Often used together, Private Equity (PE) and Venture Capital (VC) are different concepts pertaining to infusion of capital through equity purchase by investors. Thought to be similar concepts, PE and VC differ from each other in their basics. With the focus to invest in companies possessing ideas or expansion related plans or simply with a view of getting a profitable exit, citing the growth prospect of the investee companies, this article aims to explain the concept of PE and VC, along with laying down the differences between the concepts and finally explaining in brief, the legal mechanisms that govern PE and VC.
What are PE and VC?
PE can be defined as the capital investment, which is made by investors or companies in well-established businesses and enterprises. These well-established businesses and enterprises are private companies that are not a part of the stock exchange. Generally, PE investments are made in exchange for equity or ownership stake. Even though the investors are not involved in the day-to-day running of their portfolio companies, they provide a range of support and advice on strategy, financial management, and operations. The degree of their involvement will depend on the size of their stake in that company. If the stake they own is small, they may not be much involved in the company’s operation. However, if they own significant percentage of ownership in the stake, they will be more involved in the company’s operations so that the eventual outcome is profitable.
VC, on the other hand, are funds invested by Investors or companies at start-up businesses or businesses that are at an early stage, where the enterprise is still unsettled and the investment, in turn, entails a degree of risk, in exchange for equity or an ownership stake. VC investments generally aim to make investments in ideas and innovations, with the potential for growth. Venture capitalists take risk of investing in start-up companies, with the hope that they will earn significant returns when the company becomes a success. VC investments provide management, networking and other support to an entrepreneur. While choosing companies to invest in, Venture capitalists consider the company’s growth potential, the strength of its management team, and the uniqueness of its products or services.
Key Differences between PE and VC
The first difference lies in the nature of companies in which investment is made. PE investments are made in matured private companies at the later stage, wherein, the companies may be deteriorating or failing to make the profits that they should, due to inefficiency, or the companies may be looking for expansion. VC on the other hand, invests in start-up businesses or businesses that are at an early stage with high growth potential.
Second difference lies on the risk in the investment. Since the PE investments are made in matured companies having good record, the risk factor tends to be lower as compared to VC, as the VC investments are provided to start-up businesses at an early stage, where the enterprise is still unsettled.
Third difference lies in the percentage of total investment made in a single company. PE investors mostly buy entirety of the ownership of the companies in which they invest. As a consequence, such companies are in total control of the investors after the buyout. VC investors invest in 49% or less f the equity of the companies.
Legal Framework
- The Companies Act, 2013: The Companies Act, 2013 specifies the conditions and procedures relating to the issuance and transfers of shares and other securities, as well as, states the rules and procedures to be followed by the board of directors and shareholders.
- The Income Tax Act, 1961: The Income Tax Act, 1961 specifies all direct taxation related aspects of transactions, including applicable taxes on income generated, capital gains tax, exemptions for investments made in companies, tax benefits, as well as, the methods to determine the valuation of shares and the securities.
- Securities and Exchange Board of India (Alternative Investment Funds) Regulations, 2012: The investment in various organizations is now routed from the “Alternative Investment Funds”, which are established for the purpose of making investments. The Regulations provide a legal framework for the pool investment funds in India.The regulations mandate registration of all Alternative Investment Funds (“A1 F”) and restrict any person or entity from acting as an AIF unless registration from SEBI has been procured.
- Securities and Exchange Board of India (Foreign Venture Capital Investor) Regulations, 2000: The SEBI (Foreign Venture Capital Investor) Regulations, 2000 regulates investments by the Foreign Venture Capital Investors (“FVCI”), which are investors incorporated or established outside India and propose to make investments in VC in India. The Regulation specifies investment criteria for a FVCI, conditions, restrictions, obligations, responsibilities, etc.
- Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 2011: The SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 provides an exit option to shareholders in case any person acquires shares or voting rights which entitles him to 25% or more voting rights.
- The Foreign Exchange Management Act, 1999: The Foreign Exchange Management Act, 1999 (FEMA) enables the Reserve Bank of India (RBI) to monitor and regulate all foreign investments into target companies in India, acting in this regard under or pursuant to powers granted to it, under the Reserve Bank of India Act, 1934 and related banking laws and regulations.
- Foreign Direct Investment Policy: Foreign Direct Investment (“FDI”) Policy is issued by the Department for Promotion of Industry and Internal Trade of the Government of India. The policy regulates the inflow of FDI in India and further imposes general conditions and sector-specific conditions on these investments. The two types of routes for FDI, as mentioned in the policy, are the Automatic Route and the Government Approval Route. In case, the investment falls under the Automatic Route, no permissions and approvals need to be taken by the investors; however, if the same falls under the Government Approval Route, due permissions need to be in place.
- Other laws: In relation to the due diligence processes that are typically conducted in connection with, and prior to the conclusion of PE and VC, the laws that are typically relevant are labour laws, environmental laws, and rules requiring appropriate registrations with various governmental agencies, depending on the industry or area in which the target companies conduct their businesses and operations.
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