The Reserve Bank of India announced new rules permitting startups to raise a maximum of USD 3 million or equivalent through external commercial borrowings (ECB) in a financial year. The decision, effective as of October 27, 2016, allowing ECB access to startups is the latest move by the government of India to incentivize startup growth. The other incentives include a Rs 10,000 crore (USD 1.5 billion) “Fund of Funds for Startups” earmarked to provide capital to startups, a three-year break from income tax on profits, a Rs 500 crore (USD 75 million) credit guarantee and a capital gains tax exemption. The new rules also significantly alleviate the previous difficulties venture capitalists faced when investing in Indian startups.
A startup seeking ECB funding and the form of the ECB funding must meet certain qualifications in order to gain approval from the Reserve Bank. Designation as a “startup” from the central government is necessary as of the date the borrower raises ECB funding. Also, the ECB must contain a minimum average maturity period of three years. The lender must be a resident of a country who is a member of the Financial Action Task Force (FATF) or FATF-style regional bodies. However, the ECB rules prohibit lenders that are overseas branches or subsidiaries of Indian banks and wholly owned subsidiaries or joint ventures of an Indian company.
The Reserve Bank’s new rules allow flexibility in the use and structure of the ECB. For example, the borrower may use the funds from the ECB for “any expenditure in connection with the business of the borrower.” Furthermore, the Reserve Bank did not set a maximum cost for the ECB, leaving the lender and borrower to decide on cost. “Any freely convertible currency or Indian Rupees or a combination thereof” is permitted when structuring ECB funding. The ECB may be in the form of loans or preference shares that are either non-convertible, optionally convertible or partially convertible. Also, the ECB may be freely convertible into equity and the startup may elect what form of security to use when seeking out ECB funding.
The ECB rules decrease the regulatory scrutiny placed on venture capitalists who desire to invest in India. For instance, Dr. Raghuram G. Rajan, Governor of the Reserve Bank of India, stated, “These measures will create an enabling framework for receiving foreign venture capital…and [simplify] documentation and reporting procedures.” Previously, venture capitalists’ attempts to invest in Indian startups were hampered by the Foreign Exchange Management Act, which was both onerous and cost-detrimental to many potential venture capitalist investors. The new rules on ECB provide venture capitalists with a less burdensome and more cost-efficient avenue to invest in Indian startups up to the prescribed limits.
Overall, the Reserve Bank’s new rules provide startups in India access to capital markets heretofore unavailable. By allowing for flexibility in the structure of the ECB, the Reserve Bank provided relatively relaxed access to this resource. The new rules will allow strategic startups to develop and deploy assets that promote growth and efficiencies.
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