Facilitate Venture Capital Funding

Until early 2001, the focus of the venture capital investors in India was on the information technology sector. However, with the slowdown in the technology sector, the venture capital investors have diversified their interest into other high potential sectors including the media and entertainment sector. According to the Indian Venture Capital Association, the total amounts of venture capital funding during the year 2001-02 was approximately USD 1.1 billion^{303 and this pool of VC funding is likely to go up to USD 10 billion by 2007.}

Within the media sector, while IT related services as post-production services, animation, etc. have been attracting interest from VCs, the case for venture financing in films is becoming more and more compelling. The reasons for this interest in films stems out of several factors which are as follows:

• industry status given to the film sector has made this sector eligible for clean institutional funding and is now being perceived as an organized sector;
• entry of new breed of producers who have shown their clear preference for institutional funding as against funding from private financiers who charged exorbitant interest rates;
• slow shift in the viewers preference from a star based system to substance based thereby opening up more opportunities for new talent thereby reducing the risk of the projects which were otherwise exposed to the vagaries of stars;
• growing professionalism amongst the stars thereby moving away from hand-shake arrangements to more formal legal agreements;
• growing popularity of Indian films in the international markets thereby widening the market base for the Indian films and also reducing the geographical risk to that extent;
• introduction of film insurance products and concepts of completion guarantees which reduce the risk of the financier on account of delays and cost over runs;
• improved entertainment infrastructure in terms of multiplexes have improved the viewership and rise in ticket prices combined with higher disposable income has resulted in higher potential revenues;
• growing acceptability of film production houses in the capital markets thereby offering an exit opportunity to the investors/shareholders in production companies (e.g. Mukta Arts, Balaji, Padmalaya, etc.)
• additional sources of revenues through in-film advertising, merchandising, efficient distribution mechanism on different mediums including satellite, cable, internet, etc.
• increased market savyiness of the Indian producers in marketing their projects in the overseas markets;and
• Opening of the film sector to foreign investment thereby providing international funding to flow into this sector.

Most of the above factors have made investing in films an attractive opportunity for the venture capitalists and private equity players. There has been growing interest amongst the Indian institutions (such as IDBI, ICICI), banks (Bank of India, Punjab National Bank, etc) and corporates (Idream Production, Pantaloon, Tatas, Reliance, Sony Entertainment, etc) in this sector and they have committed significant amount of funds to this sector. Further, internationally, a strong community of successful expatriates also seem to have great deal of interest in the Indian film sector and have shown their keenness in participating in this sector. Foreign studios/production houses (e.g. MGM, Warner Brothers, 20th Century, etc.) would also be open to participate by way of a strategic interest or as investors in a film fund. These developments open up newer opportunities for local as well as foreign VCs to pool monies from these sets of potential investors and invest in Indian or India related film projects. Several domestic players have announced plans of setting up film funds however; the regulatory hurdles as highlighted herein have to an extent stifled the flow of VC funding to this sector.

Regulatory Framework for VCs in India

Domestic and offshore venture funds investing in India are regulated by the Stock Exchange Board of India (“SEBI”) vide the SEBI (Venture Capital Funds) Regulations, 1996 (“VC Regulations”) and SEBI (Foreign Venture Capital Investor) Regulations, 2000 (“FVCI Regulations”) respectively. These set of regulations permit investors to register themselves with SEBI and avail of certain benefits provided thereunder.

The foreign investment regime in India permits foreign investment into the equity of a film company. However, the provisions are silent as to the investment in an individual film project. A venture capital investor may make investments in the media sector using a variety of structures such as a company, a trust or a production company. There are several advantages and disadvantages of adopting these structures for investing in the media sector.

A venture capital fund (“VCF”) can be established in the form of a company (“VCC”) or in the form of a trust. VCC or a VCF can be organised in India and registered with the SEBI under VC Regulations. The VCF can then pool investments from the investors and make investments either in companies engaged in the business of film production or in special purpose vehicles (“SPVs”) created for each project. Under the current VCF Regulations or FVCI Regulations, a VCF/VCC can only invest in a venture capital undertaking (“VCU”) which has been defined to mean an Indian unlisted company. Thus, direct participation in film projects is not possible and any investment would need to be routed through SPVs set-up for each project. Also, by virtue of the definition of a VCU, VCF/VCCs are not permitted to invest in companies whose shares are already listed on a stock exchange in India.

According to the VC Regulations, the maximum investment in one VCU by a VCF/VCC is 25% of its corpus. Thus, a VCF/VCC would be required to make investments in at least four companies. A VCF/VCC would be required to invest at least 75% of its investible funds in equity or equity linked instruments of a VCU. Further, debt investment by a VCF/VCC cannot exceed 25% of its investible fund and that too would be restricted to undertakings in which the VCC/VCF already has and equity exposure. In addition, a VCF/VCC can invest only unto 25 per cent of its investible fund by way of subscription in an IPO subject to a 1-year lock-in period.

For setting up a venture capital fund, the trust structure has certain advantages over a company structure. For example, as company the VCC would also be governed by the Companies Act, 1956 which could pose some difficulty at the time of repatriation of capital in the event of a loss since a company cannot redeem equity or preference shares unless out of profits or fresh issue of shares. Thus, if the VCC suffers a loss, the VCC will not be able to return the capital to its investors. Additionally, there are other issues relating to the winding up of a company, payment of dividends etc. that arise due to this structure. As compared to this, a trust structure offers much more flexibility in respect of distribution of income and capital. However, since a VCC/VCF cannot participate directly into the projects, investments would have to be routed through SPVs which itself would pose some of the above problems which are faced by companies.

With a view to the above, a recommendation has been made to SEBI to permit VCC/VCFs to participate directly into the projects. For example, infrastructure funds are permitted to participate into the projects. This would call for a change in the definition of a VCU to widen the scope to include projects itself.

However, the investors do desire, they may invest through setting up of a production company without following the VCF/VCC route. Since FDI is now permitted unto 100% in this sector, this should not pose to be a constraint. However, the instrument of investment would have to be carefully structured since otherwise the repatriation issues applicable to a company mentioned above would also pose a problem under this structure.