchange closures. Mutual funds can currentlyimpose restrictions on redemption after approval

    from the board of the AMC and trustees.This neworder of the SEBI will prevent AMCs from freelyimposing limits on redemptions in any of theirschemes at any time, merely with a board ortrustee approval which is a very investor friendlymove as their redemption rights will be protected.Source: SEBI/HO/IMD/DF2/CIR/P/2016/57

    Restrictions on Redemption of Mutual Funds

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    Regulations in relation to constitution/management of IPF, utilization of IPF, andcontribution of IPF have been prescribed.

    Source: SEBI/HO/MRD/DP/CIR/P/2016/58 dated June 07,2016&SEBI/HO/CDMRD/DEICE/CIR/ P/2016/94 datedSeptember 26, 2016

    Regulation of Investor Protection Fund (IPF) of depositories

    With a view to rationalizing and expediting theprocess of giving approval, it has been decided thatECB proposals received in the RBI above a certainthreshold limit (re-fixed from time to time) beplaced before the Empowered Committee. The RBI

    will take a final decision in the cases taking intoaccount the recommendation of the EmpoweredCommittee.

    Source: A.P. (DIR Series) Circular No. 80

    ECB- Faster approval process

    • RBI had earlier permitted Indian corporates toissue Rupee denominated bonds overseas withinthe ceiling of FPI investments in corporate debt.

    • Foreign investments in Overseas Rupeedenominated bonds shall now be reckonedagainst the Combined Corporate debt limit ofINR 244,323 Cr. However, these investments shall

    not be treated as FPI investments and hence shallnot be under the purview of the SEBI (ForeignPortfolio Investor), Regulations, 2014

    • The entire Combined Corporate debt limit of INR244,323 Cr shall be available on tap forinvestment by foreign investors.

    Source: SEBI/HO/IMD/FPIC/CIR/P/2016/67

    Foreign Investment in Rupee denominated bonds issued overseas byIndian Corporates

    Under Regulation 24 of the Delisting regulationsthe whole time directors, promoters andcompanies promoted by such individuals shall notaccess the securities market for a period of 10 yearsfrom the date of such delisting.

    Regulation 23(3) requires promoters to acquiredelisted equity shares from public shareholdersprovided that such shareholders have the optionof retaining their shares. The value of these sharesis to be determined by an independent evaluator

    Restrictions on Promoters and Whole Time Directors of CompulsorilyDelisted Companies Pending Fulfilment of Exit Offers to the Shareholders

    JUNE

    2016

    AUGUST

    2016

    SEPTEMBER

    2016

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    that is appointed by the Stock Exchange fromwhich the company has been delisted.In addition to the existing restriction imposedunder Regulation 24 of the Delisting Regulations,in order to ensure effective enforcement of exitoptions to the public shareholders in case ofcompulsory delisting and taking into account theinterests of investors it was found necessary by SEBIto strengthen the relevant regulatory mechanisms.To this end the following regulations now apply tocompanies whose fair value is positive:• The equity shares held by the promoters /

    promoting group shall not be transferred and allcorporate benefits accruing to these shares suchas dividend shall be frozen, till an exit option incompliance with Regulation 23(3) of thedelisting regulation is not provided to publicshareholders

    • The promoters and whole time directors of sucha delisted company shall not be eligible tobecome directors until the exit option specifiedabove is provided.

    Source: SEBI/HO/CFD/DCR/CIR/P/2016/81

    With a view to make the process of transmissionof Securities more efficient and investor-friendly,SEBI had issued a circular dated October, 2013.After receiving comments by the investors however,the SEBI through this latest circular tried to removethe discrepancies in its earlier circular by modifyingclause 2 of Annexure-A.

    It has been now clarified that the affidavit isrequired for the identification and claim of legalownership to the securities. Clarity has also beenbrought with regards to the required successioncertificate/ probate of Will, henceforth removingthe difficulty in interpreting those terminologies.Source: SEBI/HO/MIRSD3/CIR/P/2016/0000000085

    Standardization and simplification of process of share transmission

    • SEBI tightened corporate governance norms oncompensation agreements between promotersand private equity (PE) funds so that theywouldn't cut other shareholders out of the loopand allowed foreign portfolio investors to invest

    directly in corporate bonds without a broker. • The markets regulator also approved raising the

    ceiling on shares reserved for employees in publicissues to `5 lakhs from `2 lakhs.

    Corporate governance norms on compensation agreements betweenPromoters and private equity (PE) funds

    • No RBI approval required by a SEBI registeredFVCI.

    • Investment permitted in equity or equity linkedinstrument or debt instrument issued by anIndian company whose shares are not listed ona recognised stock exchange at the time of issueof the said securities/instruments and engagedin any of the prescribed sectors.

    • FVCI can invest in equity or equity linked

    instrument or debt instrument issued by anIndian 'startup' irrespective of the sector in whichthe startup is engaged.

    • FVCI can also invest in units of a Venture CapitalFund (VCF) or of a Category I AIF (Cat-I AIF) orunits of a Scheme or of a fund set up by a VCFor by a Cat-I AIF.

    Source: A.P. (DIR Series) Circular No. 7

    Liberalization of norms of investment by a Foreign Venture Capital Investor(FVCI) registered under SEBI (FVCI) Regulations, 2000

    OCTOBER

    2016

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  • NOVEMBER

    2016

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    Foreign investment up to 100% under theautomatic route in ‘Other Financial Services’ ispermitted.Other Financial Services will include activities whichare regulated by any financial sector regulator viz.RBI, SEBI, IRDA, PHRHDA, NHB or any otherfinancial sector regulator as may be notified by the

    Government of India in this regard. Such foreign investment shall be subject toconditions, including minimum capitalisationnorms, as specified by the concerned Regulator/Government Agency

    Source: A.P. (DIR Series) Circular No. 8

    Foreign investment in Other Financial Services

    To simplify the procedure relating to ECB, it hasbeen decided to delegate the powers to designatedAD Category-I banks to approve requests fromborrowers for extension of matured but unpaidECB, subject to the prescribed conditions.

    Powers are also delegated to designated ADCategory – I banks to approve cases of conversionof matured but unpaid ECB into equity subject tosame prescribed conditions.Source: A.P. (DIR Series) Circular No.10

    Further simplification of ECB approval process

    • The fourth Bi-monthly Monetary Policy Statementfor the year 2016-17 released on October 04,2016 has permitted Startup enterprises to accessloans under ECB framework.

    • The borrowing per Startup will be limited to USD3 million or equivalent per financial year either in

    INR or any convertible foreign currency or acombination of both.

    • Regulations on eligibility, maturity, recognizedlenders end uses, conversion to equity andguarantee obligations have been prescribed by RBI.

    Source: A.P. (DIR Series) Circular No. 13

    ECB by Start Ups

    The revised DTAA provides for changes in the taxregime including, inter alia, source based taxationof capital gains arising from alienation of sharescomprising more than 5% of share capital.

    The Protocol will be effective for investments madeon or after April 01. 2017.

    Source: Press Release dated October 26, 2016 by CBDT

    Amendment to Indo-Korea DTAA

    • As announced in the Union Budget 2016-17, ithas been decided to expand the investmentbasket of eligible instruments for investment byFPIs under the corporate bond route to includeunlisted corporate debt securities in the form ofnon-convertible debentures/bonds issued bypublic or private companies subject to prescribedconditions.

    • Investment by FPIs in unlisted corporate debt

    securities and securitised debt instruments shallnot exceed INR 35,000 Cr within the extantinvestment limits prescribed for corporate bondsfrom time to time, which currently is INR2,44,323 Cr.

    • Further, investment by FPIs in securitised debtinstruments shall not be subject to the minimum3-year residual maturity requirement.

    Source: A.P. (DIR Series) Circular No. 19

    Investment by FPI in corporate debt securities

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    General Health insurers have been given thefreedom to invest out of their funds abroad,without prior approval of the RBI subject to twoconditions (i) Statutory requirements of the hostcountry; and (ii) IRDAI regulations, if any and in

    accordance with applicable FEMA regulationsrelating to investments abroad.

    Source: RBI/2016-17/137 A.P. (DIR New Series) CircularNo.18 [(1)/12 (R)]

    Investments by General Health Insurers

    SEBI Board has approved the followingamendments related to Angel Investors:• The upper limit for number of angel investors in

    a scheme is increased from forty-nine to twohundred.

    • The definition of startup for Angel Funds’investments will be similar to definition of DIPPas given in their startup policy. Accordingly,Angel Funds will be allowed to invest in startupsincorporated within five years, which was earlierthree years.

    • The requirement of minimum investmentamount by an Angel Fund in any venture capitalundertaking is reduced from �`50 lakhs to �`25lakhs.

    • The lock-in requirements of investment made byAngel Funds in the venture capital undertakingis reduced from three years to one year.

    • Angel Funds are allowed to invest in overseasventure capital undertakings upto 25% of theirinvestible corpus in line with other AIFs.

    Source: PR No. 161/2016, SEBI Board Meeting

    Amendments relating to Angel Investors

    • With the GST, there will just be one registration,a common tax rate. Complete uniformity. Foraccounts departments, tax payment will be muchsimpler, as will return filing.

    • Lower Taxes on Small Businesses: With the GST,however, tax burdens will be heavily reduced forbusinesses with a turnover of `10 lakhs to `50lakhs, and those with revenue of `10 lakhs neednot apply for GST at all.

    • Easier Business Expansion: A VAT registration isrequired in every state one wants to operatefrom and this creates a hurdle in terms ofbusiness expansion. With a central law, havingthe same rate of tax everywhere, this hurdle getsremoved quite a lot. GST requires theentrepreneurs to get only one license for theircompany and with only one license you can dobusiness in any number of states. Businessexpansion will now become seamless.

    Goods and Service Tax (GST) (To be implemented from April 01, 2017)

    The Union Cabinet on August 31, 2016 hadapproved the scheme for grant of PermanentResidency Status (PRS) to foreign investors subjectto the relevant conditions as specified in the FDIPolicy and other rules notified by the Governmentfrom time to time. The Union Cabinet has nowreaffirmed the same vide a press release datedNovember 29, 2016. The detailed rules are yet to

    be notified.In order to get the permanent residential status, aforeign investor must fulfil the following additionalcriteria (i) bring a minimum of �10 crores within18months or �25 crores within 36 months (ii) foreigninvestment should result in generatingemployment for 20 residents in a financial year.Source: Press Release dated November 29, 2016

    Permanent residency status to foreign investors

    Like the revised Indo-Mauritius DTAA, the revisedIndo-Cyprus DTAA, inter alia, provides for thesource-based taxation of capital gains arising on

    alienation of shares.

    Source: Press Release dated November 18, 2016 by CBDT

    Amendment to Indo-Cyprus DTAA

  • PE & VC SECTOR: KEY ISSUES, IN PERSPECTIVE

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    As per a 2015 survey by Nasscom (the National Association of Softwareand Service Companies) India has paved the way to secure the thirdposition in the world with three to four startups emerging every day,primarily in the areas of e-commerce, consumer services andaggregators. The report also states that total funding in 2015 hadgrown by about 125% from a year earlier. Various campaigns launchedby the government – Start Up India, Make In India, Digital India,National Policy for Skill and Entrepreneurship – and various other policymeasures in the form of tax rebates have contributed to a favourablestartup ecosystem.

    A startup may seek funding for varied reasons. Funding can providecapital required to back its business plan or the pace at which it aimsto grow, visibility and reputational benefits, a mentor that willconstantly guide it in making critical business decisions, risk allocationand other benefits.

    Legal due diligenceA startup may go through various stages of fundraising, includingangel funding, seed round funding and growth/early stage funding.After the angel funding stage, an important exercise that a startup willhave to go through during a fundraising process, after having executeda term sheet, is a legal due diligence.

    A legal diligence exercise is typically conducted at the seed and thegrowth/early stage rounds of funding and identifies: (a) risks associatedwith the investment; (b) a risk mitigation plan; and (c) a list of itemsthat would need to be inserted in the definitive documents in thenature of conditions precedent to funding, conditions subsequent,representations and warranties to be obtained from the founders, andindemnities.

    Most startups spend a lot of time developing their business and tendto neglect various legal and regulatory compliances. The importanceof a legal diligence cannot be underestimated given that the investorwill not write the cheque until they are satisfied with the outcome ofa legal diligence. Given the above it is important for startups to puttheir house in order before commencing fundraising initiatives.

    Key aspectsA legal due diligence on a startup will cover five main areas: (a) captable; (b) regulatory; (c) intellectual property; (d) agreements; and (e)employment.

    Cap table: This includes a thorough check on the issued and paid-upshare capital of the startup. Startups often fail to make importantfilings with the Registrar of Companies or other regulatory bodies andhave many small shareholders. It is important for a startup to have aclean and a short list of shareholders on its cap table as the lack ofsuch a list could be a nuisance during subsequent rounds of funding.

    I.FUNDRAISING

    FOR STARTUPS: ISYOUR HOUSE IN

    ORDER?

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    Regulatory: Obtaining appropriate registrations and approvals for thenature of the business is also very important. Startups often tend totake risks at the early stages, which come to haunt them when theygrow. It is imperative for startups to seek appropriate legal advice atthe inception stage. Another regulatory aspect to be considered incases of foreign investment is the foreign direct investment norms.Since most startups operate in the area of business-to-consumer e-commerce, some structuring could be needed to facilitate theinvestment.

    Intellectual property: It is important for startups to ensure that theintellectual property which is a valuable asset of the company isprotected adequately. This may include registering the intellectualproperty and entering into detailed employment agreements,containing comprehensive intellectual property assignment clauses,with members of the research and engineering team. Founders shouldalso ensure that they are not violating any employment terms of anyprevious employers. Startups often fail to take adequate steps toprotect their intellectual property.

    Agreements: It is important for startups to document theirarrangements with suppliers, vendors, consultants, etc. Startupsgenerally are lax and fail to put in place formal arrangements with thirdparties, which could help resolve a dispute.

    Employment: Various labour laws impose penalties for non-compliance,in view of which it is important for startups to understand theapplicability and compliance requirements of the relevant labourstatutes.

    ConclusionThe key to successful fundraising is recognizing and accordinglypreparing for diligence exercises and investor scrutiny from theinception stage. Being prepared prior to even thinking of fundraisingwill go a long way in ensuring a satisfactory outcome when afundraising opportunity arises.

    It is also important to look at due diligence as a housekeeping exerciseand be open with potential investors about non-compliance. This willhelp build a positive, trusting, working relationship and establish thegroundwork for an ongoing partnership.

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    India is seeing a boom in private investments in e-commerce andtechnology startups and a large number of funds have invested billionsof US dollars in such online companies. Most of these private equityinvestors are expected to exit their portfolio companies through sharelistings, putting a spotlight on the sector and the potential candidatesfor an initial public offering (IPO).

    Bankers expect them to explore overseas markets, mainly the Nasdaqexchange in the US, due to various regulatory requirements in India aswell as the difficulty in finding valuation benchmarks on exchanges onwhich no comparable rivals trade. This has also motivated startups toexternalize their business models to offshore jurisdictions, particularlySingapore.

    Taking the above into consideration the Securities and Exchange Boardof India (SEBI) floated a discussion paper on an “alternate capitalraising platform“ as a next step to address the lacunae. Some of theimplications that would be required to be considered in this regard arediscussed below.

    Key considerationsPre-tax operating profit: Regulation 26(1)(b) of the SEBI Issue of Capitaland Disclosure Requirements) Regulations, 2009 (ICDR Regulations),prescribes that a company may float an IPO if it has a minimumaverage pre-tax operating profit of �150 million (US$2.3 million),calculated on a restated and consolidated basis, during the three mostprofitable years out of the immediately preceding five years. SEBI’stight grip on profitability adds to the startup’s woes before getting anod for its IPO.

    Lock-in restrictions: Under regulation 36(a) of the ICDR Regulations,the promoters are required to offer a minimum 20% of post-issuecapital as lock-in for a period of three years. The lock-in provisionensures promoters’ skin in the game for at least three years. However,many start-up companies that have flourished in recent times, andseveral which have also achieved scale, have a lower foundingmembers’ holding (often less than 20%) and a large institutionalinvestors’ holding.

    Objects of the issue and basis of issue price: The ICDR Regulations requiredisclosure of the objects of the issue and the basis of the issue price,including the purpose of the issue, means of financing the project forwhich monies are proposed to be raised, proposed deployment status ofthe proceeds at each stage of the project, interest of promoters anddirectors, earnings per share, diluted earnings per share, price-earningsratio, pre-issue average return on net worth, etc. Start-up companies areoften loss-making and belong to sectors for which there are nocomparable financial ratios available, which acts as a process limitation.

    End-use restrictions: SEBI has prescribed restrictions on the wayscompanies can use their IPO proceeds and retains discretion to rejectoffer documents if a big chunk of the issuance is not allotted to

    II.LISTING VENUEFOR STARTUPS:

    ISSUES AND WAY FORWARD

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    creating tangible assets. Startups require funds for brand building (anintangible asset) and any regulatory restriction on this would defeatthe purpose of their capital raising exercise.

    Minimum post-issue paid-up capital requirement: The BSE (BombayStock Exchange) prescribes a minimum post-issue paid-up capital ofthe startup of �100 million for an IPO on the exchange. This may restrictthe access of some startups to the BSE as a listing platform to raisecapital.

    The best alternativeOne of the primary questions with regards to listing of startupsconcerns their ability to attract institutional investors and valuationissues. Given that technology companies have soaring valuations withdeeper liquidity requirements, the debate revolves around whether aseparate exchange for such start-up companies is needed or whetherthey should be allowed to list on the main board of the stockexchanges with easier norms. The issue is critical to address in view ofthe negligible activity in other specific platforms such as SMEexchanges (for small and medium-sized enterprises) and institutionaltrading platforms, which have been unable to attract significantinterest from the investor community.

    The better approach would be to allow listing on the main board ofthese “alternative“ companies with certain regulatory relaxations asagainst proposing an alternative platform.

    A constructive move on this front in the nature of the proposed StartupAct, which would address issues on delayed incorporation, cumbersomedocumentation and single window clearance, would hopefully arrestexternalization plans of the startups and take the government’s ease ofdoing business initiative notches higher. The framework should ideallyprovide for adequate analyst coverage for the startups to target suitableinvestors for their stock.

    In the US, the average tech company has around 20 analysts coveringits stock. The aim should be surpassing that number and providing aneven better capital raising platform to Indian startups than Nasdaq. Theproposed startup listing platform should ideally take this opportunityto address the entire gamut of issues from incorporation to exit listing.

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    The period between 2006 and 2008 saw a large number of venturecapital and private equity (PE & VC) deals in the Indian market. Theexit rights negotiated by PE & VC investors during the heydey of India’sgrowth story gain importance in today’s context, as most of the fundshave now reached the end of their fund lifecycle. In view ofdecelerating capital markets, exits remain a key challenge for PE & VCinvestors, and this has hampered fresh fundraising prospects from theirlimited partners (LPs) in the absence of a track record.

    Key factors in an exit include: 1) the promoters managing and negotiating rights and expectations of

    the new investor with those of the exiting investor or any othercontinuing investors;

    2) the exiting PE & VC preference for a complete release and waiver fromthe investee company, its promoters and the new investor from all pastand future liabilities, and negotiating representations, warranties andconsequent indemnities; and

    3) the new investor conducting thorough due diligence.

    VC/PE investors should negotiate the following five exit challenges asearly as the term sheet stage:

    Due diligence: A common challenge PE & VC investors face includesnegotiating and agreeing on the scope of the diligence exercise. Anexisting investor should always try to limit the scope of diligence to thebare minimum and ensure it is conducted in a timely manner. Some otherchallenges include: 1) procuring the active cooperation of the promoters; 2) absence of enough secondary data; and 3) reluctance among promoters of a family-run businesses to shareinformation with investors conducting diligence. From the purchasers’perspective, it is imperative to gather as much market intelligence on thecredentials and background of the promoters, in particular the reasonfor the PE & VC exit.

    Warranties and indemnities: The extent and nature of warranties to besought from an existing PE & VC investor will entirely depend on thestatus of that investor (i.e. financial investor or a strategic investor). Anincoming investor would want a full set of representations andwarranties, but to what extent the exiting investor can provide suchindemnities is a moot question. The exiting investor should limit itsrepresentations and warranties to title, author and performance.

    Tax indemnities: Post the Vodafone judgment, seeking a withholdingtax indemnity on capital gains from the seller has become a keychallenge. Some safeguards that purchasers have considered includecash holdback for an agreed percentage of purchase consideration,tax insurance, and backstop indemnities from LPs. These mitigators,however, need to be evaluated keeping in mind the lifecycle of thefund and provisions relating to clawback contained in the funddocumentation. The recent protocol of 10 May which amended theIndia-Mauritius double taxation avoidance agreement has cleared the

    III.FIVE EXIT

    CHALLENGES FOR VC AND PE

    INVESTORS

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    air of uncertainty by exempting transactions undertaken prior to 1 April2017 from the purview of capital gains tax (CGT), after which the taxon capital gains will be charged at 50% of the domestic CGT from 1April 2017 until 31 March 2019, and at the full rate after 1 April 2019.The above issues continue to be relevant until the India-Singaporetreaty is formally modified.

    Buyback: This route is predicated upon the target company havingenough resources to honour its buy-back commitments. There is a viewthat buyback of compulsorily convertible preference shares (CCPS) issuedto a foreign investor is not permissible under India’s foreign directinvestment (FDI) policy as such buyback would be akin to the redemptionof preference shares, which would indirectly run afoul of the FDI policy,which states that preference shares should be compulsorily convertible.In view of this, CCPS would have to be converted to equity mandatorily,and after conversion the company would have to meet with theconditions specified in the Companies Act, 2013.

    Put/call options: Enforceability of put and call options has always been atopic of debate with conflicting regulatory and judicial views.Clarifications by the Securities and Exchange Board of India on 3 October2013, and the Reserve Bank of India on 9 January 2014, specificallyrecognizing put and call options as valid contracts have helped easeinvestor concerns. But their implementation still requires promotercooperation and has resulted in such disputes being referred toarbitration.

    There are enough issues in terms of economic progress, sector-specificlegal and regulatory compliance, and risks associated withimplementing an exit strategy that could jeopardize the returns ofexiting PE & VC investors. Active promoter cooperation is vital for anysuccessful exit. A systematic approach by PE & VC investors towardstheir investments and returns, and managing their relationship withthe promoters is key to a successful exit.

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    Branding, customer data, technology such as software, mobileapplications, etc., form an integral part of the intellectual property (IP)portfolio of any start-up company. Protection of IP is crucial for startupsin view of the value it brings to the business, right from attractinginvestors and making financing easier to leveraging againstcompetition, generating revenue from licensing, assignment or transferarrangements, and contributing to the company's branding andmarketing strategy. Given the above, startups need to invest and takeas many measures as they can to protect their IP.

    Perils of infringementIn addition to protecting their IP from third party infringement, startupsshould be aware of others' IP rights to ensure that someone else's rightswill not limit them or prevent them from operating their business. Therehave been various cases where prominent brand names or logos havebeen infringed and the courts have passed restraining orders orinjunctions in relation to the infringements.

    In December 2014, Delhi High Court in Make My Trip (India) Pvt. Ltd VsMake My Tours Pvt. Ltd held that the defendant (Make My Tours) hadinfringed the mark and logo of the plaintiff (Make My Trip) on thegrounds that use of the mark and logo by the defendant was likely tocause confusion and deception and was bound to mislead the public tobelieve that the plaintiff was the source of the defendant's services.Hence the court ordered an injunction to prevent the defendant fromusing the same mark and logo.

    In another case, Tata Sons moved the World Intellectual PropertyOrganization's WIPO Arbitration and Mediation Center demanding thetransfer of the domain name “oktatabyebye.com“ from the owners ofthe name on the grounds that “tata“ in oktatabyebye was similar toTata. The court held in favour of Tata Sons and the domain nameoktatabyebye.com was transferred in favour of Tata Sons.

    Thus, IP infringement not only affects brand value but may result incompanies closing shop or having to rebrand themselves. Therefore,depending on the nature of service/product, it is extremely important toseek IP protection.

    Danger of theftMany startups have an in-house research and development team ofemployees who create works that carry IP rights. Early stage startupsoutsource branding and marketing work to third party consultants.Thus a lot of sensitive, proprietary, confidential client data, dealer data,etc., are handled by employees and consultants and may be stolen bythem.

    Another aspect that founders of startups tend to overlook is that whenthey start their own business, they may unintentionally use the tradesecrets of their previous employer and this may invite action from theemployer on grounds of violation of confidentiality obligations

    IV.KEY ASPECTS OFINTELLECTUAL

    PROPERTY RIGHTS FORSTARTUP’S

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    imposed under their contract with their previous employer. It istherefore important that founders make sure that using anyinformation from prior employers does not amount to illegal use ofthe prior employer's IP.

    Safeguarding one’s rightsIn light of the above, the first step to secure IP is through registration.Depending on the nature of service/product, startups can register theirservices and products as: (a) trademarks, to protect word signature,name, device, label, or combination of colors; (b) copyrights, to protectoriginal literary, musical and artistic works and cinematographic filmsand sound recordings (e.g. website design, graphics); (c) patents, toprotect any invention which is novel, non-obvious and has utility (e.g.software development); and (d) designs, to protect original designscreated for particular articles to be manufactured by industrialprocesses or means.

    Another step in seeking IP protection against theft is executingcomprehensive employment agreements and non-disclosure and IPassignment agreements with clauses on non-compete, confidentiality,non-solicitation, IP protection, assignment of inventions/IP, work forhire, etc. Also, when licensing any IP to a third party, a detailedlicensing/sub-licensing agreement must be executed.

    Issues pertaining to IP protection may sometimes get brushed asideduring the early stages of a business as it seems an expensiveproposition for a startup to act on. However, it is important to do acost/benefit analysis to determine which IP protection is best suited forthe business and put in place an IP strategy to obtain and sustainbenefits for the business in the long run as for most startups IP is theonly business asset.

    Also, a lot of startups prefer to vest and register their IP rights in theiroffshore company incorporated in a developed country and license therights to its wholly owned Indian subsidiary as the IP laws in developedcountries are more robust and stringent. Slightly older companies mayalso consider conducting an IP audit for a systematic review of the IPrights owned or acquired by the company to accurately gauge andassess its IP portfolio.

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    Employee stock option plans (ESOPs) are being widely used by bothpublic companies and startups as a means of monetary compensationand to provide incentives for employees. While startups use employeestock options in order to attract talent on account of not being ableto afford high salaries and to manage direct cost, publicly tradedcompanies use such plans as a retention tool. The wealth creatingpotential of ESOPs has been highlighted by reports about how theyhave created millionaires of employees at Infosys and the likes ofFlipkart.

    Globally, companies adopt one or more of the following types of plans,depending on their business requirements and objectives: (a) employeestock option scheme (ESOS); (b) employee stock purchase plan; (c)restricted stock units; (d) stock appreciation rights; and (e) phantomstocks. In India, the most commonly used ESOP vehicle by privatecompanies is the ESOS. Also, ESOP structuring can be done by settingup a trust based on commercial and tax considerations.

    Statutory compliance: It is mandatory for every private company andpublic unlisted company that proposes to issue employee stock optionsto employees to have in place an ESOP scheme that is in consonancewith section 62(b) of the Companies Act, 2013, read with rule 12 of theCompanies (Share Capital and Debentures) Regulations, 2014 (ESOPRegulations). Prior to the ESOP Regulations, there was no legislationregulating issuance of ESOPs by private companies. Public listedcompanies, however, have been governed by the Securities andExchange Board of India (Share Based Employee Benefits) Regulations,2014.

    Who is an eligible employee: The ESOP Regulations permit issuance ofESOPs to: (i) permanent employees who have been working in Indiaor outside India; (ii) directors; and (iii) employees of subsidiaries,associate companies and holding companies. However, a director(directly or indirectly holding more than 10% of equity shares), anemployee who is a “promoter“ and consultants are excluded fromdefinition of an employee to whom employee stock options can issued.There has been a major concern around exclusion of promoters fromthe definition of employees under the ESOP Regulations, which hasled to structuring promoter compensation by way of issuance of sweatequity, convertible preference shares, equity shares with lock-inprovisions, etc. The startup community and the report of CompaniesLaw Committee led by Tapan Ray have raised this issue, which isexpected to be addressed in this budget session.

    The Foreign Exchange Management (Transfer or Issue of any ForeignSecurity) Regulations, 2004, permit resident employees of foreignsubsidiaries in India or Indian companies (in which a foreigncorporation directly or indirectly holds equity) to acquire options fromits foreign holding company, provided the options are issued under acashless ESOS (without any remittance from India) and that the sharesunder the scheme are offered globally on a uniform basis.

    V.EMPLOYEE STOCK

    OPTIONS INSTARTUPS: ALLYOU NEED TO

    KNOW

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    Vesting schedule: The ESOP Regulations stipulate a minimum lock-inperiod of one year between grant of options and vesting. However, asa general practice most companies adopt a vesting period over fouryears, where options vest proportionately or otherwise over each year.Typically, vested options become exercisable on the occurrence of aliquidity event.

    Exercise price: Vested options can be exercised at an exercise pricewhich is usually at par for startup companies and at a discount to fairmarket value for slightly more mature companies. ESOP vehicles usuallyalso stipulate the exercise period, i.e. the period during which thevested options can be exercised.

    Transfer restriction: ESOPs usually impose transfer restrictions in linewith the charter documents of companies on the shares that are issuedupon the exercise of options. In certain cases, companies prefer to keepcontrol over the vested shares. In such situations various mechanismsor structures can be devised to address this concern.

    ConclusionStartups and public listed companies consider ESOPs as a majorincentive to motivate key employees, retain intellectual capital, attractnew talent and create wealth for employees. Accordingly, it isimportant to structure an ESOP vehicle taking into account thecommercial and tax implications on the company.

    The startup community as well the Companies Law Committee led byTapan Ray in its report pressed for relaxations of the ESOP Regulationsand ESOP taxation so as to allow flexibility in structuring of ESOPs andsimplify the ESOP issuance process. It is hoped that the budget sessionwill be productive in addressing these concerns.

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    The last few years have witnessed a sluggish primary market activityand very few startups and mid-size companies have taken effectivesteps towards going public. In this background, one of the typical exitstrategies that assumes importance as a feasible exit option remainsthe put/call option.

    SEBI has historically objected to options as being in contravention toSecurities Contracts (Regulation) Act, 1956 (“SCRA“) which permittedonly spot delivery contracts. Initially, the Government vide itsnotification dated June 27, 1961 exempted specified contracts for pre-emption or similar rights contained in the promotion or collaborationagreements or in the articles of association of limited companies.Although there was no specific mention of “options“, however thesame could be implied to be similar to ‘pre-emption’. However, vide anotification dated June 27, 1969, the Government under Section 16of the SCRA prohibited all kinds of contracts except spot deliverycontract or contract for cash or hand delivery or special delivery in anysecurity under SCRA. The SCRA was amended in the year 2000providing that a derivative contract would be invalid if they weresettled outside the stock exchange.

    In the case of Cairn and Vedanta merger and in Diageo and UnitedSpirits merger, SEBI prohibited the use of call/put options in theagreements. Further, in the informal guidance dated May 23, 2011issued to Vulcan Engineers Limited, SEBI specified that an optioncontract would not meet the criteria of a spot delivery contract underSection 2 of the SCRA and would also not be considered as a validderivative contract under Section 18A of SCRA.

    However, SEBI relaxed its position through a notification dated October3, 2013 granting validity to contracts providing for preemptive rights,right of first offer, tag-along right, drag-along right, and call and putoptions.

    The Department of Industrial Policy and Promotion (“DIPP“) vide theFDI Policy (Circular 2 of 2011) dated September 30, 2011 providedthat equity instruments issued/transferred to non-residents having in-built options or supported by options sold by third parties would losetheir equity character and such instruments would have to comply withthe extant External Commercial Borrowings (ECB) guidelines whichraised concerns for the regulators as the foreign investors were nottaking genuine equity risks in Indian companies and instead seekingan exit at guaranteed prices (which classifies such investment as debt).This attracted a lot of criticism by the investors as such a provisionaffected genuine commercial transactions, where the foreign investoris provided an exit at the then prevailing fair market value. Accordingly,this provision was deleted vide Press Release on FDI Policy (Circular 2of 2011) dated October 31, 2011. Later, the RBI vide its circular datedJanuary 09, 2014, permitted issuance of equity shares, fully andmandatorily convertible preference shares and debentures containingan optionality clause. However, the circular specified that such anoption / right should not provide a guaranteed return to such investor

    VI.OPTION

    CONTRACTS: ENFORCEABILITY

    ISSUES

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    at the time of exit and subjected the same to conditions such as (i) minimum lock-in period of 1 year from the date of the agreement,(ii) buy-back of securities to be at a prevailing price or at a valuedetermined at the time of exercise of such an option etc.

    The Supreme Court in Vodafone International Holdings vs. Union OfIndia & Anr, observed that the provisions for pre-emption rights, call/putoptions etc., incorporated in investment agreements, may regulate therights between the parties which are purely contractual and such rightsshall have efficacy only if such shares are owned by the parties. It wasalso held that the shares in a company are freely transferable in anymanner subject to the articles of association of such company.

    In the case of Nishkalp Investments and Trading Co. Ltd. v. HindujaTMT Ltd the Bombay High Court took a view that a contingent contractis within the scope and applicability of the SCRA. The question whicharose in this case was with respect to a buyback agreement torepurchase certain specified shares where the shares were not listedon the stock exchange by a certain agreed date. In this case, theBombay High Court held that a contingent contract for anarrangement of buyback of shares is hit by the provisions of the SCRAand is invalid in law.

    The issue on enforceability of option contracts was further dealt within MCX Stock Exchange Limited vs. SEBI, wherein the Bombay HighCourt cleared the air by holding that option contracts are differentfrom forward contracts, which are prohibited under SCRA.

    For a long period, companies and investors have been concernedregarding the enforceability of option contracts. The aforesaid positiontaken by the Indian regulatory authorities is an investor friendly stepand in the right direction that should surely boost investor appetite forIndian portfolio companies.

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    Banks, non-banking financial companies, debt funds and companies areincreasingly using the route of private placement of listed and unlistednon-convertible debentures (NCDs) to raise funds from players such aspension funds, insurance companies, foreign portfolio investors andmutual funds to retire debt and for on-lending. However, this route isbeset with legal and regulatory challenges, some of which are outlinedbelow.

    RBI approval: Creation of security over immovable property in favour of aforeign lender requires prior approval of the Reserve Bank of India (RBI)under the Foreign Exchange Management (Acquisition and transfer ofimmovable property in India) Regulations, 2000. This poses a challengein structuring the security package.

    Classification as “deposits“: Under the Companies Act, 2013, bonds ordebentures issued by a company must be secured by a first charge or acharge ranking pari passu with the first charge on the tangible assets ofthe company. Any subsequent charge is considered as a deposit, andoptionally convertible debentures are also now considered as deposits.However, compulsorily convertible bonds or debentures convertiblewithin five years are exempted from the definition of deposits.

    Contractual restrictions: Step-in rights of the existing lenders of theborrower company may require the security package to be structuredeither by way of substitution of rights in favour of the NCD holders or byway of a charge over the immovable property.

    Industrial zoning restrictions: India’s urban development authorities leaseparcels of land to industrial enterprises restricting their right to create anysecurity interest on the leased land without the authority’s prior approval.Such approvals are usually discretionary and pose both structuring andtimeline challenges.

    Stamp duty issues: High rates and lack of uniformity in the levy of stampduty poses a challenge for security creation.

    Enforcement timelines: The remedies under the Securitisation andReconstruction of Financial Assets and Enforcement of Security InterestAct, 2002, and the Recovery of Debts Due to Banks and FinancialInstitutions Act, 1993, for fast-track disposal of enforcement proceedingsare not available to other NCD investors. They would need to resort totime-consuming civil law remedies. Post-decree execution proceedings inIndia are a nightmare creating further challenges to the enforcement ofsecurity interest.

    Insolvency proceedings: Section 14(1)(c) of the Insolvency and BankruptcyCode, 2016, provides for placing a moratorium on the debtor’soperations during the insolvency resolution process. During this “calmperiod“, no judicial proceedings for recovery, enforcement of securityinterest, sale or transfer of assets, or termination of essential contractscan take place against the debtor. This restricts the right of the NCDholders to enforce their security.

    VII.NON-

    CONVERTIBLE DEBENTURES:

    ISSUES IN PRIVATE

    PLACEMENT

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    Inadequate penal provisions: Section 138 of the Negotiable InstrumentsAct, 1881, does not prescribe a strong deterrent for dishonour of acheque.

    Security cover: Under the Companies Act, a company can issue secureddebentures only upon creation of a charge on its assets or immovableproperties having sufficient value for redemption of such debentures. Thisrequirement with respect to adequacy of security poses a challenge forcompanies with an asset light model. Further, debentures secured by wayof share pledges are not recognized as “secured debentures“ in terms ofrule 18(1)(d)(i) of the Companies (Share Capital and Debentures) Rules,2014, which further weakens the security package.

    Asset quality and valuation: The Indian real estate market is a volatilespace in which the valuation of assets is not range bound. Being anunregulated market, the degree of credit risk is higher for real estateassets than other asset classes. Although the transactiondocumentation typically provides for maintaining adequate securityfrom the borrower, there is no assurance that the value of the securitywill remain adequate to secure the redemption of the NCDs.

    Public offer norms: The issuer company is required to strictly complywith the private placement guidelines provided under the CompaniesAct for private placement of NCDs, which can be issued to a maximumof 200 people per financial year. In case of breach such placementwould be construed as a “public offer“ under the act, leading toonerous compliances. However, many issuers of NCDs take a differentposition on what constitutes “public“, thereby leaving scope for debateon whether an issue is valid.

    It is time for the regulators and the government to focus on makingthe legal framework for debt instruments simpler and enforceable forensuring a challenge-free debt market.

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    A Real Estate Investment Trust (“REIT“) is a trust that uses pooledcapital of investors to purchase and manage income property (“EquityREIT“) and/or mortgage loans (“Mortgage REIT“). REITs offer severaladvantages to people who do not have sufficient money to invest inreal estate but desire to own property. Other than UnitHolders/Investors, the other primary players in REITs constitute theTrustee, Sponsors, Managers and Principal Valuer.

    The Securities and Exchange Board of India (“SEBI“) has vide anotification dated September 26, 2014 notified the SEBI (Real EstateInvestment Trusts) Regulations, 2014 (“SEBI REITs Regulations“)towards regulating investments in REITS. The SEBI REITs Regulations,inter alia, set out the registration requirements and procedure ofregistration, and eligibility requirements of REITs as well as that of theprimary players. The key highlights of the SEBI REITs Regulations areset out below:

    Eligibility Requirement for REIT: A REIT must be a trust set up under theIndian Trust Act, 1882 and registered under the SEBI REITs Regulations.The trust deed of a REIT has to be duly registered, is required to setout that its main objective is to undertake the activity of REITs andshould also include the responsibilities of the Trustee. There should notbe any disciplinary action taken by the SEBI or any other regulatoryauthority against the REIT or any related party. The parties to the REITshould be fit and proper persons as per in Schedule II of the SEBI(Intermediaries) Regulations, 2008. Further, multiple classes of units ofREIT are not allowed.

    Investments through a SPV: REITS may invest either directly or througha SPV. Where the investment is through a SPV, it is required to holdcontrolling interest and not less than 50% equity in such SPV. Also, theSPV is required to hold 80% equity in the REIT assets. Multilayer SPVstructure may not be permitted and multiple schemes under REIT arenot permitted.

    Dividend Distribution: SEBI REITs Regulations prescribe mandatorydistribution of at least 90% of the net distributable cash flows toinvestors on a half yearly basis and at least 90% of the sale proceedsfrom sale of assets to unit holders, unless reinvested in anotherproperty.

    Foreign Investments in REITs: The RBI has vide a circular dated April 21,2016 permitted foreign investments in REITs without any approvalrequirements. NRIs and FPIs have also been allowed to invest in REITsunits.

    The said circular also provides that downstream investment by REITswill be regarded as foreign investment if either the Sponsor or theManager is not Indian 'owned and controlled' as defined in Regulation14 of the Foreign Exchange Management (Transfer or Issue of Securityby a Person Resident Outside India) Regulations, 2000. In case thesponsors or managers are organized in a form other than companies

    VIII.REAL ESTATEINVESTMENT

    TRUSTS (REITS)REGULATORY & TAXATION

    ASPECTS

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    or LLPs, SEBI would have the power to determine whether the sponsoror manager or investment manager is foreign owned and controlled.Also, SEBI in its Board Meeting held on September 23, 2016 haspermitted REIT to invest in two level SPV structures through a holdingcompany, subject to sufficient holding in the holding company andthe underlying SPV and other safeguards including (i) the right toappoint majority Directors in the SPV; and (ii) the requirement by theholding company to distribute 100% cash flows realized fromunderlying SPVs and at least 90% of the remaining cash flows. Further,REITs have been allowed to invest up to 20% in under constructionassets.

    Open for high net worth entities: Till the market develops, REIT unitscan be offered only to high net worth individuals/institutions with aproposed minimum subscription size of INR 2 Lakhs and unit size ofINR 1 Lakh each. All unit holders are given equal voting rights. Also,voting by related parties for any unit holder's approval is not taken intoconsideration.

    Valuation Requirements: SEBI REITs Regulations prescribe a mandatoryrequirement for full-fledged valuation of all REIT assets on a yearly basisthrough a registered valuer. Semi-annual updation is also mandatory.Net Asset Value is required to be declared within 15 days from thedate of valuation/ updation of valuation of assets. Any acquisition/transfer of REIT Assets is required to meet the prescribed valuationguidelines.Listing Requirements: After registration, REITs are required to raisefunds through an initial public offer and subsequently through followon offers, rights issues and qualified institutional placements. In thisregard, SEBI Regulations prescribe the following:

    i. Detailed disclosures are required in case of a follow on offer, rightsissue, qualified institutional placement, etc.

    ii. REITs units have to be in dematerialized form and are mandatorilyrequired to be listed on recognized stock exchanges in India andcontinue to be listed unless delisted as per the SEBI Regulations.

    iii. The minimum IPO asset size of REITs is prescribed as being INR500 Crore and the minimum offer size is prescribed as INR 250Crore.

    iv. A minimum of 200 subscribers are required to form a REIT(excluding related parties) and the minimum public share in aninitial offer should not be less than 25% of the number of unitsof the REIT on post issue basis.

    v. The procedure for delisting of REITs has also been provided underthe SEBI Regulations.

    REIT Investments: At least 80% of the value of REITs Assets is requiredto be invested in completed and rent generating properties. Specificconditions are prescribed for investing the balance funds in otherassets. Further, REITs are required to invest in at least two projects andinvestment in any one project should not exceed 60% of the value ofassets owned by the REIT. REITs are permitted to invest only in the

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    assets situated in India. Lastly, a specific list of inclusions (like TDRs,land and any permanently attached improvements to it (whetherleasehold or freehold, etc.) and exclusions (like Hospitals, Hotels andconvention centers with specified conditions, agricultural land,mortgages, other REITs units, etc.) have been provided under the SEBIREITs Regulations.

    Taxation Perspective

    i. Dividend Distribution Tax (DDT): The Finance Budget of 2016proposes that any distribution made out of income of SPV to REITsand infrastructure investment trusts having specified shareholdingwill not be subjected to any DDT. It is exempted for