The new FDI rules put restrictions on investments from land-border countries including China
Siddarth Pai said the lack of clarity around the impact on beneficial owners is a big concern
FDI restrictions come at a time when startups are already facing a capital crunch
On April 17, the Department for Promotion of Industry and Internal Trade (DPIIT) issued a circular putting investment from land-border countries under the government approval route. While the restrictions apply to countries like Myanmar, Nepal, Pakistan and Bangladesh as well, the focus has come down on China, given its larger role in the Asian and Indian market. Considering the influx of Chinese capital in India over the last few years, there have been many concerns around the ambiguity, uncertainty and impact of this decision on the startup ecosystem.
To discuss the same, we hosted the first edition of “The Inc42 Show”, where Inc42 CEO Vaibhav Vardhan moderated a session featuring Siddarth Pai, founding partner of 3one4 Capital; Girish Vanvari, founder, Transaction Square – a tax, regulatory and business advisory firm; Deena Jacob, cofounder and CFO of neobanking startup Open and Amit Bhandari, an energy studies fellow at Gateway House, Indian Council on Global Relations.
Besides highlighting why Chinese investments matter to Indian startups, the panel pinpointed the impact of the restrictions not only on the VC ecosystem but on the overall funding outlook, taking into account the similar approaches in the US, Canada, Germany, Australia and other markets.
The discussions also revolved around beneficial owners, in simple words, the ultimate beneficiaries of any investment. There have been concerns about whether the new rules impact the ultimate beneficial owner or just beneficial owners. The difference here is that the former has to be a person, while the latter can also be an entity i.e. either an individual or a company.
Over the past ten days, the new rules have been debated thoroughly on social media and in our coverage. The first question often is why does it matter? Bhandari explained it simply.
“China is not a market economy, follows a model of state-backed capitalism. The companies like Tencent, Alibaba and Huawei are national champions which have implicit state backing and almost limitless balance sheet. So it is not a fair competition and especially in the current scenario, where markets are down and company valuations are really damaged, Chinese companies may be in a position to unduly benefit from this kind of situation.”
Explaining how Chinese investments have shifted from growth-stage investments to seed rounds, Pai said that a large part of the Indian startup ecosystem has raised money from Chinese funds, VCs or LPs.
Talking about the timing of the notification, Open’s Jacob said that the move would put more businesses in a hard place. Currently, businesses are facing capital crunch and the restrictions create bigger struggles in raising external capital to tide through the crisis.
Vanvari noted that the new rules restrict all Chinese investments — direct or indirect — even with as little as 1% stake. He noted that if the government examines any investment, there would be some Chinese investor behind it, maybe across layers. Pai and Vanvari both added that for now FPIs have been left out of this circular.
The other big question is whether the regulations put restrictions on investments from Hong Kong too? As Hong Kong is a “special administrative region” for China, some Chinese laws do apply to Hong Kong too, with certain exceptions. In terms of India’s stance on the two countries, India has seen Hong Kong as a part of China for a long time. So does this matter in the context to the FDI regulations?
Pai explains that since most larger funds, as well as corporations, have offices in Hong Kong for investments and business relations with other countries, the FDI rules might also impact many VCs, LPs and investment houses in Hong Kong.
The third big concern was the time it would take for investments to be approved by the government. Essentially under the regulated investment, the company has to apply for approval through a central government portal which will then send the application to the respective ministry, which will then approve it in 12 to 16 weeks. This process is already being followed for some investments. Vanvari explained approvals can take 12 weeks or even 12 months.
“I did a deal in my life, which was a Fosun deal, which took three years,” Vanvari said.
Jacob brought in the entrepreneur’s perspective saying that once the fundraising process starts, even under the automatic route, it takes anywhere between 3-6 months to get completed. The government dependency prolongs the wait beyond term sheet clauses, ambiguity on the availability of capital and could push companies out of business.
The panellists also stressed upon the fact that since the direct or indirect transfer of stake is restricted, it is unclear whether Chinese investors can sell their stake to other investors — Chinese or otherwise — without going through approval. They also spoke about Chinese investors being the most active ones given the current situation and how some deals have been put on hold due to the lack of clarity in the press note.
Pai added, “The lack of clarity is the greatest anathema to investing in capital. Capital only invests when there is clarity— on the timelines, on what beneficial ownership is, and the process — and with the lack of all that, there is going to be a paralysis in the entire place and paralysis is going to adversely affect the entire startup economy.”