It took four years for the government to introduce the regulation for Alternative Investment Asset Class [Venture Capital (VC), Private Equity (PE) & hedge fund] after the word ‘venture capital’ was mentioned for the first time in the budget speech of 2015. Alternative Investment assets, particularly venture capital and private equity if let to flourish, have proven to play a meaningful role in economic development of a country, mainly in terms of innovation fueled by risk capital, job creations, and contributor to corporate governance.
The “Specialized Investment Fund Regulation 2075” introduced by the Securities Board of Nepal (SEBON) is a good move forward as it will allow domestic pooling of capital and mobilize startups and small business to scale up; but a lot more needs to be clarified in the regulation for VC and PE industry to truly take off. Some of the major points in the regulations are listed below:
Coordination and consistency between key institutions: Inter regulators harmonization and consistency, especially between the SEBON, Nepal Rastra Bank (NRB) and the Department of Industry (DOI) is the most important prerequisite for the implementation of this regulation.
Minimum investment: As per the regulation, minimum investment that a Limited Partner (LP) can make is NPR 5 million. This is likely to restrict the market to seasoned and deep pocket investors and will also have limit the small and retail investors wanting to invest as an angle investor.
Management fee: The regulation sets a minimum corpus of NPR 150 million and 2% of the corpus is required at all time as Sponsor/General Partner (GP) as a sign of commitment. Paid up capital of NPR 2 million or more is required. More clarity is required on whether the management fee earned could be contributed as sponsor commitment or not.
Regulation for foreign investors: Foreign Investors (except for Bilateral and Multilateral agencies) are neither allowed to invest nor are governed by this regulation. Restricting foreign private equity players to invest might limit exit options for local PE Funds, as foreign investor might be an exit option for local PE funds. Most probably, foreign PE funds would continue to prefer Foreign Direct Investment (FDI) route to invest, as it requires additional layer of approval and added labyrinth paperwork and delays.
Tax pass through status: Clarity is required on whether the ‘pass through status’ will be provided to funds or not. The ‘tax pass through’ system for taxation of fund ensures that investors do not pay more taxes than they would, had they made the investments directly themselves. To incentivize investors who are investing through a ‘pooled fund’, tax incentives should be provided. Cost related to ‘value creation’ and advisory efforts by the fund should be allowed to be considered when calculating the Capital Gains Tax (CGT).
One-year lock in period post Initial Public Offering (IPO): Considering a limited life nature of the VC/PE funds, one-year lock in period is encouraging. This will incentivize private equity investors to invest through the funds route for investing in IPOs, as opposed to direct investment. This may also contribute to improved corporate governance of the companies via board representation or shareholder activism and in-turn benefit minority shareholders.
Non – Resident Nepalis (NRNs) allowed to invest in funds: Non-resident Nepalis (NRNs) will be allowed to invest in the funds as per the regulation; but more clarity and certainty is required on applicability of taxes and route of investing. NRNs should be subjected to same tax rate as applicable to local investors and applicable Double Tax Avoidance Agreement (DTAA should be honoured).
Investment in equity, equity link instruments and convertibles: Regulation allows investment in equity, equity link instruments and convertibles, which is a welcoming move. However, the funds would require prior SEBON approval to optionally convert the financial instrument. This might hamper day to day ‘urgency’ of the business and create a lag if company’s takeover and turnaround is immediately required by the fund.
Financial institutions can be investors: Banks and Financial Institutions (BFIs), pension funds, insurance companies can be investors in the funds. Unlocking domestic capital pool and channeling it towards risk taking enterprises is an encouraging step. However, regulators of BFIs need to make immediate amendments to ensure that BFIs are not discouraged to invest in funds as there are certain restrictions investing in private and unlisted type of companies.
Regulation envisage: Fund managers have the role of “Prudent Men”, again an encouraging step, but the regulation requires the CEO and the Board of directors to be Business/Finance/Management/Legal/Chartered Accountant (CA)/Certified Financial Analyst (CFA) by academic background. People with education background in any other field that add value should be allowed to manage the fund, especially the vertical sector focused VC & PE funds.
Shabda Gyawali, Investment Director
Dolma Impact Fund