This article is written by Nishish Mishra Rajnish pursuing Diploma in M&A, Institutional Finance, and Investment Laws (PE and VC transactions) from LawSikho.com.

Introduction

The business structures which are amenable to foreign direct investment (FDI) and therefore the sectoral caps have continued to be a really important factor for cross-border investments in India for years. Currently, however, FDI is allowed up to 100% in most sectors or activities. FDI in private and public limited Indian companies is very common in the modern-day. The discussion below explains the regulation of FDI in several business structures.

Which structure is perfect for receiving foreign investment in an Indian business

Incorporating a private limited company is generally the optimal choice for an entrepreneur who wishes to pick a structure that’s suitable for receiving foreign investment. Investors are usually easier with investing in companies than in other structures like limited liability partnerships (LLPs). If the target is to boost foreign investment at some point in time incorporating a corporation for the venture is right. Foreign investment in other structures like sole proprietorships, partnerships, and LLPs or trusts either requires approval of the Federal Reserve Bank of India (RBI)/ concerned administrative ministry/department as per the standard operating procedure for processing FDI proposals.

Foreign direct investment in several business structures

• Foreign direct investment in a limited liability partnership

Although FDI in LLPs is permitted, the conditions on which it’s allowed are restrictive compared to the conditions for FDI during a company. Limited liability partnerships require regulatory approval for receipt of FDI, they can’t make investments into other ventures and can’t take foreign loans, hence, it’s advisable to structure a business as a corporation if FDI is contemplated.
The key features of FDI into an LLP, compared to a corporation are given below:
1) FDI is allowed in LLPs through an automatic route, subject to the subsequent criteria:
a. 100% FDI must be allowed therein sector for a corporation structure without government approval under the FDI policy (see discussion below to know which sectors are under automatic route), and
b. There should be no performance-related conditions within the FDI policy. Surely sectors like construction development, the FDI policy stipulates a minimum amount of investment, or there’s a lock-in period prescribed before which the investor cannot exit from the venture. In such sectors, FDI isn’t permitted.
c. FDI in LLP is subject to the compliance of the conditions of LLP Act, 2008
2) An Indian company or an LLP, having foreign investment, is additionally permitted to form downstream investment in another company or LLP sectors during which 100% FDI is allowed under the automated route and there are not any FDI linked performance conditions. Foreign capital participation is allowed only by monetary consideration. (In the case of a corporation, foreign capital also can be injected in sort of import of capital goods or technology.)
3) Conversion of an LLP having foreign investment and operating in sectors where 100% FDI is allowed through automatic route and there are not any FDI linked performance conditions, into a corporation is permitted under automatic route. 
4) LLPs also are not eligible to avail external commercial borrowings i.e., to boost overseas debt.

• Foreign direct investment in trusts

FDI isn’t permitted in trusts, aside from risk capital funds which are registered with SEBI and investment vehicle. FDI during a risk capital fund structured as a trust requires approval of the acceptable ad ministry/department identified by the Department of Industrial Policy and Promotions (DIPP). However, FDI investment into a risk capital fund structured as a corporation is permitted under the automated route.

• Foreign direct investment in partnership firm/proprietorship concern

  • FDI by NRI/PIO with non-repatriation basis

A non-resident Indian (NRI) or an individual of Indian origin, residing outside India can invest within the capital of a firm or a proprietary concern in India on a non-repatriation basis on the subsequent conditions:
a. Amount is invested by inward remittance or out of NRE/FCNR(B)/NRO account maintained with authorised dealers/authorised banks.
b. The firm or proprietary concern isn’t engaged in any agricultural/plantation or land business or medium sector.
c. Amount invested shall not be eligible for repatriation outside India.

• Investments with repatriation option

NRIs/PIO may seek prior permission of Federal Reserve Bank for investment in sole proprietorship concerns/partnership firms with repatriation option. The procedure, however, will be decided in consultation with the government of India.

• Investment by non-residents aside from NRIs/PIO

A person resident outside India aside from NRIs/PIO may make an application and seek prior approval of Federal Reserve Bank for creating an investment within the capital of a firm or a proprietorship concern or any association of persons in India. The procedure is going to be decided in consultation with the government of India.

• Foreign direct investment in companies

As explained earlier, so as to stop cumbersome scrutiny of the venture by Indian regulators and to determine operations faster, it’s going to be advisable to avoid an LLP or trust structure and choose a corporation.

• Foreign direct investment in start-up companies

A start-up company means a personal company incorporated under the Companies Act, 2013. Start-up companies can issue equity or equity-linked instruments or debt instruments to Foreign Venture Capital Investor (FVCI) against receipt of foreign remittance as per FEMA regulation. Additionally, start-ups can issue convertible notes to an individual resident outside India subject following conditions:
1) A private resident outside India (other than an individual who may be a citizen of Pakistan or Bangladesh or an entity that’s registered/incorporated in Pakistan or Bangladesh) may purchase convertible notes issued by an Indian start-up company for a variety of twenty-five lakh rupees or more during a single tranche.
2) A start-up company engaged during a sector where foreign investment requires government approval may issue convertible notes to a non-resident only with government approval.
3) A start-up company issuing convertible notes to an individual resident outside India shall receive the quantity of consideration by inward remittance through banking channels or by debit to NRE/FCNR(B)/ escrow account maintained by the person concerned in accordance with Foreign Exchange Management (Deposit) Regulations, 2016. Provided such escrow account shall be closed immediately after the wants are completed or within six months whichever is earlier.
4) NRI’s may acquire convertible notes on non-repatriation.
5) An individual resident outside India may acquire or transfer, by way of sale, convertible notes, from or to an individual resident in or outside India provided the transfer takes place in accordance with the pricing guidelines as prescribed by RBI. Prior approval from the govt shall be obtained for such transfers just in case the start-up company is engaged during a sector during which government approval is required.
6) The start-up company issuing convertible notes shall be required to furnish reports as prescribed by RBI.

Conclusion

We studied above briefly the sectors during which the FDI permitted and also how a start-up can leverage these regulations to their growth. The govt of India recently has really been very active in forming, amending, and modifying acts, rules, and exemptions, thus, allowing and permitting FDI in these sectors is one of its such initiatives.

References

• https://www.investopedia.com/financial-term-dictionary-4769738

• https://ajsh.in/foreign-direct-investment-in-startups/

• https://inc42.com/resources/how-fdi-amendments-will-impact-fresh-investments-from-china-in-the-indian-startup-ecosystem/

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