Things NRI Investors should know before Investing in Indian Startups

The thriving startup ecosystem of India has piqued the interest of Non-Resident Indians (NRIs) who seek investment opportunities, with their excess capital, in their home country. However, these opportunities come with extremely comprehensive and detailed regulations to consider prior. The Reserve Bank of India (RBI) has set investment ceiling limits, and NRIs must choose between repatriable and non-repatriable accounts for their investment. The Foreign Direct Investment (FDI) policy defines the sectors where FDI is permitted, offering NRIs the freedom to invest in a diverse range of industries. Understanding these rules is absolutely necessary for NRIs before making any investments in India.

Understanding Investment Limits:

The investment limits for NRIs in Indian startups and fixed by the Reserve Bank of India (RBI) and the ceiling limits vary depending on the type of company under consideration.

In some cases, the ceiling limit could be 10% of the total paid-up capital and for other startups, it could even go up to 24% of the total paid-up capital. However, in the case of a single individual NRI Investor, the investment is capped at 5% of the total paid-up capital of the company. NRI investors should carry out detailed and in-depth research into the startup they are vying to invest their capital in, in order to make sure that their intended investment amount does not violate the prescribed limits. This regulation is in place to prevent undue foreign influence on Indian companies and protect the interests of domestic shareholders.

Repatriation Options:

NRI Investors have the option to choose between two types of accounts to execute their investments in Indian startups — the NRO (Non-Resident Ordinary) account and the NRE (Non-Resident External) account. The NRO account is non-repatriable, meaning the funds cannot be transferred freely to the country of residence of the NRI. The NRO account is most suitable for income that has been generated within the borders of India, such as rental income or dividends from investments in Indian companies. Whereas, the NRE account is a repatriable one, which allows the NRI Investors to freely and largely without restriction repatriate investment proceeds, which could include both the principal amount as well as any Returns on Investment (ROI), to their home country. This choice of account is dependent on, for the most part, the financial goals of that particular NRI Investor and their desire for repatriation.

Foreign Direct Investment (FDI) Policy:

The Foreign Direct Investment (FDI) policy in India is what regulates the flow of Foreign Direct Investment into Indian companies. The policy outlines the various sectors in which the government permits FDI and the conditions and limits of such investments.

If an NRI wishes to make investments in Indian startups then they should refer to the FDI policy as a detailed framework to understand the opportunities and regulations. The policy segments the sectors into various categories, but primarily the automatic route, the government way, and prohibited sectors. These days, most of the startup-related sectors are covered under the automatic route which makes it quite easy for NRIs to invest in Indian startups.

The FDI policy grants NRIs the flexibility to explore various investment opportunities across different industries, such as technology, healthcare, education, etc. Although some sectors may require prior government approval, startups in most industries are unlikely to fall under this category.

Despite the flexibility, it is absolutely pivotal to stay within the investment limits set by the Reserve Bank of India (RBI) to ensure compliance and avoid regulatory issues switch the government. This approach allows NRI Investors to put their capital into startups without the risk of exceeding prescribed capital limits.

Eligible Investment Instruments:

NRIs can invest their capital into shares and convertible debentures of Indian companies using a wide variety of sources which include remittance from foreign bank accounts, NRE/FCNR(B) accounts, or investments from persons residing outside India, including NRIs.

However, it’s important to understand that the investment made shall be considered a Foreign Direct Investment by the Indian Govt only when it has been made in specific instruments. These instruments are equity shares, full and mandatorily convertible preference shares, and fully and mandatorily convertible debentures, among others.

Pricing Guidelines:

The pricing of FDI instruments must adhere to specific guidelines. For companies listed on recognized Indian stock exchanges like the Bombay Stock Exchange(BSE) and National Stock Exchange (NSE), the price is determined according to the guidelines laid down by SEBI (Securities and Exchange Board of India).

For unlisted companies, a fair valuation is calculated by a SEBI registered Category — I Merchant Banker (such as Libord or #Dimensional Capital Services) or a Chartered Accountant using the Discounted Free Cash Flow Method (DCF). For the purpose of transfer of shares from a resident to a non-resident, the pricing follows guidelines set by the RBI for preferential allotment. These guidelines ensure that NRIs and foreign investors pay a fair market price for the shares or debentures of Indian companies that they acquire.

Convertible Instruments:

While NRIs are permitted to invest in convertible instruments in India, the FDI policy lays down that the determination of the price and the conversion formulae must be done upfront at the time of issuance of such instruments. This is done in order to avoid any disputes or manipulation in the future with regard to conversion terms. It is also mandated that the price at the time of conversion should not be lower than the fair value calculated at the time of issuance, following the guidelines set by the Foreign Exchange Management Act (FEMA) for unlisted companies or SEBI (Issue of Capital and Disclosure Requirements) Regulations for listed companies.

Furthermore, when NRI Investors subscribe to the Memorandum of Association of an Indian company as initial subscribers, they may invest at face value, which is a standard practice for startup founders as well as early investors in India.

In conclusion, NRIs considering investing their capital in Indian startups must consider all of these important and various aspects to ensure compliance with regulations and to make safe and practical investment decisions. Understanding the investment limits, repatriation options, FDI policy, eligible instruments, pricing guidelines, and convertible instrument rules is essential for a successful and legally compliant investment journey in India’s dynamic startup landscape in which the government is extremely proactive in terms of regulation.