Operating Alternative Financing in Nepal: Venture Capital and Private Equity Funds
In the Nepalese financing sector, Private Equity (hereinafter referred to as “PE”) and Venture Capital (hereinafter referred to as “VC”) are relatively new buzzwords and they are gaining popularity over the traditional way of bank financing over a few past years. Until the introduction of the Specialized Investment Funds Regulation, 2019, (hereinafter referred to as the “Regulation”) they were set up as investment companies and were governed by the Companies Act, 2006 (hereinafter referred to as the “Act”) like any other company but faced restriction to invest in other companies exceeding 90% of its paid-up capital and 100% of free reserves.
The introduction of the Regulation has recognized PEs and VCs as specialized investments with the motive of further promoting and regulating such funds in Nepal, provided that such funds play a prominent role in providing finance to small and medium enterprises seeking capital.
PEs and VCs are private financing vehicles both falling under the broad umbrella of alternative funding. People might confuse these two funding options as the same or interchangeable as both provide collateral-free capital. However, there are significant differences in terms of their scale of investment, time of investment in businesses, the scope of investment, the degree of control they assume in the business.
VC fund has been defined under Rule 14 (2) (2) of the Regulation as “the fund whose securities are at the initial phase of operation and not listed with the stock exchange market, or a fund making equity investments as a form of capital in the business related to innovative knowledge, skills, or competency or new goods, services, technology, or intellectual property”. VC is guided by the idea of investing mostly in the early stage of the company until it reaches a sufficient size and credibility so that it can be provided liquidity. In essence, a venture capitalist buys a stake in an entrepreneur’s idea, nurtures it for a short period, and exits through a trade sale, initial public offering, write-offs, buy-backs, etc. So, VC fills the gap between the sources of funds for innovation and lower-cost sources of capital.
On the other hand, Rule 14 (2) (1) of the Regulations defines PE as “a fund injecting initial equity, or other instruments related to equity”. A PE fund is such a fund that invests in mature and already established private companies whose financial status is deteriorating. They invest either injecting equity capital or entirely buying out the companies (leveraged buyout). By making equity investments, they act as an equity partner of the companies that they invest in and offer strategic assistance in the managerial and governance level of the investee company to scale up and expand their business operation. In other words, it facilitates business to sustain in the market.
Incorporating PEs and VCs
The primary step towards operating private financing begins with the incorporation of an investment company pursuant to the Act. With the enactment of Regulation, governance of PEs and VCs has now been broadened and regulated under the Regulation. Throwing light over the incorporation of VCs and PEs in Nepal, the Regulation has been considered to be a milestone in Nepal providing VCs and PEs to incorporate in a wider range of prospects.
Minimum Standards for Registration of PEs and VCs
To get the funds registered, the following minimum standards must be met:
- Having the fund’s capital of at least 150 million rupees,
- The fund manager must hold at least two percent investment in the fund and there must be a provision for the continuous holding of such investment,
- Provision of limiting the number of unitholders (investors holding certain units of securities of the fund) up to two hundred,
- The nature of the fund shall be close-ended,
- Provision of distributing dividend only as a return to the unitholders,
- Provision allowing unitholders to purchase units up to five million.
Registration of PEs and VCs
Rule 14 of the Regulation has provisioned that PE and VC funds must get registered in the Securities Board of Nepal (hereinafter referred to as “SEBON”) before their operation. In order to get registered, an application must be submitted in the SEBON in the specified format along with the following details and documents:
- Statute of the fund,
- Audited financial statement of the previous fiscal year and the annual report of the fund, (a copy of the periodic financial report verified by the management if the fund has not completed a fiscal year after establishment),
- Projection of three-year business investment, including projected financial statements of coming three years,
- A copy of the decision of the Board of Directors (hereinafter referred to as “BOD”) regarding registration and release of the fund,
- Details regarding any action taken against the director or chief executive officer of the proposed fund manager under the law related to securities or other prevailing laws,
- A commitment letter of unitholder having 10% investment in a proposed fund to keep investment throughout the period of the fund,
- Details regarding the investment procedure of the proposed fund,
- Details about office location and area of the office, office equipment, and communication devices, and human resources,
- Details of an investment agreement entered into with unitholders of the fund,
- Particulars regarding the release of the fund, if it is to be issued in different phases,
- Name and full address of the director or chief executive officer and details regarding ownership or engagement in other companies or fund managers, if any.
If the SEBON deems it appropriate after necessary inspection, the applicant is provided Registration and Release Certificate. The time period of the fund so registered could range from five to fifteen years.
Registration of International PEs and VCs
PEs and VCs legally registered abroad can get their legal recognition in Nepal. PEs and VCs established abroad can also be registered in Nepal for which following documents are required along with an application:
- Certified copy of registration certificate of the fund,
- Certified copy of the statute of the fund and a certified version of it in Nepali language,
- Audit report of last fiscal year,
- Certified copy of the decision of BOD of the foreign company relating to registration and release of the fund and a certified version of it in Nepali language,
- Certified copy of agreement concluded with the fund manager,
- Amount of investment to be brought from abroad.
Further, the Foreign Investment and Technology Transfer Act, 2019 also allows institutionalized foreign investors to incorporate VCs with the approval of SEBON.
Time Period of Fund
The time period of a fund operated by VC and PE shall be of five to fifteen years and such time period shall also be mentioned in an investment agreement. After the completion of such time period, the fund shall be terminated.
Investment in PEs and VCs
Banks and financial institutions, insurance companies, retirement fund, provident fund, citizen investment fund, welfare fund, bilateral or multilateral international institutionalized investors, foreign persons, foreign companies, foreign VC and PE funds, Nepali institutions having objective of making investment, Nepali citizen, and non-resident Nepali, among others, can invest in VC and PE funds. The investment has to be followed by an investment agreement concluded between the fund manager and the investors.
Therefore, such alternative funding in a way gives vibrancy to the business sector and helps the entrepreneurs grow and pave their path towards growth and success and also helps the business to sustain in the competitive market. The reason behind their popularity is collateral-free financing and also their strategic support and introduction to new business connections. The Regulation has been welcomed by the related stakeholders given the sector was waiting for legal recognition and a framework for its operation. However, being a new concept in the context of Nepal, the clear idea about PEs and VCs has not reached out to all entrepreneurs, people with new business ideas, existing businesses still leaving them behind just because of lack of capital or their inability to capitalize through collateral-based traditional banking channels. The awareness about PE and VC funds among such people will further boost the growth of the PE and VC funds, enabling them to create a significant impact in the Economy of Nepal.