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Corporate Finance


The law relating to corporate finance is a very vast subject and is covered under the various enactments. The important ones are the Companies Act, 1956, Securities Contract Regulation Act, 1956, Securities and Exchange Board of India Act, 1992, Foreign Exchange Management Act, 1999, Banking Regulation Act, 1949, the Reserve Bank of India Act, 1934, and various Rules and Regulations made under these Acts. Let us briefly deals with each one them.

Companies Act

Broadly speaking, monies can be raised by Companies in two forms: (1) Share Capital and (2) Loan Capital.

Share Capital

The Companies Act allows two kinds of share capital for raising monies viz: (a) Equity capital (b) Preference Capital.

Equity share (Common Stock in the USA) capital can be with equal voting rights or differential voting rights. Redemption of Equity capital can be made only after following the buy-back process prescribed under the law.

Preference share capital (Preferred Stock) means capital which:
  • carries a preferential right with respect to the dividend; and
  • carries preferential right for repayment of capital on a winding up.
Preference share capital can be redeemable, cumulative or non-cumulative (with regard to dividend), participating or non-participating (with regard to liquidation proceeds), convertible or non-convertible or optionally convertible (to Equity shares). In addition to these basic differences, the Preference shares can also carry various other rights and obligations also such as "Tag Along", "Drag Along", "Full Ratchet" etc. These are new advents typically used in Angel, Venture Capital or Private Equity funding and not under traditional Company law.

Preference shareholders are entitled to attend the Annual General Meetings and vote only on matters concerning them or affecting their interest as per the terms of issue. As in Equity capital, redemption of capital can be made only after following the buy-back process prescribed under the Act except in case of Redeemable Preference shares and redemption is as per the terms of issue.

Whilst there are no restrictions on payment of dividends, the procedure for declaration of dividends is provided in the Companies Act. Equity shareholders are entitled for dividend only out of profits after due allowance for depreciation and preference dividend, if any. Accordingly, so long as there are distributable profits in the Company, dividends may be declared from the first year onwards. Whilst the dividends are tax free in the hands of shareholders, it attracts dividend distribution tax in the hands of the Company.

Loan Capital

Companies can also raise loans locally from banks, financial institutions etc. Such borrowings can be secured or unsecured.

If the borrowing is secured, then the Company will have to create charge on assets of the Company and register the same with the appropriate regulatory authorities. Security in the form of Guarantee or Comfort of letter from parent company in respect of subsidiaries is also not uncommon. If the same secured borrowing is securitized in form of bonds or debentures (securities are issued against the borrowing), then setting up of debenture trust and appointment of debenture trustees to address the interest of debenture holders is must. Such derived instrument can take various forms such as convertible, non-convertible, etc.

If the borrowing is unsecured and not from certain categories of lenders such as banks, financial institutions etc., then the same will be treated as "public deposits" and this attracts stringent norms.

Options and Warrants

Off late, the market is seeing increased number of instances of raising monies through options, warrants etc. for certain tax and other advantage. These instruments being in the nature of derivatives will derive value from other underlying securities such as shares, debentures etc. There is certain prohibition / restriction on issue share warrants to bearers (which is a negotiable instrument transferable by mere delivery. This is very common in the USA and European countries) but registered warrants can be freely issued.

Companies Act, 1956 along with the Rules and Regulations made thereunder can be found at http://www.mca.gov.in/Ministry/acts_bills.html.

Securities Contract Regulation Act

As the name itself suggests, this Act relates to the contract is securities and matters incidental to that. It also deals with establishment of stock exchanges and listing of securities. Generally this Act assumes importance only when the Company intends to go public and get itself listed.

Securities Contract Regulation Act, 1956 along with the Rules and Regulations made thereunder can be found at http://www.sebi.gov.in/Index.jsp?contentDisp=Section&sec_id=1.

Securities and Exchange Board of India Act

SEBI Act is an important piece of legislation in the corporate arena enacted by the Parliament. This Act enables SEBI (equivalent of SEC in the USA and FSA in the UK) to regulate raising of capital from the public and operation of intermediaries in the capital market. Thus, as long as you do not tap the public for raising monies, this Act and Rules / Regulations made under this Act has least relevance to you.

While SEBi Act contains only skeleton law with certain enabling provisions, the Central Government has made number of Rules and SEBI has made number of Regulations / Schemes / Guidelines under this Act which actually conatitutes the significant portion of the law.

For example, SEBI has framed Regulations for investments by domestic and also Foreign Venture Capital Fund, Foreign Institutional Investors, Mutual Funds, Real Estate Mutual Funds etc which are important in the respective domains. Most of the private equity funds formed outside India enter into India through Foreign Venture Capital Fund route. Domestic Venture Capital Funds are normally formed as Trusts and registered with SEBI under the Venture Capital Fund route due certain income tax advantages. There are also many pure play private equity funds which are not registered with SEBI at all.

The most important parameter to be kept in mind under all these routes is there are certain investment restriction particularly investment in plan vanilla real estate (not real estate securities) which one should be wary of. SEBI has recently published a draft law pertaining to Real Estate Investment Trust (REIT) which is yet to see the light of the day.

SEBI has made Disclosure and Investors Protection Guidelines, 2000 which lays down criteria for raining moneys from the public and getting the securities listed. There is already a proposal to replace this archaic Guidelines with SEBI (Issue of Capital and Disclosure Requirements) Regulations which is yet to see the light of the day.

Securities and Exchange Board of India Act, 1992 along with the Rules and Regulations made thereunder can be found at http://www.sebi.gov.in/Index.jsp?contentDisp=Section&sec_id=1.

Foreign Exchange Management Act

This Act assumes importance wherever there is movement of funds from or to India. Central Government as well as Reserve Bank of India administers this Act.

The Regulations made by RBI under this Act allows various entry options for foreign investors in India. The most preferred routes are as follows:

(1) Foreign Direct Investment (FDI) where foreign investors can directly invest in the shares of the domestic companies. Most of the industries fall under the automatic route where no statutory approval is required for investments, some fall under the approval route where statutory approval (approval of Foreign Investment Promotion Board - FIPB) is required. There are few areas such as agriculture, plantation etc where FDI is prohibited. FDI is not allowed in partnership firms and other forms of business.

(2) Foreign Venture Capital Investor (FVCI) route avalable only for FVCIs registered with SEBI. The critical difference between FDI and FVCI is that the investors are required to enter and exit the companies at certain valuation norms (framed by the erstwhile Controller of Capital Issue) under FDI route which is not applicable for FVCI. FVCIs can enter and exit the company at any negotiated share price.

Dividends received by non-resident shareholders can be repatriated outside India without prior approval from the Reserve Bank of India.

Borrowings from sources outside India (known as External Commercial Borrowings or ECB) are subject to Regulations prescribed by RBI. ECBs are subject to several conditions including a condition that it cannot be utilized for working capital or real estate and that interest rate cannot exceed LIBOR + 200 basis points. Prior approval of RBI would be required if the ECB does not satisfy any of the conditions prescribed for automatic approval.

There are various special provisions and previlage for NRIs and POIs which are dealt under the relevant Regulations. For example, while inward remittance funds is a must for FDI route, NRIs can also utilize their India income to purchase shares but on non-repatriation basis.

Foreign Exchange Management Act, 1999 along with Rules and Regulations made thereunder can be found at http://www.rbi.org.in/scripts/Fema.aspx.

For the past few years, RBI has also taken up noble act of consolidating all the relevant Rules, Regulations, Circulars, Clarifications and issuing consolidated master circulars in relation to most of the aspects involving foreign exchange. These master circulars can be found at http://www.rbi.org.in/scripts/BS_ViewMasterCirculars.aspx.

Banking Regulation Act and Reserve Bank of India Act

Both these Acts are important because all Banks in India including Reserve Bank of India are subject to these Acts. RBI will keep regulating the Banks and their activities under these Acts. For example, if you want to set up a Special Economic Zone and avail loan from the Bank for the same, will the Bank treat you as a normal industry or a real estate industry for the purpose of risk weightage? RBI has prescribed the lending norms here and banks are bound by the same. With adoption of Basel II norms from 2008 onwards, these laws have assumed greater significance.

These Act along with Rules and Regulations made thereunder can be found at http://www.rbi.org.in/scripts/NotificationUser.aspx.

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