The recent round of review has introduced a number of changes, and we will attempt to discuss all of the major ones on this Blog. At a broad level, the changes appear to be investor friendly as they seek to remove several obstacles that have long held back foreign investment in crucial sectors. In fact, this round represents one of the more progressive sets of changes made to FDI policy in recent times, as we shall examine. Neither the substance of the policy nor its timing are surprising, given recent reports appearing in the press about a steady drop in the FDI flows into India in recent times. Clearly, the effort seems to be to arrest the slide.
This post surveys the changes relating to pricing of convertible instruments. Investors, particularly financial investors such as private equity funds, are generally keen on investing in convertible instruments (such as preference shares or debentures) because the conversion price can be linked to future performance of the company, thereby incentivizing the management and promoters to make the business more profitable. This is more important in businesses where the value lies in the future. Start-up or early stage businesses may command low valuations based on current performance, but may demonstrate tremendous potential that may be realized only in the future. Convertible instruments enable promoters and managers to capture that potential in current valuation by linking the conversion price to the performance. Commercially, such conversion based on a formula seems beneficial to the company and its promoters (by their ability to secure better valuation) as well as investors (who minimize the risk of poor performance).
Even though convertible instruments are accompanied by sound commercial logic, they have not been very welcome by regulators in India. After long periods of ambiguity in the FDI policy, the erstwhile Consolidated Circular of 2010 provided as follows:
The DIPP has done well to recognise this issue, and has attempted to address this by amending the relevant clause in the new policy (Circular No. 1 of 2011) as follows: