PDF VC Handbook
PDF VC Handbook
PDF VC Handbook
Handbook On
Venture Capital
An Entrepreneur's Guide to
PRODUCT OFFERINGS
Private Equity & Venture Capital Deals Database: Investments and Exits
since 1998 with data on private company financials and deal valuation
multiples
1. Types of Investors
6. Knowledge Partner:
7. Directory Section
Types of Investors
Accelerators / Incubators
Seed Funds
Types of Investors
Social/Impact Funds
Directory Section
Click on heading to go the section
FUNDING COMPANY
RANGE REVENUE
Active Incubators $ -
Active Accelerators $ $
Angel Networks $$ $
Deal Platforms $$ $
Seed Funds $$ $
This Term Sheet summarizes the principal terms proposed by the Investor with respect to
its investment in the Company (“Transaction”). This Term Sheet should not be construed
as including all the terms relating to the Transaction. Such terms would be contained in
the definitive agreements recording the Transaction to be negotiated and executed by all
the parties (“Definitive Agreements”).
Parties hereto shall act in good faith to negotiate, complete and execute Definitive
Agreements and related documents reflecting the intent contained herein latest by
February 1, 2016 (“Term”).
This Term Sheet shall expire on the completion of the Term or execution of Definitive
Agreements between the Parties, whichever is earlier. Upon termination, this Term Sheet,
except for the exclusivity, confidentiality, governing law and dispute resolution provisions,
shall lapse automatically, unless renewed by mutual consent of the parties hereto.
Capitalized terms used herein but not defined shall have the meaning ascribed to them
below.
TRANSACTION
Terms of Investor CPs Dividends: The holders of the Investor CPs shall be entitled
to an interest of [0.1%] per annum.
Liquidation Preference:
TRANSACTION
Terms of Investor CPs Conversion: The conversion price of Investor CPs shall be
[xxx]% of the price per equity share determined at the time
of Series A Funding.
Completion of the Within a reasonable time after execution of this Term Sheet
Transaction but in no event later than Day-Month-Year.
Minority Protection Company will not take any of the below mentioned actions
without express written approval of the Investor; provided
that, if such action or decision is taken at a board meeting
the affirmative vote of a Director nominated by the Investor
will be required:
TRANSACTION
Information Rights The Company will deliver to the Investor: (a) annual audited
financial statements 90 days after the end of each financial
year, (b) bi-annual un-audited financial statements, and (c)
Annual management reports, plans and budgets.
Further Financing (New Any future issue of equity or convertible instruments by the
Shares)/ Anti-dilution Company shall be first offered to the existing shareholders
in the ratio of their shareholding in the Company at the time
of issuance.
TRANSACTION
Investor’s Right to Sell Investor CPs shall be transferable to any person after the
Series A Funding Date.
The Promoters shall have the right of first refusal [or first
offer right] on transfer of all or any of the Investor CPs or any
transfer of equity shares issued upon conversion of Investor
CCD’S in proportion to their shareholding in the Company.
Promoters Drag Along If the Promoters at any time propose a transfer to a third
Right party transferee all or portion of their collective
shareholding that is in an aggregate equal to 51% of the
collective shareholding of the Promoters, then the
Promoters may also elect to require the Investor to also
transfer, to the third party transferee, as part of the drag
along sale, that number of Investor CPs or equity shares
issued upon conversion of equity that is pro rata to the
shares proposed to be transferred by the Promoters, at the
same purchase price and other terms that are applicable to
the Promoters shares.
TRANSACTION
Exclusivity Until expiry of the Term, Company will not take any action
to, directly or indirectly, encourage, initiate or engage in
discussions or negotiations with or provide information to,
any other person or entity concerning the Transaction.
TRANSACTION
Amendment The Parties may amend the terms of this Term Sheet by
mutual consent in writing.
Governing Law and Any disputes arising out of or in connection with the
Dispute Resolution validity, interpretation or implementation of this Term Sheet
shall be governed by the laws of [India] and Courts at
[Bangalore] shall have sole jurisdiction.
For Promoters
Name:
Designation:
For Investors
Name:
Designation:
Venture capital investments include (i) subscribing to securities such as ordinary equity
shares, equity shares with differential voting rights (“DVR Shares”), preference shares,
equity-linked instruments, and convertible notes, or (ii) providing financial assistance in
the form of a term loan or subscribing to non-convertible debentures or any such similar
instruments.
Where funding is in the form of financial assistance, and not capital investment, the
promoters retain ownership of the company in its entirety. Most early-stage companies
prefer to raise capital through equity financing for several reasons, including interest on
loans which is typically a cost for early-stage companies and, further, lenders may require
collateral to secure the loan. Servicing the interest on loans is another challenge for such
companies. On the other hand, with capital investments, the return-on-investment is
usually generated after a defined period of time, when it is expected the company will have
stabilized its business.
Start-up notification:
The Ministry of Commerce and Industry notification of February 19, 2019 relating to ‘start-
ups’ permits a start-up to be incorporated as a private limited company under the
Companies Act, 2013, or be registered as a partnership firm under the Indian Partnership
Act, 1932, or a limited liability partnership (“LLP”) under the Limited Liability Partnership
Act, 2008.
The Budget for 2020-2021 has proposed some benefits for start-ups:
(a) eligible start-ups have been permitted 100% deduction of profits and gains for
three consecutive assessment years (as against seven years currently applicable)
out of 10 years, where the total business turnover is not more than Rs. 100 crores
(as against Rs. 25 crores currently applicable).
after the expiry of 48 months from the end of the relevant assessment year; or
from the date of the sale of such specified security or sweat equity share by
the employee/assessee; or
from the date on which the employee/assessee ceases to be the employee
of the eligible start-up, whichever is earlier, on the basis of rates in force of
the relevant financial year in which the said security is allotted or
transferred.
Prior to this proposal, tax was required to be paid at the time of exercise of
option by an employee and such tax was calculated on the fair market value
of the security.
Benefits of an LLP
As mentioned above, foreign direct investment in an LLP is permitted only when there are
no performance-related conditionalities in the sector in which the LLP operates. LLPs in
the IT & ITeS sector, or the services sector, for instance, can receive 100% FDI, since these
said sectors currently do not have any performance-linked conditions under the FDI policy.
In view of this, early- stage companies in such sectors, which have no conditions attached,
can consider the LLP structure.
Ordinary equity shares are the most common instrument for investment in a
company. An ordinary equity share provides ownership in the company at par
with other equity shares/equity shareholders, without any preference or priority.
Each share represents one vote, and the economic benefits and voting rights are
associated with the number of ordinary equity shares held by a shareholder in
the company. Typically, investors do not prefer to subscribe only to ordinary
equity shares, since all ordinary equity shares rank pari passu inter-se each other
and give no additional or preferential rights to an investor vis-à-vis the founders.
Differential Voting Rights (DVR) shares are very popular with venture capital
investors and early-stage companies. DVR shares can be issued with differential
rights as to dividend, voting, or otherwise.
While DVR shares can be issued under the Companies Act, 2013, subject to
fulfillment of the various conditions mentioned therein (such as articles
permitting the issuance of DVR shares, being approved by the shareholders at a
general meeting, the company not having defaulted in filing financial statements
and annual returns for the last three financial years, etc.), the said conditions are
not applicable to a private limited company, per a notification issued by the
Ministry of Corporate Affairs in this regard. In any case, most of the conditions
are not onerous, to be fulfilled given a recent amendment to the same which
relaxed the eligibility requirement of the company with a consistent track record
of distributable profits for the last three years.
Preference Shares
Equity linked instruments are securities that are convertible into ordinary equity
shares, at the option of the holder of the instrument, or at the option of the
issuing company, or as mutually agreed between the holder and the issuer, or
on expiry of an agreed period of time.
An investor can also seek the right to convert instruments into equity at a
discount (subject to the pricing guidelines where the investor is a foreign
investor) in specific circumstances, including where the founders have
committed a default in terms of the agreement executed with such investors, to
compensate for the loss suffered. f no conversion is undertaken, the instruments
can be redeemed by the company by paying the holders of such instruments the
agreed amounts, per the terms of issue.
A table with certain specific characteristics of optionally convertible preference shares and
optionally convertible debentures is set out in the next page:
Authorised share capital is the maximum Since debentures are debt instruments
amount of capital which a company is until converted (and not shares), there is
authorised to issue. A company cannot no requirement to increase the authorised
issue ordinary equity shares, DVR shares share capital of a company in order to
and preference shares without having issue OCDs. The authorised share capital
sufficient authorised share capital. is required to be increased only at the time
of conversion of the OCDs into ordinary
Companies are required to incur certain equity shares.
statutory expenses in the nature of stamp
duty and registration fees for the purpose of Although this provides some flexibility to
creating and increasing authorised share the company at the time of issue of OCDs
capital. Where OCPS are proposed to be by not having to incur the stamp duty and
issued, a company will need to ensure that registration fees for the higher authorised
there is sufficient authorised share capital in capital, in certain cases investors stipulate
order to undertake such issuance.
that the company maintain sufficient
headroom in the authorised capital at the
time of issuance of convertible debentures
itself, so that at the time of conversion,
particularly in case of an event of default
where the investor and founders will likely
be in a conflicting position, the investor
can seek conversion into equity, without
requiring cooperation from the founders to
increase the authorised share capital.
Dividend/ Interest
The rate of dividend on preference shares Since OCDs are debt instruments, the
can be nominal and as mentioned above, provisions relating to loans in the
preference shares can be issued as a non- Companies Act, 2013, may require to be
cumulative instrument. complied with and this entails that an
interest may be chargeable on OCDs, at
least at the same rate of the interest
chargeable on Government Securities of
the same tenor as the OCDs.
Liquidation
Preference shares will rank higher than Debentures will rank higher than
ordinary equity shares in case of liquidation preference shares and ordinary equity
of a company. shares in case of liquidation of a company,
even where debentures are unsecured.
Convertible Notes
Similar to compulsorily convertible debentures, convertible notes are debt instruments that
can be issued by start-ups per the extant foreign exchange regulations. Foreign investors are
permitted to subscribe to convertible notes, only if issued by a start-up registered with the
Department of Promotion of Industry and Internal Trade, subject to the other conditions of the
regulations, such as a minimum investment of Rs. 25,00,000 to be brought in a single tranche.
The distinguishing feature between a compulsorily convertible debenture and a convertible
note is that a compulsorily convertible debenture has to mandatorily convert into equity, and
a convertible note is convertible or redeemable per the terms of the note. This characteristic
of a convertible note is similar to that of an optionally convertible debenture, where the
instrument can be either redeemed or converted. While optionally convertible debentures are
not ordinarily permitted to be subscribed to by foreign investors, as mentioned above,
regulations permit start-ups to issue convertible notes similar to optionally convertible
debentures, in order to make investments in start-ups more attractive. Convertible notes must
be converted into ordinary equity shares or redeemed within a period of five years from the
date of issue of such notes.
SAFE
Simple agreement for future equity (SAFE) is a financing agreement between the company
and domestic investor and is similar to a warrant, except that the actual price per share may
be determined at a later stage. A start-up can raise funds without the requirement of having to
issue any securities. A SAFE typically contemplates that the domestic investor will either
receive cash payment with an upside or receive stock of the company on certain events or a
date, as mutually agreed between the parties. Such trigger events could be a future equity
financing round, maturity date of the SAFE, and sale of the company. In the case of SAFE, the
parties defer the actual valuation of the company until the securities are issued, since the
securities are not valued at the time SAFE is executed.
Subject to sectoral caps and conditions, an eligible Indian party (i.e., company, registered
partnership firm, limited liability partnership, and any other entity in India, as may be notified
by the RBI) can make investments outside India for bona fide business activities, by
subscribing to/acquiring shares of a foreign entity, or by way of share swap. All overseas
investments in aggregate made by an Indian party cannot exceed 400% of the net worth of
the company, as per its last audited balance sheet.
The RBI recently updated the ‘frequently asked questions’ (FAQs) relating to overseas direct
investments. In an attempt to address round- tripping concerns, the RBI has stated in the
FAQs that an Indian entity cannot set up a subsidiary in India through its WOS or a JV in a
foreign jurisdiction, or acquire a WOS, or invest in a JV that already has a direct or indirect
investment in India.
With a multitude of global opportunities for companies, it is common to have Indian parties
set up a WOS or JV in a foreign jurisdiction. This RBI clarification stipulates that such WOS or
JV cannot repatriate any portion of its funds to India. While the aforesaid prohibition relating
to round-tripping was always understood, by expre sly incorporating this clarification in the
FAQs, companies will now be required to put in an application specifically seeking approval
to structure such investments, and approval will be granted on a case-by-case basis,
depending on the merits. In bona fide cases, approval may be forthcoming.
This article is only an attempt to explain key aspects of prospective investments by venture
capital investors in India and making investments/setting up operations overseas. All views
provided herein are personal and should not be construed as legal advice or opinions of the
Firm.
Bangalore
Raj specializes in corporate commercial, banking & finance, cross-border investments &
acquisitions, and employment matters. He has extensive experience in debt transactions
(secured & mezzanine), private equity, project finance, joint ventures, and regulatory &
policy issues governing such transactions. Raj has facilitated many high profile acquisitions
and investments in a variety of sectors involving complicated structuring and
documentation.
Bangalore
Rakki practices in the areas of real estate, finance, general corporate commercial, private
equity and general corporate advisory. She has represented clients in commercial
litigations and debt recovery matters. Rakki regularly advises clients including banks/
NBFCs in connection with acquisition and subscription of shares and debentures in various
sectors such as real estate, hospitality and education. She also regularly advises developers
and landowners in connection with joint development agreements and development
management agreements.
Shares with differential rights is a departure from the traditional concept of one- share-
one-vote. It is a structure where companies can create a dual class of equity shares that
provides for rights to vote and to claim dividend differential to the economic interest of the
underlying shares. The “differential” can either be upward or downward. Either way,
shares with differential rights skews control in favour of a certain category of shareholders
in a manner that is not proportionate to their economic contribution. Therefore differential
rights are useful to founders who can retain control over their companies even though
their equity is diluted with successive rounds of financing.
Dual class structures are not a recent phenomenon, as they have been a feature of the
share market since before the Great Depression in the US. More recently, tech companies
(Google, Alibaba, Snapchat, and Facebook), have issued shares with differential rights. In
India, the Tatas, Pantaloons Retail, and Gujarat NRE Coke Limited have also pursued the
path of shares with differential rights.
Differential rights are a well recognized concept in overseas markets. The US, Canada,
Hong Kong, Singapore, Denmark, Spain, Sweden, and Italy all allow dual class structures,
with Hong Kong and Singapore opposed to such structures until 2018 when they too
began to permit them.
Section 86 of the (Indian) Companies Act, 1956 read with the Companies ((Issue of Share
capital with differential voting Rights) Rules, 2001 allowed companies to issue shares with
differential rights with regard to voting, dividend, and any other matters as prescribed,
subject to certain conditions on the availability of distributable profits and subject to an
overall ceiling of 25% of the company’s share capital.
Listed companies however, were disallowed from issuing shares with superior rights of
voting or dividend both in the listing agreement and the Securities and Exchange Board of
India (SEBI) (Listing Obligations and Disclosure Requirements), Regulations, 2015. By
implication, therefore, inferior rights were not frowned upon in listed companies. These
were largely carried forward to the existing law in the Companies Act, 2013 [Section 43
and Rule 4 of the Companies (Share Capital and Debentures) Rules, 2014] and the SEBI
Listing Obligations and Disclosure Requirements), Regulations, 2015.
Earlier this year “SEBI” and the Ministry of Corporate Affairs (“MCA”) launched a series of
amendments permitting companies in certain sectors to issue Superior Shares pre-Initial
Public Offering (“IPO”) as also on a rights issue or bonus basis post IPO. The amendments
on the contrary, disallowed inferior voting rights in listed companies. The amendment
came on the heels of the approval of the SEBI framework at the SEBI board meeting on 27
June 2019 as per the consultancy paper on “Issuance of shares with Differential Voting
Rights” dated 20 March 2019.
A comparative of the law on shares with differential rights pre and post the amendments is
as follows:
Pre Amendments
For Listed Public Companies Private Limited & Unlisted Public Companies
Listed companies were not allowed to Issue of shares with differential rights is
issue shares with superior rights in respect possible if a company meets the following
of voting and dividend. conditions:
Post Amendments
Issue of shares with differential rights is possible if a company meets the following
conditions:
No penalty imposed by the Reserve Bank of India/ SEBI/ Sectoral regulators that has
been unpaid but a period of five years has not lapsed since payment of penalty
No default on payment of dividends, redemption, repayment of debt/deposits
74% of total voting power as overall ceiling
Authorized by its Articles of Association
Authorized by an ordinary resolution at a general meeting
Listed companies are allowed to issue Superior Shares through a rights issue or a bonus
issue, provided they have outstanding Superior Shares issued to their promoters and
founders. Superior Shares already issued to the promoters are subject to the following
conditions:
The superior voting rights shall not extend to the following matters:
For ease of reading, shares with differential rights that provide superior rights in
comparison to an ordinary share are referred to as “Superior Shares” and those that
provide inferior rights in comparison to ordinary shares as “Fractional Shares”.
The 2019 amendments have clearly veered away from the position that hitherto
disallowed promoters holding Superior Shares from listing their companies. The
amendments have been welcomed by founders across the country, boosting the
confidence of promoters who are on the IPO roadmap on the sticky issue of hostile
takeovers.
In providing promoters with the much-required control, SEBI has also tried to bring in the
balance of corporate governance by mandating that (i) a listed company with Superior
Shares must have its board and key committees dominated by the presence of at least a
majority of independent directors; (ii) a ceiling on the number of voting rights they can
exercise; and (iii) a ceiling of 74% on the entire number of Superior Shares. Another good
measure would have been prescribing the minimum number of ordinary shareholding
percentage required to convene any general meeting or vote on any matter where the
superior shareholders exercise their vote. Further, the protections of corporate
governance set out above have not been incorporated in the Act and are currently
required only for listed companies. Hence, for all practical purposes, in an unlisted
company, the promoters’ power is unchecked, apart from the check of Section 241 of the
Act, and the promoters could, by convening extraordinary general meetings, overrule the
decisions reached by the board that has heavy investor representation.
On the other hand, Regulation 41A(3) of LODR has gone overboard in stating that the
holders of Superior Shares cannot exercise their superior rights over the following matters:
The term “substantial value transaction” is wide-ranging and could encapsulate any
merger or amalgamation or change of control within its ambit. In such a scenario, the
promoters’ only recourse would be Section 241 of the Companies Act, 2013 in respect of a
claim of oppression or mismanagement.
While pursuing the path of reinstating control in the hands of the company’s founders, SEBI
is also simultaneously contemplating the inclusion of controlling shareholders as promoters
of a company. Only time will tell how the two changes will complement each other to achieve
SEBI’s objective, as the definition of controlling shareholders could include private equity
funds that are not the founders of the company.
The ICDR allows Superior Shares to be issued only to promoters who hold executive
positions in the company. It has, however, become increasingly common for promoters of
listed companies to move their personal holdings to family trusts or holding companies that
are operated by their families for better estate planning. In such a case, the SEBI regulations
are not immediately clear on whether such family trusts or promoter holding company
structures may be issued Superior Shares.
SEBI has justified its choice to restrict the issue of such Superior Shares to companies in
sectors that utilize technology and intellectual property sectors as companies in the new
technology sectors have asset-light models, with little or no need for debt financing but
with continuous equity infusions. The ICDR also requires that such technology companies
eligible to issue Superior Shares must be “intensive” in the use of technology, intellectual
property, etc. As the term “intensive” is not defined, it is subject to interpretation,
especially as today’s business models for most companies are technology-driven. Further,
the use of the term “intellectual property” is quite broad, especially in a common law
jurisdiction such as India. It could potentially include any company that has an active
“brand”, irrespective of any actual innovation or deployment of technology. The eligibility
criterion may have space for more objectivity, allowing more financial parameters such as
the debt-equity ratio of the eligible company.
The Companies Act, 2013 states that a company cannot issue shares with differential rights if
it has (a) defaulted in its repayment/redemption of deposits, debt/statutory/employee dues,
payment of dividend; or (b) been penalized by a regulator in order to prevent continued poor
management of the company. However, the Act is silent on the treatment of Superior Shares
while in default. The law would have been more purposeful had it stated that all existing
Superior Shares or Fractional Shares stand converted to ordinary shares on a conversion ratio
of 1:1 in order to maintain balance of power until the default is remedied.
Overall, the move by SEBI and MCA is a welcome amendment in the right direction,
attempting to provide for checks and balances through well-planned regulation. However,
only time and the manner of its implementation will prove the measure of its success.
Authors:
Bhavana's key focus area is General Corporate Commercial, Mergers & Acquisitions (M&A)
and Private Equity (PE) & Venture Capital. She covers the full spectrum of assisting business
through their life cycle from incorporation, day to day legal advice on business operations,
seed and early stage growth capital financings as well as in strategic alliances.Her practice
areas include advise on setting up business in India, day-to-day business operations,
corporate compliance and governance and business structuring and restructuring.
Prior to joining JSA in 2014, she worked in other law firms. Her interests also include
engaging with startups and working with entrepreneurs in the impact and rural financial
inclusion space.
Imagine that, while sitting on your couch at home, you strap on a sphygmomanometer to
measure your blood pressure;. your IoT-enabled device syncs with your cloud-based health
files to upload your readings. This AI-enabled cloud database studies the patterns of your
blood pressure, notices an increasing trend, and sends a push notification to your doctor,
recommending an increase in dosage. Your doctor takes a quick look at the AI-generated
graphs and tables, accepts the software’s suggestion, and signs off on the higher dose.
You are sent an e-prescription for the new dose. Imagine also that you can grant revocable
access to this database to all your medical service providers, giving every doctor you consult
full access to your medical history – you can designate different doctors as your primary
points of contact for various issues. Now, every one of your chosen healthcare providers can
note that you have been placed on stronger blood pressure medication. If this new dosage
has any cross-practice concerns, such as adverse drug interactions, the AI system will notify
the relevant doctor.
The healthcare industry is the playground for such advanced disruptive technologies. This
has us pondering the question: how will the law keep pace with the changes in drug
discovery, genetically-personalized medicine, telemedicine, online pharmacies, robotic
surgical arms AI-aided radiology, IoT-enabled medical devices, and diagnostic software.
Could it be that law can regulate all of them by making a single tweak, namely, treat software
itself as a medical device?
To balance patient safety and public health with technology-driven innovations in healthcare
is a Sisyphean task. In India, the nodal law governing pharmaceuticals is the Drugs and
Cosmetics Act, 1940 (“DCA”). Under this parent law DCA, rules have been passed,
including the Drugs and Cosmetics Rules, 1945 (“DCR”) and the Medical Devices Rules,
2017 (“MDR”).
The DCA has stated that a drug includes devices intended for internal or external use in the
diagnosis, treatment, and mitigation or prevention of disease in human beings and animals.
The MDR meanwhile defines devices as substances used for in vitro diagnosis and other
substances notified by the Central Government. Thus, a combined reading leads us to the
fact that, under India law, all notified medical devices are treated as “drugs” and the DCA is
applicable to such devices.
The Foreign Exchange Management (Non-Debt) Rules, 2019 (“FDI Rules”), which
regulate foreign direct investment in India, defines “medical device” in a manner similar to
that of the European Union (“EU”). The FDI Rules define “medical device” to largely mean any
instrument including the software, intended by its manufacturer to be used specially for
human beings and animals for the specific purposes of diagnosis, prevention, monitoring,
treatment, and alleviation of any disease or disability. The FDI Rules consider software to be a
medical device.
Venture Intelligence - Handbook on Venture Capital
33
This has been the position under the FDI Rules, even though domestic laws (DCA and MDR)
do not regulate software in or as a medical device.
However, on 18 October 2019, the Central Drugs Standards Control Authority (“CDSCO”), the
nodal organization under the DCA, issued a draft notification inviting public comments when
it proposed to notify software as a medical device. Although this notification has not yet
become law, given the ubiquity of software in the healthcare industry, it is only a matter of
time before this is given the effect of law. It becomes important, therefore, to understand the
challenges involved in categorizing software as a medical device.
While the States legislate for “healthtech”, it is crucial for them to regulate software in the
medical devices industry.
The US Food and Drug Administration (“USFDA”) classifies medical device software into
three main categories:
Software used in the maintenance or manufacture of medical devices requires the least
regulation, as the resultant medical device is (or will soon be) regulated under extant DCA
laws and standards.
Software in a medical device requires a greater degree of regulation, as existing laws and
standards governing the relevant hardware may not be equipped to handle a “smart” device.
For instance, an IoT-enabled pacemaker that provides real-time heart data to a
database/virtual platform, or an IoT/AI-enabled device that regulates dosages of intravenous
drugs based on monitoring of blood markers, will not be specifically provided for under
Indian law and standards governing non-enhanced devices.
This has been the position under the FDI Rules, even though domestic laws (DCA and MDR)
do not regulate software in or as a medical device.
However, on 18 October 2019, the Central Drugs Standards Control Authority (“CDSCO”), the
nodal organization under the DCA, issued a draft notification inviting public comments when
it proposed to notify software as a medical device. Although this notification has not yet
become law, given the ubiquity of software in the healthcare industry, it is only a matter of
time before this is given the effect of law. It becomes important, therefore, to understand the
challenges involved in categorizing software as a medical device.
While the States legislate for “healthtech”, it is crucial for them to regulate software in the
medical devices industry.
The US Food and Drug Administration (“USFDA”) classifies medical device software into
three main categories:
Software used in the maintenance or manufacture of medical devices requires the least
regulation, as the resultant medical device is (or will soon be) regulated under extant DCA
laws and standards.
Software in a medical device requires a greater degree of regulation, as existing laws and
standards governing the relevant hardware may not be equipped to handle a “smart” device.
For instance, an IoT-enabled pacemaker that provides real-time heart data to a
database/virtual platform, or an IoT/AI-enabled device that regulates dosages of intravenous
drugs based on monitoring of blood markers, will not be specifically provided for under
Indian law and standards governing non-enhanced devices.
The term “Software as a Medical Device” (SaMD) is defined as software intended to be used
for one or more medical purposes that perform these purposes without being part of a
hardware medical device.
SaMD is a medical device including an in-vitro diagnostic (IVD) medical device and is
capable of running on general purpose (non-medical purpose) computing platforms. The use
of the term “without being part of” means software not necessary for a hardware medical
device to achieve its intended medical purpose. If the intended purpose of the software is to
drive a hardware medical device, then the software is not treated as a medical device. When
software is used in combination (e.g., as a module) with other products, including medical
devices or interfaced with other medical devices even those incorporating hardware , then
they meet the definition of SaMD. Mobile apps that meet the foregoing definition are also
considered SaMD.
SaMD may also provide the means and suggestions for mitigation of a disease; furnish
information for determining compatibility, diagnosing, monitoring and treating physiological
conditions and congenital deformities; be an aid in diagnosis, screening, monitoring, and
determination of predisposition; and enable prognosis, prediction, determination of
physiological status. From this wide range of uses, it is clear that SaMD is a standalone
software that serves a medical purpose. While such SaMD may work/be interoperable with, or
even be incorporated in hardware (including hardware of a medical device), the existence of
such device is not necessary for the software to carry out its primary task. Diagnositc software
(used frequently in radiology and cancer detection) is a striking example of SaMD. However,
software that “drives” a medical device or “embedded software” (such as the software in
home-use glucometers that help analyze blood sugar readings and display results), software
that does not have a medical purpose of its own (such as encryption software, which
encodes medical data without any analysis or medical purpose of its own), a database that
does not have a medical purpose, or software that merely monitors quality/functioning of a
device to enable repair/maintenance are not considered SaMD.
In the Indian context, it does not suffice to merely issue a notification designating software as
a medical device, as extant laws are ill-equipped for the task. How, exactly, will India choose
to define SaMD? This definition can draw on the existing IMDRF definition and that used by
the EU Medical Devices Regulation 2017 (“EUMDR”). The need is for a comprehensive and
technology-agnostic definition, which will then inform all subsequent lawmaking in this
regard. Once software is designated as a medical device, it will become subject to all the
licensing requirements currently in place for drugs and other medical devices. However, the
laws do not contain any standards for SaMD (unlike, say, the prescriptions by the Bureau of
Indian Standards (“BIS”) for 974 medical devices, including surgical knives, pacemakers,
etc.).
At what stage will SaMD be considered safe for public use? What will be the risk classification
for SaMD? Any attempt to find sound answers to such queries is fraught with problems.
Legislation will have to seek to address how it will account for software bugs, updates and
bug fixes, disaster recovery programs, and risks from use or prohibition of open-source
software. Much thought must also be given to the mechanisms to be in place for clinical trials
of SaMD, and clinical or pre-clinical evaluations or tests to ensure their safety, stability,
security, interoperability, etc.
Other queries that still elude the law is how legal systems will provide for failed
interoperability, which may result in glitches or corruption of data, and how such SaMD will
be tested for repeatability, reliability, performance, risk management, and information
security.
From the point of view of regulatory capacity, it is also important to deliberate upon how
CDSCO and ancillary authorities will equip themselves to legislate, monitor, regulate, test,
and assess SaMD. Professionals with appropriate technical qualifications will have to form
part of these governmental authorities, and the law will need to be amended accordingly.
Importantly, it will be necessary to delve into the participatory risk matrices for
products/services and fix liability for defects or malfunctioning of SaMD. This could see some
evolution in medical negligence jurisprudence as well as in cybersecurity that forms the
backbone of devices and sharing of data that such devices will store and access.
The single most important question with regard to the proposed large-scale use of SaMD will
be data privacy and security. Health data, being sensitive and personally identifiable data,
must be subject to the highest standards of data privacy and security. The Government of
India’s final stance on localization of non-financial data as also personal data protection
norms, which are still at a bill stage, will also dictate the growth of this sector.
Regulating SaMD is a challenge for legislators all over the world despite the growing interest
and importance accorded by legislators and government to the public. The EUMDR is
currently the gold standard in this regard, with detailed regulations to handle SaMD, but even
these are not without their lacunae.
The Indian pharmaceutical and medical devices industry is at a crucial stage of growth. On
the one hand, they stand to benefit from the growing global trade war as countries look to
diversify their offshore manufacturing activities. On the other, the Indian generic drugs
industry has received its share of FDA investigation reports, which have pointed to the non-
compliance in India-based facilities that they deem serious.
With the DCA turning 80 years in 2021, it may be time for a recast of the critical areas of this
piece of legislation. The legislation for SaMD should be chartered along with ancillary
legislations that are bound to impact this space such as data protection, labeling, e-
pharmacies, medical negligence, and consumer protections laws.
Authors:
Aarthi started her practice in the US in 2001 as a foreign legal consultant concentrating on
the US-India business corridor until 2006. In 2010, she co-founded Vichar Partners that
merged its law practice with J. Sagar Associates in April 2014.
Aarthi’s practice focuses on the full spectrum of corporate laws and transactional matters:
mergers and acquisitions, venture capital transactions, private equity, foreign collaborations
including joint ventures and licensing transactions. She has extensive experience in working
in the India region, having acted for bidders, target companies, sellers and advisors in such
transactions. Her significant work also includes representing India clients investing in foreign
markets, family businesses in southern India in their growth initiatives and corporate
advisory, restructuring of family holdings.
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