CHAPTER 2

Perpetual succession is defined as a pattern which determines the continuation of

any firm. The death of the owner does not have any effect on the firms operations

Enterprise value is a measure of a company's total value. it looks at the entire market
value rather than just the equity value, so all ownership interest and assets claims
from both debt and equity are included. enterprise value (EV) can be thought of as
the effective cost of buying a company or theoretical price of a target company

Grandfathering refer to an alteration of the rules that apply to a certain investment or

investment techniques while stipulating that investment actions taken before a
certain date remain subject to the old rules

The distribution waterfall is the order in which a venture capital or private equity fund
makes distribution to both its limited and general partners. Think of it as a hierarchy
that decides on the order in which profits are distributed to the different type of
investors that have decided to share the risk and pool their investment in the same
fund

Joint investors shall mean where each of the investor contribute towards the AIF

A special purpose vehicle is a legal entity. in case of VC and PE funds it refers to the
LLP or other structure that are created for the specific purpose of pooling investment
from investors to create a fund and making investments out of the pooled capital in
companies or in other such funds.

In the income tax act it is stated that permanent establishment referred to in clause
(iii) include a fixed place of business through which the business of the enterprise is
wholly or partly carried on

As per SEBI (FVCI) regulation 2000 designated Bank means any bank in India which
has been permitted by the reserve Bank of India to act as banker to the foreign
venture capital investor

Fiduciary is A person or party that has an obligation to act in good faith, trust,
honesty and best interest of another.

One is said to act in a fiduciary capacity or to receive money or contract a debt in a

fiduciary capacity, when the business which he transact or the money or property
which he handles, is not his own or for his own benefit but for the benefit of another
person, as to whom he stands in a relation implying and necessitating great
confidence and trust on the one part and a high degree of good faith on the other
part
In SEBI FVCI regulation it is stated that " domestic custodian" means a person
registered under the security and exchange board of India ( custodian of security)
regulation 1996

Foreign direct investment is investment made to acquire a lasting interest in or

effective control over an enterprise operating outside of the economy of the investor

As per SEBI regulations "foreign institutional investor" means an institution

established or incorporated outside India which proposes to make investment in
India in securities

As per SEBI regulations " qualified institutional buyer" means: a mutual fund, venture
capital fund and foreign venture capital investor registered with the Board. ( the SEBI
regulations include other investors also that are categorized as QIBs, here only the
relevant category is mentioned)

A withholding tax is an amount of money that is taken in advance from someone's

income in order to pay some of the tax they will owe
With holding tax is also defined as tax deducted at source, especially one levied by
some countries on interest or dividend paid to a person resident outside that country

Conflict of interest is A situation that has the potential to undermine the impartiality of
a person because of the personality of a clash between the person's self interest and
professional interest or public interest

• Business cycle of PE fund

1. Fund Raising: the fund manager raise funds from investors. Pension fund,
insurance companies, high net worth individuals and corporate houses usually invest
in private equity funds
As per the SEBI AIF Regulation 2012, all the VC/PE funds have to get themselves
registered with SEBI

2. Investment: After getting the capital commitment from the investors, the fund
manager, based on the specific stated objectives of the fund, looks for promising
ventures/ entrepreneurs in need of funds. A stringent evaluation process is
undertaken which is called due diligence, before structuring the deal.
Deal structuring refers to deciding the total commitment of funds to an investee
company the instruments that will be used for financing and the stages in which the
funds will be infused.
 The fund manager usually insist on a seat on the board of director of each investee
company.
In India PE funds are regulated by SEBI

3. Holding: PE investments are fairly long term and illiquid.

4. Exit: the PE funds exit the investments after 3 to 7 years. The exit options include
IPO, secondary sale, which means selling the stake to another PE fund, sale back to
the promoters, sale to a company, mergers and acquisitions etc. sometime if the
investee company fails to take off, the exit also could be due to bankruptcy. after the
exit, the residual value is distributed among the investors. the fund created thus gets
liquidated. The PE fund may raise another fund for investments.

Investments out of offshore funds in Indian funds/ companies are governed by FEMA
1999 and RBI apart from SEBI regulations.

In India VC and PE funds are regulated by SEBI, RBI and CBDT.

SEBI AIF Regulation 2012 governs the structure and investments of VC/PE funds,
RBI governs the foreign capital inflows/ outflows in conjunction with FEMA and
CBDT governs the taxation of income/ earnings of the fund and its investors.

The VC/ PE funds in India can be structured as a trust or a company or limited

liability partnership(LLP) or a body corporate.
Formation and liquidation of trust are governed by the Trust act 1882, of companies
by the companies act 2013, of LLPs by the LLP act 2008 and body corporate by the
special statute under which it is created.
Most of the VC/PE funds are structured as trust in India.

Types of legal structure of VC/PE funds in India

A. Trust: As such a trust is the more favoured structure amongst the existing AIFs in
India since the regulatory framework governing trust structures is minimal and allow
the management independence with respect to formulating its own standards of
governance.

A trust is formed under the provision of the Indian trust act of 1882. In the trust
structure:
• The trustee is incharge of the administration of the trust and may be entitled to a
trusteeship fee.
• An investment manager may be appointed by the trustee to manage the schemes/
funds launched by the trust. the manager manage the fund as per the investment
management agreement. the fund managers' role is to identify good investment
opportunities as per the Stated investment objectives of the fund, make the
investments; nurture and hand hold the investee companies; exit the investment at
the right time through appropriate exit strategy and distribute the returns of the
investors. the fund manager are compensated by way of management fees and
carried interest. the investment are made through the trust which is the investment
vehicle
• the contributors are the investors who make a capital commitment to the fund
launched by the trust.

The procedure involved in the formation of a trust are far more easy as compared to
the formation of a body corporate, a company and a partnership

By nature VC and PE investments are long term but self liquidating. the fund
managers seek to exit investments in 5 to 10 years time frame

The preferred vehicle for setting up a domestic VC fund is a trust. A VC fund set up
in the form of a trust is entitled to tax pass through status under the provision of the
ITA on the fulfillment of criteria set out under the ITA.
In India VC and PE trust enjoy tax pass through benefit subject to certain conditions.

The trustee and investment manager have to strictly adhere to the trust deed.

B. Limited liability partnership (LLP):

limited liability partnership are governed by the LLP act 2008. In India the limited
liability partnership act 2008 was published in the official gazette of India on January
9 2009 and has been notified with effect from 31 March 2009.

A limited liability partnership is a new corporate structure that combines the flexibility
of a partnership and the advantage of limited liability of a company at a low
compliance cost. In other words it is an alternative corporate business vehicle that
provide the benefit of limited liability of a company but allow its members the
flexibility of organizing their internal management on the basis of a mutually arrived
agreement as is the case in a partnership firm.

Internationally LLP are the preferred vehicle of business particularly for service
industry or for activities involving professionals.

It is a form of partnership. subject to conditions laid down in the act any individual or
body corporate maybe a partner in a limited liability partnership. In case of VC/ PE
fund structured as LLPs, there is a general partner who manages the fund and the
investors in the fund are limited partners

As per the act every LLP should have minimum two partners. the act further States
that every LLP should have minimum 2 designated partner who are individuals out of
which one of them has to be a resident in India.
The responsibility of designated partner include doing of all acts, matters and things
as are required to be done by the limited liability partnership in respect of compliance
of the provisions of this act, including filing of any document, return, statement and
the report, pursuant to the provision of this act and as maybe specified in the limited
liability partnership agreement and would be liable to all penalties imposed on the
limited liability partnership for any contravention of those provision
The cost of formation of LLP is far less than that of formation of a company. the
procedure including drafting and filing of the article of association, memorandum of
association, etc. are not applicable to the formation of LLP.

LLP have the best characteristics of partnership and companies

C. Company: company is the third type of structure that can be adopted for VC and
PE funds. company means a company incorporated under the companies act 1956.
all the regulations under the company act 1956 and now companies act 2013 will be
applicable to the AIF structured as a company.

D. Body corporate: SEBI permits VC and PE funds to be structured as a body

corporate. SEBI regulation state that in case the applicant is a body corporate it is
set up or established under the law of the central or state legislature and is permitted
to carry on the activities of an alternative investment fund

ROUTES OF VC AND PE INVESTMENT IN INDIA

Investment in VC/PE funds are made by domestic investors and by foreign investors
1. Domestic investors include HNIs, pension fund, insurance companies and other
based in India. they invest in a domestic VC/ PE funds which is in turn invested in
companies.
2. Foreign investors are governed by SEBI foreign venture capital investors (FVCI)
regulation. such investors have the option of investing directly in undertakings/
companies in India or invest in a domestic VC PE fund alongside the domestic
investor or in a VC/PE fund in which only foreign investor make investment.

A. Domestic/onshore structure: in a pure onshore structure the investments are

pooled from domestic investors by setting up a domestic pooling vehicle. the
investors contribute by making a capital commitment to a fund launched by trust/
LLP/ company. the fund manager/ asset management company make investment
out of the fund as per the stated investment objectives.

In domestic/ onshore structure for fund registered with SEBI the income earned from
investment is not taxed at the fund level and is taxed only at the hand of the
investors

In domestic/ onshore structure under the liberalized remittance scheme of Reserve

Bank of India, Indian resident can remit abroad up to USD 250000 per person per
financial year for any permissible current or capital account transaction or a
combination of both subject to the restriction and condition laid down in the foreign
exchange management act 1999 and related rules and regulations
B. Pure offshore structure: in a pure offshore structure and offshore pooling
vehicle is set up. the offshore investor enter into a subscription agreement with the
offshore funds. the offshore fund is managed by an offshore investment manager.
the onshore investment advisor readers advisory service to the offshore investment
manager who makes investment in companies in India