Venture Capital and Private Equity Funds Halt Investments Due to RBI Regulations

Venture Capital and Private Equity Funds Halt Investments Due to RBI Regulations. Image/Mint

Regulatory Change Creates Backlog of Deals and Uncertainty

Venture capital and private equity funds have temporarily halted new and follow-up investments in India due to recent changes in the Reserve Bank of India’s (RBI) regulations. Fund managers and founders have expressed concerns over these changes, leading to a backlog of deals, and have sought clarification from the banking regulator.

Capital Call Process Disrupted

In the fundraising process for private equity and venture capital funds, investors or limited partners (LPs) commit capital to a fund, but the transfer of this capital is not immediate. Fund managers request capital on a deal-by-deal basis through a process known as a “capital call” or “drawdown.” The funds then issue partly paid units to the LPs. However, two months ago, RBI modified Form INVI, which must be submitted by investment funds (such as AIFs, REITs, and INVITs) to RBI when they receive capital commitments from foreign investors. This modification was intended to prevent the filing of partly paid units.

Industry Uncertainty and Appeals to RBI

The change in regulations caught the industry by surprise, and some AIFs discovered it only when attempting to file Form INVI. Industry groups have made representations to RBI seeking clarity on the issue but have not received a response. As a result, the entire fundraising process appears to be stuck, affecting both fund managers and founders waiting to close fundraising deals.

Multiple Challenges for AIFs

AIFs are facing multiple challenges under the new rule. They cannot draw down capital from foreign investors because they cannot file Form INVI. Additionally, AIFs that have already declared a final close are unable to issue new units, limiting their ability to raise follow-on investments. Since AIF units are considered securities, the inability to issue partly paid units may expose the funds to tax implications that were not originally intended for AIFs.

Need for RBI Clarity and Caution

Industry experts and advisors are urging RBI to provide clarity on the situation, as the regulatory change conflicts with Sebi’s permission for AIFs to issue partly paid units. Some advisors are cautioning fund managers against using Form INVI, as it may not be suitable for AIFs and could lead to inaccurate disclosures and regulatory action in the future.

The regulatory uncertainty surrounding the capital call process and partly paid units highlights the challenges faced by the venture capital and private equity industry in India.

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