A Private Equity Fund

Dedicated to Nepal

Regulatory Issues in Private Equity Investment in Nepal

Final

Date: Aug, 2014

Prepared by

Dolma Development Fund

[email protected]

www.dolmafund.org

In collaboration with

Strictly Confidential
CONFIDENTIALITY

This document should be held in the strictest of confidence. The information contained within is highly
sensitive and inappropriate or unauthorised disclosure may cause significant harm or disruption to the
progress of the Dolma Development Fund, its partners and their ability to achieve their objectives.
Dissemination of this document or its content should be on a need to know basis only.
TABLE OF CONTENTS

EXECUTIVE SUMMARY ....................................................................................................................................... 10

Entry Aspect of the PE Funds ................................................................................................................................. 11

Absence of Blanket and Automatic Approval Procedures ............................................................................ 11

Minimum Capitalization Norms .................................................................................................................... 12

Negative List, Positive List and Sectoral Caps.............................................................................................. 12

Treatment of the Foreign Loans .................................................................................................................... 12

Limited Investment Instruments .................................................................................................................... 12

Operational Aspect of PE Funds ............................................................................................................................. 13

Penalty Driven Filing Requirements ............................................................................................................. 13

Restriction to Indemnify the Director's Liability ........................................................................................... 14

Limitation on Delegation of Authority .......................................................................................................... 14

Investment Limit ........................................................................................................................................... 14

Blacklisting ................................................................................................................................................... 14

Dispute Settlement ........................................................................................................................................ 15

Restrictive Approach in Treating Hybrid Instruments .................................................................................. 15

Exit ................................................................................................................................................................... 15

Duplication in Approval Procedure ............................................................................................................... 15

Valuation Norms ........................................................................................................................................... 16

Restriction in Issuance of Shares at Premium Rate ....................................................................................... 16

Lock In Period ............................................................................................................................................... 16

Redemption of the Redeemable Preferential Shares ..................................................................................... 18

Tax Matters ............................................................................................................................................................. 18

Taxation in Change of Ownership ................................................................................................................. 18

Double Taxation Treaty................................................................................................................................. 18

Guidance on Taxation of Hybrid Instruments ............................................................................................... 19

Finality of Withholding Tax .......................................................................................................................... 19

Chapter One: Introduction to Private Equity Fund in Nepal ................................................................................ 20

1.1. Understanding Private Equity .................................................................................................................... 20

 1.2. Private Equity Market in Nepal ....................................................................................................................3

1.3. Participants of the Private Equity .................................................................................................................6

1.4. Governance Regime and Regulators in Nepal .............................................................................................8

1.4.1. Specific Laws and Regulators ...........................................................................................................9

2.4.2. General Laws and Regulators ......................................................................................................... 13

Chapter Two: Entry of Private Equity Fund .......................................................................................................... 15

2.1. Entry Options: Onshore Vehicle and Offshore Vehicle ............................................................................. 15

2.2. Setting Up of Private Equity Fund ............................................................................................................. 17

2.2.1. Offshore PEFs ................................................................................................................................. 17

2.3. Permitted Sectors ....................................................................................................................................... 19

2.4. Investment Options .................................................................................................................................... 21

2.5. Permitted Forms of Offshore Funds and Portfolio ..................................................................................... 21

2.5.1. Permitted Forms of Offshore Funds ................................................................................................ 21

2.5.2. Permitted Forms of Portfolios ......................................................................................................... 22

2.6. Onshore PEFs ............................................................................................................................................. 22

2.6.1. Approval Requirements .................................................................................................................. 22

2.6.2. Permitted Forms of Organization .................................................................................................... 22

2.7. Definitions of Related Terms ..................................................................................................................... 25

2.8. Permitted Forms of Investments ................................................................................................................ 25

2.8.1. Equity Shares .................................................................................................................................. 26

2.8.2. Loans ............................................................................................................................................... 26

2.8.3. Preference Shares ............................................................................................................................ 28

2.8.4. Debentures ...................................................................................................................................... 28

2.8.5. Shareholders‟ Loan ......................................................................................................................... 29

2.8.6. Other Hybrid Instruments (such as Income Participation Certificate) ............................................ 29

2.9. Review of Entry of Private Equity in India ................................................................................................ 31

2.9.1. Entry Routes.................................................................................................................................... 31

2.9.2. Regulatory Framework ................................................................................................................... 31

2.9.3. Offshore funds ................................................................................................................................ 32

2.9.4. Entry Process .................................................................................................................................. 32

 2.9.5. Limits on investments by Foreign Institutional Investors (FII) ....................................................... 32

2.9.6. Pricing Methodology....................................................................................................................... 32

2.9.7. Modality of PE Fund as per AIF Act .............................................................................................. 34

2.9.8. Permitted Instruments for Private Equity Funds under the FDI Scheme ........................................ 34

2.9.9. Permitted Instruments for Foreign Investors under ECB Scheme .................................................. 36

2.9.10. Conversion Period ........................................................................................................................... 36

2.9.11. Lock-In ............................................................................................................................................ 36

2.9.12. Gain from Sale of CCDs ................................................................................................................. 36

2.9.13. Permitted Instruments Under ECB .................................................................................................. 37

2.9.14. External Commercial Borrowings (ECB), (India, 2012)................................................................. 37

2.10 Review of Entry of Private Equity in Sri Lanka ......................................................................................... 39

2.10.1. Regulatory Framework ...................................................................................................................... 39

2.10.2. Offshore Vehicles .............................................................................................................................. 40

2.10.3. Entry Process ..................................................................................................................................... 40

2.10.4. Sectors Opened for Foreign Investment ............................................................................................ 41

2.10.5. Share Transaction and Private Placements ........................................................................................ 41

2.10.6. Permitted Instruments for Foreign Investors ..................................................................................... 41

2.10.7. Lock In Period ................................................................................................................................... 43

2.10.8. Incentives Offered on Investments .................................................................................................... 44

2.10.9. Review of Entry of Private Equity in Bangladesh ............................................................................. 45

2.10.10. Regulatory Framework .................................................................................................................... 45

2.10.11. Offshore Vehicles ............................................................................................................................ 46

2.10.12. Entry Process ................................................................................................................................... 46

2.10.13. Investments Sectors......................................................................................................................... 47

2.10.14. Limits on Investments by FII .......................................................................................................... 47

2.10.15. General Incentives........................................................................................................................... 47

2.10.16. Modality of PE Fund ....................................................................................................................... 47

2.10.17. Investment Instruments under FDI .................................................................................................. 48

2.10.18. Lock-In Period ................................................................................................................................ 49

Chapter Three: Operational Aspects of the Private Equity Fund......................................................................... 50

 3.1. Rights of minority shareholders ................................................................................................................. 50

3.2. Qualification for Board of Directors .......................................................................................................... 52

3.3. Representation of Portfolios and Directors‟ Liabilities .............................................................................. 53

3.4. Delegation of Authority ............................................................................................................................. 53

3.5. Blacklisting ................................................................................................................................................ 54

3.6. Visa and Work Permit ................................................................................................................................ 55

3.7. Dispute Settlement ..................................................................................................................................... 55

3.8. Filing and Reporting Requirement ............................................................................................................. 55

3.9. Investment Limit ........................................................................................................................................ 56

Chapter Four: Exit and Repatriation ...................................................................................................................... 57

4. Exit ............................................................................................................................................................. 57

4.1. Exits through Private Route ....................................................................................................................... 59

4.1.1. Buyback of Unlisted Shares ............................................................................................................ 59

4.1.2. Exit exercising put option ............................................................................................................... 60

4.1.3. Capital Reduction ............................................................................................................................ 60

4.1.4. Redemption of the securities ........................................................................................................... 61

4.1.5. Loan Repayment ............................................................................................................................. 61

4.2. Exits through Public Route ............................................................................................................. 62

4.2.1. Initial Public Offerings ("IPOs") ..................................................................................................... 62

4.2.2. Public Sale of Securities in Secondary Market ............................................................................... 65

4.2.3. Redemption of Debentures .............................................................................................................. 65

4.2.4. Buyback of Listed Shares ............................................................................................................... 65

4.2.5. Disposal of Shares by way of Private Placement ............................................................................ 66

4.3. Other Relevant Issues ................................................................................................................................. 66

4.3.1. Valuation Method for Pricing of Securities .................................................................................... 66

4.3.2. Promoter's Lock-In.......................................................................................................................... 67

Chapter Five: Tax Aspects of the Private Equity in Nepal .................................................................................... 69

5.1. Taxation in Change of Ownership ............................................................................................................. 69

5.2. Double Taxation Treaty ............................................................................................................................. 70

5.3. Guidance on Taxation of Hybrid Instruments ............................................................................................ 70

 5.4. Finality of Withholding Tax ....................................................................................................................... 70

Chapter Six: Issues and Recommendation .............................................................................................................. 71

Bibliography ............................................................................................................................................................... 99

Annexure ..................................................................................................................................................................... A
ABBREVIATIONS

1. AIF Alternative Investment Fund

BAFIA Bank and Financial Institution Act, 2006

CCDS Compulsorily Convertible Debenture Shares

CCPS Compulsorily Convertible Preference Shares

DCF Discounted Cash Flow

DFID Department for International Development (UK)

DIPP Department of Industrial Policy and Promotion

DOI Department of Industry

Draft FITTA Draft Foreign Investment and Technology Transfer Act

DTA Double Taxation Treaty

ECB External Commercial Borrowings

FDI Foreign Direct Investment

FITTA Foreign Investment and Technology Transfer Act, 1992

IEA Industrial Enterprises Act, 1992

IPO Initial Public Offering

IRD Inland Revenue Department

ITA Income Tax Act, 2002

LLP Limited Liability Partnership

MCR Minimum Capital Requirement

NRB Nepal Rastra Bank

NRN Non-Resident Nepalese

OCR Office of the Company Registrar

PE Fund Private Equity Fund

SAARC South Asian Association for Regional Cooperation

SEBI Security Exchange Board of India

SEBON Security Exchange Board of Nepal

SME Small and Medium Scaled Enterprises

VCF Venture Capital Fund

VCU Venture Capital Undertakings

Disclaimer
This intervention was led by Dolma Impact Fund with the support of DFID Nepal. The research,
data collection and diagnosis were a collaborative effort of Pioneer Law Associates and Kriti
Capital & Investments Ltd.

The objective of the report is to review and analyse the existing regulations for foreign private
equity investment in Nepal and make comparative review with similar practices in SAARC
countries. The chapters on entry options, operational issues, tax aspects of private Equity fund
in Nepal has been prepared by Pioneer Law Associates while the introductory chapter and the
chapter on repatriation and exit has been prepared by Kriti Capital and Investments Ltd. The
report has been prepared based on publicly available information, interview with related
stakeholders, review of related regulations, and practical experience related to foreign
investment and capital market of the Pioneer Law and Kriti Capital. The implications, issues and
suggestions of reforms are the views of the Pioneer Law and Kriti Capital and does not
necessary represent the views of Dolma Development Fund.

Pioneer Law Associates Pvt. Ltd Kriti Capital & Investments Ltd.

Pioneer House, 246 S Mathuri Sadan, 6th Floor,

Sahayog Marg, Anamnagar, Kathmandu, Ravibhawan, Kathmandu, Nepal

Nepal.
Phone No.: +977-1-4221340 Phone No.: 01-4276786, 01-4281776

Email: [email protected] Email: [email protected]

Website: www.pioneerlaw.com Website: www.kriticapital.com.np

EXECUTIVE SUMMARY
This report was commissioned to study the legal and regulatory environment concerning the entry, exit
and operation of the Private Equity Funds (the "PE Funds") in Nepal.

The PE Funds for the purpose of this report should be understood as a registered fund (both offshore and
onshore) which pools the investible funds through private particularly by selling bonds, debentures and
other forms of assurance and carefully invests in equity or risk capital in targets identified and selected by
investment experts in the PE Funds through loan, equity and other hybrid instruments.

This report was produced with a joint mandate to review existing legal and regulatory framework, identify
bottlenecks and caveats concerning the operation and exit the of PE Funds and also mandated to suggest
possible short term and long terms reforms to be undertaken in view of providing comfortable legal and
regulatory environment for PE Funds in Nepal.

Nepalese Law does not have a single and comprehensive regulatory framework to provide for regulation
of the PE Funds like our neighboring SAARC nations. Legal provisions and requirements applicable in
the context of setting-up, operation and exits of the PE Funds are scattered in different laws.

Theoretically, three different types of PE Funds: - (a) Offshore PE Funds (the funds which are registered
and organized outside of Nepal), (b) Foreign Onshore PE Funds (the funds which are registered in Nepal
after obtaining the regulatory approvals including the approvals for the foreign investments), and (c)
Domestic Onshore Funds formed fully owned by the local investors, can invest in Nepalese portfolios and
targets subject to obtaining of investment approvals and some regulatory restrictions.

ENTRY ASPECT OF THE PE FUNDS

ABSENCE OF BLANKET AND AUTOMATIC APPROVAL PROCEDURES

Automatic approval route and blanket approval route are not yet allowed for foreign investors in Nepal.
The Offshore PE Funds are required to obtain approval, at least from: - (a) Investment Board or Industrial
Promotion Board/Department of Industries (depending upon the size of investment) and from Nepal
Rastra Bank (NRB; the Central Bank) before they can invest in portfolios of permitted sector Investment
from the Offshore PE Funds, whatever the case may be, are regarded as the foreign investment and are
subject to the negative list, implied positive list and permissibility of the investment instrument.
Approvals from the authorities are required in every instance of investment and divestment making the
foreign investment cost intensive and time consuming. Operation of the FITTA's Negative List, IEA's
implied positive list1, sectoral caps under different scattered policies and the prohibitive treatment of
investment instrument leave only a few sectors open for Offshore PE Funds investment.

1
As a matter of practice, foreign investment is allowed only for the sectors which are identified as Industrial sector
under IEA.
MINIMUM CAPITALIZATION NORMS

Minimum capitalization requirement is also a serious obstacle preventing the Offshore PE Funds to select
to inject seed capital in the small and medium enterprises (SMEs) and venture capital undertakings. While
at present such general minimum capitalization requirement for foreign investment is fixed as Rs. 5
Million, the Draft FITTA is expected to increase it up to USD Ten Million ( Rs. 956,800,000 calculated at
the exchange rate of USD 1 = 95.68) making the situation worse than before for the SMEs. Such
requirements may be relaxed for certain sectors of the SMEs and Venture Capital Undertakings to boost
up investment in such sector.

NEGATIVE LIST, POSIT IVE LIST AND SECTORAL CAPS

Negative List in the FITTA, implied positive list in the IEA and sector specific caps scattered on different
policies for foreign investment has left only a handful of sectors open for foreign investment in Nepal.
There are no public documents which provide for exhaustive list of the sectors that are open for foreign
investment and the approach by the authorities in interpreting the 'implied positive list' is highly
inconsistent, for example: While casinos are being operated under foreign investment and are allowed to
do so, at present, proposals to operate Casinos under Foreign Investment are being rejected at the DOI
showing the implied positive list. The Draft FITTA has proposed to impose/ prescribe sectoral caps on
additional number of sectors for investment than which are currently available.

TREATMENT OF THE FOREIGN LOANS

NRB approach in treating/allowing foreign loans and foreign investment through different investment
instruments also present itself as a caveat in investing in Nepal. The company can avail foreign loan
subject to following conditions: - (a) only if the company cannot avail loan from domestic banks and
financial institutions; (b) the interest rate under foreign loan is lower than prevailing interest rate in
domestic market. NRB's restrictive condition in repayment of foreign debt is also an issue that cannot be
overlooked. NRB allows the debtor availing foreign loans only in the following conditions - (a) if it does
not have any debt payable to local banks and financial institutions, and (b) if it is not blacklisted as a
defaulter. The restrictive approach in treating foreign loans needs to be revised in order to allow the
Onshore PE Funds to avail foreign loans.

LIMITED INVESTMENT INSTRUMENTS

The investment options available to the Offshore PE Funds are very limited. Pursuant to BAFIA, only
licensed bank and financial institutions are authorized to carryout banking and financial institutions and
the tragedy for the Onshore PE Fund is that their lending function has been recognized as banking
transaction under Section 47 of the BAFIA. As the Banking Function is reserved for licensed Banks and
Financial Institutions, PE Fund or any Investment Company are restricted to make any loan investment.
Unless NRB and other stakeholders remove this restriction, Offshore PE Funds will be restricted to invest
in the portfolios of targets/undertakings by way of loan or any other instrument that have element of debt.

Regulation of the PE Funds (both Onshore and Offshore) through the scattered provisions makes the
regulatory environment complex and cumbersome. Requirement to obtain approvals for doing/ executing
nearly everything: each instance of investment, divestment, and return of sale proceeds following arduous
procedures increasing the cost and time of investment and affecting the investor's ability to make swift
decisions. Lack of sufficient clarity in the existing laws: to take an example, lack of sufficient clarity on
the areas where an investment company can invest its money out of its fund and by which instrument, has
also aided to make the situation unfriendly for entry of PE Funds as well as investment in portfolios of
chosen targets and undertakings.

The scattered provisions applicable in course of setting up or operation and exit of the PE Funds has make
PE Funds regime confusing and less predictable. A single notification of authorities, say NRB's exchange
control notification, can have a potential effect to shut down the entire business of PE Funds. To deal with
the uncertainty and inconsistency at the present, a special and separate regulatory regime to deal with PE
Funds which supersedes the provisions of all other law is the need of the time.

The PE Funds may be categorized into two or more different forms under a single regulatory framework
to deal with the necessity to treat them differently. For example, PE Funds investing solely investing into
Venture Capital Undertakings or SMEs may be categorized as 'A' type PE Fund and those one investing
solely in diverse portfolios in secondary market may be classified as 'B' type PE Fund. Classification of
the PE Funds on the basis of their investment function makes it easier to prescribe separate regulatory
requirement and conditions considering the peculiarity in their investment functions in an efficient way.
The recent SEBI Alternative Investment Fund Regulation in India can be taken as an example where the
PE Funds investing in VCUs and/or PE Funds investing in the listed shares has be categorized into
different types and the requirements are prescribed separately.

OPERATIONAL ASPECT OF PE FUNDS

The PE Funds will not be left at a problem-free-zone after entering into the market or making investment
in Nepalese Portfolios following arduous procedures. There are several regulatory and legal issues which
hinder the smooth operational aspects of the PE Funds.

PENALTY DRIVEN FILING REQUIREMENTS

The first issue here is the numerous filing requirements. Failure to comply with the filing requirements
will attract the penalty and the concerned authorities are very much adept in using sledgehammer
approach in imposing penalties. Companies registered in Nepal are required to file corporate documents
before the Office of the Company Registrar ("OCR") and some filing requirements appear to be
irrelevant and unnecessary. Certain requirements like: annual filing of share-capital structures (even when
there has been no change in capital structure for a period), the requirement to inform regarding
appointment of auditor etc. appears to be irrelevant. Failure to file the corporate documents within the
stipulated time will make the companies liable to pay fines and penalty and the amount of payable fine
increases with the passage of time.

In some cases the nominee directors in the investee companies appointed by investor PE Funds are
themselves liable to fines and imprisonment for failure to comply with filing and reporting requirements.
RESTRICTION TO INDEMNIFY THE DIRECTOR'S LIABILITY

Directors are personally liable to fine of up to Rs. 50,000 and imprisonment of up to 2 years for failing to
comply with the provisions of the Companies Act, 2006. The Companies Act restricts any company to
indemnify directors against personal liability. Moreover, the director's liability insurance policy cannot be
easily purchased from the local market. Strict liability on the part of directors and absence of any cushion
against such liability may deter the PE Funds or their investee undertakings to take risky-yet-strategic
decisions. Some qualified directors may find it difficult to become a member of the Board as they may
face imprisonment if anything was to go wrong in the company..

LIMITATION ON DELEGATION OF AUTHORITY

It is not always possible for the Board of Directors to sit and make investment decisions each and every
time. Customarily, PE Funds appoint or contract an investment manager(s) and investment experts to
make investment decisions. However, the Companies Act, 2006 has reserved the authority of making
decisions regarding loans and investment out of the funds of the company only to the Board of Director,
however, this forced reservation does not apply to licensed Banks and Financial Institutions as well as the
company with an objective to carrying out financial services. The said limitation on the delegation of
authority, particularly to make loan and investment decisions, is not compatible on account of PE Funds.
This limitation must be revised if PE Funds are to operate in Nepal.

INVESTMENT LIMIT

Companies Act restricts the companies to lend or invest in excess of -(a) 60% of sum of total paid up
capital and free reserve, or (b)100% of the free reserves whichever is higher, however, the Companies
with the objective to sell and purchase the securities are exempted from this restriction. PE Funds pools
investment through public subscription, private placement or through other means and reinvest in
carefully chosen targets. The amount pooled in the PE Funds at any instance are very much higher than
the sum of the paid up capital and amount provisioned as free reserve in Annual Financial Statements.
The restriction will force the Offshore PE Funds to hoard the money collected in the fund. It is not clear
whether the Onshore PE Funds can organize as a Company with objective to sell and purchase securities.
PE Funds should be recognized as a Company having objective to sell and purchase securities by way of
clarification or notification.

BLACKLISTING

As per the NRB's provision of blacklisting of defaulter, the PE Funds as well as its directors and its
appointee director in the targets will be blacklisted, if the investee companies receiving 15% or more of
their equity capital defaults in loan repayment to the licensed banks and financial institutions in Nepal.
The possibility of the chosen targets or companies being blacklisted for default in servicing debt cannot
be out-ruled even if a great deal of precaution is/was employed while choosing the targets. While the PE
Funds customarily invest in hundreds of targets, default by one or two of their investee companies will
make the PE Funds blacklisted leaving no option but to shut down their entire business. The blacklisting
provisions at the present appear to be draconian for PE Funds. Revision in blacklisting norms is required
to provide for a comfortable working environment for PE funds, considering the typical investment
norms and practices of PE Funds.

DISPUTE SETTLEMENT

Offshore PE Funds investing in the portfolios of Nepalese companies have an option to choose the law
governing their foreign investment agreement only when the amount of foreign investment is more than
Rs. 500,000,000 (Five Hundred Million Nepalese Rupees). Given the fact that the arbitration process in
Nepal are plagued with procedural delays and the issue of nationality bias, the prospective Offshore
Funds willing to test the water in Nepal may not feel comfortable. The provisions in FITTA making the
autonomy of the party to choose the governing law conditional or subject to the amount of inward foreign
investment, seriously limits the SMEs and Venture Capital Undertaking's opportunity to receive the
foreign investment.

RESTRICTIVE APPROACH IN TREATING HYBRID INSTRUMENTS

The existing law of Nepal is silent in providing any guidance regarding the treatment and permissibility of
the foreign hybrid instruments. NRB has not prescribed any norms that would be applicable on raising
foreign capital through debentures and hybrid instruments, till date. Absence of regulatory norms in Nepal
should be understood as implied restriction as per the Nepalese Practice. The implied restrictions in
raising the capital in foreign currency by way of debenture or through other hybrid instrument have
limited the subscription options available to the Onshore PE Funds. NRB should prescribe the regulatory
norms for the treatment of foreign hybrid instruments in order to allow the Onshore PE funds to pool the
foreign capital to invest in the targets and portfolios of the Nepalese Companies.

EXIT

The PE Funds as a matter of custom has predetermined and short life span. Almost every of the PE Funds
has the objective and strategy to exit from their targets upon the expiry of a fixed time. The successful
operation of the exit strategy depends upon how friendly the regulatory environment for exit is.
Unfortunately, the regulatory environment is not-so-friendly in Nepal. The exit from the targets will be
very difficult for the PE Funds, unless, the existing onerous provisions on Security Law and Company
Law of Nepal are relaxed in case of PE Funds, considering their typical nature for investment and limited
lifespan. Some issues affecting the successful exit from the targets and possible ways to curb the
difficulties are highlighted below:

DUPLICATION IN APPROVAL PROCEDURE

Exiting from the targets may not be difficult for Onshore Funds, but it is a very serious matter in case of
Offshore Funds. Offshore PE Funds are required to obtain approvals, at least from - (a) DOI and (b) NRB
before they can divest their investment, or repatriate the sale proceeds and dividends. The process for
obtaining approval is fraught with procedural delays and lack of coordination among the authorities and it
can take more than two (2) months to complete even after strong persuasion and lobbying. The approval
requirements per se and the procedural delays create a sense of funds being trapped in the targets once
they enter. By exercise of control and the procedural delays, a lot of capital delay might actually be
discouraged - those who are willing to come and invest to test the water might not do so fearing that
strategic exit from the target might not to be possible.

VALUATION NORMS

NRB's Notice dated May 29, 2012 states the requirement for the submission of valuation report of the
assets and liabilities for the repatriation of the foreign investment. However, the NRB or other concerned
authorities have not specified the valuation norms and method till the date. This has resulted in ambiguity
in the choice of valuation method. In absence of specific valuation norms and methods, the NRB may
object to the particular method of valuation with a drive to - (a) protect the foreign exchange reserve by
claiming that the value of unit share is low if the other method of valuation was objected; and/or (b) to
levy higher capital gain tax claiming that the value per unit of share will be higher if another method of
valuation is used. Offshore PE Funds may not be able to implement its strategic interest to exit from the
targets in a short time frame should the authority object to the particular method of valuation. The NRB
and other authorities may coordinate in prescribing valuation method applicable for the repatriation of the
divestment, dividend and sale proceeds.

RESTRICTION IN ISSUANCE OF SHARES AT PREMIUM RATE

Companies in Nepal cannot issue share in premium rate without having the track record of dividend
distribution for a consecutive three years and without fulfilling other prescribed conditions. The said
restriction will prohibit the Offshore PE Funds to exit from the targets by selling its holding at a premium
price, even if the targets shows a promising future returns on the premium issued. While the said
restriction may be justified in the pretext of protecting the interest of the retail investors, the justification
does not hold good in all situation. The case of the PE Funds investing in the Research and Development
sector can be taken as an example.

To facilitate the speedy exit of PE Fund, PE Funds investing in the Research and Development and other
sectors having relatively higher gestation period should be exempted from the "minimum three year profit
distribution requirement" while selling or opting to sell shares at a premium rate.

LOCK IN P ERIOD

As per the SEBON rule on IPOs, All pre-IPO equity investors in non-financial institutions are unable to
exit their investments for three years post-IPO, regardless of whether they are promoters or purely
financial investors such PE Funds. Furthermore, a Company in Nepal cannot float its shares for public
issuance until after three years from the date of operation. This together grosses a six (6) year of lock-in-
period, a restrictive regulatory environment for the exit of PE Funds by offloading its shares floating
public issue. PE Funds enjoy a relatively lesser lock in period in comparison to other investment vehicles
almost everywhere. India can be taken as an example where the lock-in-period for AIF registered under
SEBI AIF Regulation, 2012 is only one (1) year. Lock-in-period should be reduced/ lowered particularly
for PE Funds taking into account their limited lifespan.
REDEMPTION OF THE REDEEMABLE PREFERENTIAL SHARES

As per the Companies Act, 2006; Redemption of the shares previously issued can be done out of -(a)
amount deposited in redemption fund which otherwise would be a distributable profit, or (b) money
received from the share issued specifically for the purpose of redemption. The said condition implies that
the company can redeem its shares only when it is in the state of profit. Due to said restrictions, PE Funds
will not be able to exit from the investee company even by selling its preferential shares at a value less
than the face value of the shares or the value of the shares at time of acquisitions. The restrictive
conditions on redeeming the shares mean that the PE Funds can never exit from the investee companies in
case the investee company is in loss.

Section 65 (5) of the Companies Act, 2006; has prescribed that the said restrictive conditions must be
amended, allowing the investee companies to redeem the Preferential Shares issued to PE Funds from the
amount available as paid up capital of the company or out of the amount collected by way of sale of
investment and assets.

The provisions may be prescribed to require the investee company to adjust the value of the redeemable
shares against assets and liabilities in case it is operating in loss or state of loss.

TAX MATTERS

TAXATION IN CHANGE OF OWNERSHIP

Section 57 of the ITA, 2002 provides that if the ownership of any entity changes by 50% or more within a
period of 3 (three) years, then such entity will be deemed to have disposed of its assets or liabilities.
Pursuant to Section 57 of the ITA, 2002, as a result of change of ownership by 50% or more-(a) the assets
and liabilities of the entity will have to be evaluated at market price and the entity will be subject to tax on
any gain amount (at the rate of the tax applicable on business income), and (b) the entity will not be able
to carry forward the losses, and such other restrictions outlined in Section 57(3) of the ITA, 2002 will be
applicable.

PE Funds will need to be provided specific waivers from the requirement of Section 57 of the ITA, 2002.
It may be noted that the Government of Nepal had introduced targeted waiver for banks and financial
institutions from the requirement of Section 57 to encourage merger and consolidation of financial sector.

DOUBLE TAXATION TREATY

Nepal has entered into double taxation treaty (the "DTA") with ten countries. In practice, however, the
intended beneficiaries under the DTA are not able to receive the double taxation benefits provided under
the DTA due to wrong application of the DTA by the IRD. The IRD should set-out the written guidance
on applicability of the DTA and situation where payments from Nepal will not be subject to the
withholding tax requirement.

GUIDANCE ON TAXATION OF HYBRID INSTRUMENTS

The usage of hybrid instruments in Nepal is not common and their tax treatment does not have any
legislative or regulatory guidance. ITA, 2002 provides substantial difference in treatment of interest and
equity. The financial impact for re-characterization of any transaction from equity to debt or debt to
equity is likely to be substantial. The IRD should set-out a written guidance with its view for tax
treatment so as to provide predictability for use and structuring of the hybrid instruments which should
meet the commercial objective of the investors and need of the investee entities.

FINALITY OF WITHHOLDING TAX

Section 92 of the ITA, 2002 provides final tax treatment for certain payments on which tax has been
withheld. The payment falling under Section 92 of the ITA, 2002 are treated as finally taxed and no
additional tax is incurred. The provision related to withholding of tax on capital gain tax is provided by
Section 95A of the ITA, 2002. Section 92 of the ITA, 2002 which provides list of payments which shall
be treated as final, does not include payments made under Section 95A. The VCFs should be provided
finality of taxes.
 CHAPTER ONE: INTRODUCTION TO PRIVATE EQUITY FUND IN NEPAL

1.1. UNDERSTANDING PRIVATE EQUITY

Private equity funds are investment vehicles formed to raise capital to make multiple investments in a
specified industrial sector or geographic region. The private equity market provides capital to invest in
unquoted companies. These investments may take the form of a purchase of shares from an existing
shareholder (a buy-out if control is acquired) or an investment in new shares providing fresh capital to the
investee company (development capital). Frequently both types of funding are provided in any given
transaction. The term „private equity‟ has no consistently-applied definition and is increasingly applied to
any investor that is not quoted on a recognized financial market. In this report we employ the definition
used within the established private equity industry. A structure of typical private equity fund is:
 Partners in PE Fund
Salary, Fee
Income
The Investment The Limited partners
Capital Gains,
Manager
Dividends and
Interest Investment Fund A
Fee Income

The General Capital Interest Scheme

Partner Investment Fund B
Capital Capital Gains,
Gains, Dividends and
PE Fund
Dividends Interest Investment Fund C
and Interest

Capital Gains, Dividends and Interest Investment Fund Z

Investment Investment Investment Investment

A B C Z

Investee Companies

Figure 1: Structure of Private Equity Fund

A private equity fund is a form of „investment club‟ in which the principal investors are institutional
investors such as pension funds, investment funds, endowment funds, insurance companies, banks, family
offices/high net worth individuals and funds of funds, as well as the private equity fund managers
themselves. The objective of a private equity fund is to invest equity or risk capital in a portfolio of
private companies which are identified and researched by the private equity fund managers. Private equity
funds are generally designed to generate capital profits from the sale of investments rather than income
from dividends, fees and interest payments. A private equity fund may take minority or majority stakes in
its investments, though invariably it will be the latter in the larger buy-outs. At the same time that a
private equity fund makes an investment in a private company, there is usually some bank debt or other
debt capital raised to meet part of the capital required to fund the acquisition.

Private equity fund managers involve in activities such as:

 Raise funds from investors to make investments, principally in private companies.

 Source investment opportunities and make investments.
 Actively manage those investments.
  Realize capital gains by selling or floating investments.

In Nepal, private equity term has not been recognized as a form of institutional investment made either by
domestic capital markets or by foreign investors. In Nepal, Foreign Investments have been defined and
categorized by Foreign Investment and Technology Transfer Act (FITTA). FITTA, 1992 defines Foreign
Investment as investment made by a foreign investor in any industry in the form of investment in shares
(equity), reinvestment of earnings from investment in shares (equity) and investment made in the form of
loan or loan facilities.

This report is an outcome of collaborative efforts of Pioneer Law Associates and Kriti Capital
Investments to provide Dolma Development Fund insights on existing regulatory framework in Nepal,
best practices and provide recommendation on broader policy and regulation changes for much needed
Private Equity business to thrive in Nepal. Thus, the objectives of this report are to:

 Study the rules and regulations that have directly or indirectly created bottleneck for private
equity/venture capital firms in Nepal.
 Understand, analyze and determine best practices in international context with special focus on
India and other relevant South Asian Countries.
 Review the regulations related to initial public offerings (IPOs).
 Understand barriers to entry and exit in the development of investment friendly market for PEs in
Nepal.
 Highlight the need of Private Equity business in Nepal and recommend on required regulatory
changes to create Private Equity friendly regulatory environment.

The report is structured in the following way: Chapter One provides basic information on Private Equity
Market, participants and PE in Nepal. Chapter Two discusses Entry options for Private Equity in Nepal
with special reference to entry options in India, Sri Lanka and Bangladesh. Chapter Three reviews the
operation aspects of PE whereas Chapter Four discusses the available exit strategies for Private Equities
with special reference to exit options in India. Chapter Five provides insights on Tax aspects of Private
Equity and final chapter concludes the report with list of key issues and recommendations.

1.2. PRIVATE EQUITY MARKET IN NEPAL

The introduction of Foreign Investment and Technology Act, 1981 and the subsequent Industrial Policy
developed a proper framework for foreign investment in Nepal. Investment Promotion meeting was held
in 1984 to promote foreign investment and to create awareness on investment opportunities in the
country.

Nepal Investment Forum was organized in 1992 in Kathmandu, which helped attract foreign investors in
Nepal. This was further enhanced by the promulgation of Foreign Investment and Technology Transfer
Act, 1992 (FITTA) and Industrial Enterprises Act, 1992 (IEA), which sought to develop one window
policy to ease the foreign investment process. National five-year plans too promoted foreign investment
in the nation.
The foreign investors were allowed to invest in any industry up to a prescribed limit except in the pre-
determined twenty-one sectors. The sectors with considerable foreign private equity investment
participation in Nepal were:

SECTORS COMPANIES WITH FOREIGN INVESTMENT

Financial Standard Chartered Bank Nabil Bank Everest Bank

Services
Nepal Bangladesh Bank Himalayan Bank United Finance

International Leasing & Finance Sagarmatha Insurance United Insurance

Manufacturing Asian Paints Nepal Unilever Nepal Ltd. Pepsi Cola

Vashuling Sugar & General Ind. Gorkha Brewery P. Ltd Dabur Nepal Ltd.

Infrastructure Bhote Koshi Power Co. Himal Power Co Panda of Nepal

Statcraft Anlegg Nepal P. Ltd

Export-oriented Nepal Bayern Electric Nara International Male Fashions

Trikumar Garment Industry Shakti Carpet Service

Tourism Hotel Himalaya Hokke Hotel (Lumbini) Monal Resort

Taini International Resort

Aviation Himalayan Helicopters Dynasty Aviation Lumbini Airways

Balloon Sunrise Nepal

Telecom Ncell UTL

Source: NRB, Foreign Exchange Department

Following timeline shows the entry of private equity investment in Nepal.

Source: Compiled by author through various sources.

Figure 2: Timeline of Entry of Foreign Investment in Nepal

In Nepal, the concept of private equity fund is fairly new. The first local private equity fund was Surya
Equity Fund, managed by Soaltee Group (Owner/Manager of Solatee Hotel Ltd.). Surya Fund is an
investment management company, intending to establish itself as the vehicle for investment and capital
appreciation for the prospective investors.

Beside Surya Equity Fund, there have been few companies incorporated as a private company with the
objective of operating like a PE Fund does. But, the active roles of such companies are yet to be seen in
the market. As the first international private equity investment, Dolma Impact Fund I has been initiated.
The Fund is being established with support from the UK Department for International Development
(DFID) to generate private sector-led growth and jobs alongside positive social and environmental impact
in Nepal.
1.3. PARTICIPANTS OF THE PRIVATE EQUITY

There are two parties involved in every corporate transaction: those acting with or for the purchaser, and
those acting with or for the owners of the Target Company and shareholders. In a private equity fund the
key figures on the purchaser‟s side are the private equity fund that will invest in the transaction and the
investment bankers who will lend in support of the deal. Partners in PE Fund are institutional and high-
net-worth investors in a fund organized by PE Fund, as opposed to investing directly in the firm. Investors
sign investment contracts that lock up their money for certain duration; generally 5 to 10 years. Partners
commit to provide capital over time, rather than a single amount upfront. The draw on this capital
depends on when investment opportunities are identified. As a result, it may be a number of years after
the original commitment of capital before all of the funds are drawn down.
 Partners in PE Fund

Negotiation Shareholderss
PE Funds
Negotiation

Lawyers, Tax Management

Experts, Advising
Consultants, services
and other
professions New Target
Company Company

Investment
Banks and
other FIs Employees
Customers

Suppliers

Figure 3: Typical participants in PE Funds

The PE Funds basically selects the target company with the assistance of investment banks and other
advisors, negotiates the acquisition price, secures debt financing, completes the acquisition or investment,
may be involved in the board of directors and manage the company either through existing management
or new management, makes major strategic and financial decisions, and decides when and how to exit
from the investment. Investment banks plays major role in private equity. They introduce potential
acquisition targets to PE, help negotiate the acquisition price, assist in securing loans, and assist in exit of
the investment.

On the target‟s side are the shareholders who are generally seeking to maximize the value they receive
from any sale. They will be represented by the management of the business or independent advisors or
both to negotiate with the PE Funds. The role of management varies based on the nature of the
investment. They may be part of the group seeking to purchase the business and therefore be aligned with
the private equity funds which is also known as inside buy-out or management buy-out. Alternatively, the
private equity fund may be seeking to introduce new management if they successfully acquire the
business which is also known as outsider buy-out or management buy-in.
1.4. GOVERNANCE REGIME AND REGULATORS IN NEPAL

Nepalese legal system is a mixed legal system largely influenced by the Common Law and Hindu Legal
System. Constitutional supremacy and independence of judiciary are recognized and guaranteed by the
Constitution of Nepal. Disputes relating to civil and criminal matters are resolved through three tiers of
court (i.e. District Court, Court of Appeal and Supreme Court), quasi-judicial authorities, tribunal and the
panel of arbitration chosen by the parties to disputes. There are 75 District Courts, 16 Courts of Appeal
and 1 Supreme Court.

Nepal has a written constitution. However, the existing constitution is the "Interim Constitution of Nepal,
2007 (2063)" which is expected to be replaced by the new constitution promulgated by the Constituent
Assembly of Nepal.

The Parliament constituted by the representatives of the people through election is tasked to pass law. In
most cases, the bill is brought to the Parliament from the Ministry of Law, Justice and Parliamentary
Affairs and relatively lesser numbers of bills are tabled at the Parliament by individual Members of
Parliament. Activities like seeking opinion from public, consulting with experts; discussion with the
stakeholders in respect to contents of Bills before tabling them at the Parliament are not widely practiced
in Nepal. In general, drafting, structuring and formalizing of the bills take place inside the Ministry of
Law, Justice and Parliamentary Affairs.

Unlike India and other jurisdictions, there is no special legal regime in Nepal to regulate Private Equity
Funds (PEFs) or Venture Capital Funds (VCFs), neither is there a single regulator. For instance, In India,
VCFs and Foreign VCFs are classified as Category I Alternative Investment Funds (Category -I AIF) and
are regulated under SEBI Alternative Investment Funds Regulation, 2012. As Nepal does not have a
separate and special regime to regulate PEFs or VCFs, different legislations will apply to the creation and
operation of the PEFs or VCFs and their investments in the portfolios.

The laws that are specifically and generally applicable to the PEFs or VCFs are listed below. However,
the list is indicative and not exhaustive as such funds may be subject to multiple regulations or
compliance as set out under other laws of Nepal.
1.4.1. SPECIFIC LAWS AND REGULATORS

Specific Law Scope Regulator Remarks

Foreign  Lists out the sectors  Department of FITTA will be applicable to

Investment and open for foreign Industry ("DoI") offshore funds while making
Technology investment. in case of foreign investments in the portfolio
Transfer Act, investment below companies in Nepal and
1992 ("FITTA")  Defines the permissible Two Billion repatriation of the returns and
forms of investment. Rupees. investments. The FITTA will
Guarantees the rights of also be applicable to create the
the foreign investors  Industrial onshore funds with the foreign
such as right to Promotion Board investments and repatriation of
repatriate the return and ("IPB") for the returns and investments by
investments, visa foreign investment such onshore funds. However,
matters. above Two Billion the FITTA will not apply to the
Rupees. onshore funds (such as
 Defines the governing
investment companies) with full
laws and mechanisms  Investment Board
local ownership.
of dispute settlement. for the foreign
investment in the
specified projects
under the FITTA does not apply to
Investment Board foreign investments in those
Act, 2012. businesses which are not
classified as an "industry" under
the Industrial Enterprise Act,
1992. For example, financial
services such as banking and
insurance businesses do not fall
under the category of "industry"
under the FITTA, 1992 and as
such any foreign investments in
such sector of business are
separately governed by the
concerned regulator/line
ministry.

Foreign Exchange  Regulates the inflow Nepal Rastra Bank FERA will be applicable to
Regulation Act, and outflow of foreign ("NRB") (the offshore funds while making
1958 ("FERA") currency Central Bank) investments in the portfolio
companies in Nepal and
repatriation of the returns and
investments. FERA will also be
 Provides approval for
applicable to create onshore
equity and loan
funds with foreign investments
investments by the
and repatriation of the returns
foreign investors
and investments by such
onshore funds. However, FERA
will not apply to the onshore
 Regulates the funds (such as investment
repatriation of return companies) with full local
and investments of ownership.
foreign investors.

Rules on inflow and outflow of

foreign currencies are regulated
and implemented by Nepal
Rastra Bank through a series of
directives, circulars and
notifications issued by Nepal
Rastra Bank from time to time.

Securities Laws  Exit of PEFs through Security Exchange The provisions of the Securities
Securities Act, initial public offerings. Board of Nepal Act and other relevant securities
2007 (SEBON). legislations will apply to the
 Lock–in period PEFs and VCFs only where the
applicable to the portfolio companies are listed
promoters and other companies. If the fund manager
Securities
categories of of such fund is a local entity,
Exchange Rules,
shareholders of the then the provisions of the
2007
listed companies Collective Investment Fund
(Mutual Fund) Regulation will
 Regulates Trustee
apply to such fund manager.
Security Issue (Onshore Trustee),
and Registration Project Manager
Regulation, 2008 (Onshore Fund
Manager) and Collective Investment Fund in
and Security Issue
Depository. Nepal are not allowed to make
and Registration
loan and equity investment in
Directive, 2008
start-up undertakings start up
undertakings and unlisted
securities has not been
Collective recognized as the permissible
Investment Fund
(Mutual Fund) sector of investment for
Regulation, 2007 Collective Investment Fund by
the Regualtion.

While the Securities Act, 2007

prescribes a broader norms on
Security Exchange laws in
Nepal, such broader norms are
administered and implemented
through regulation, byelaws,
notifications etc issued by
SEBON under Security Act,
2007.

Income Tax Act,  ITA, 2002 deals with Inland Revenue PEFs and VCFs and the tax
2002 ("ITA the levying of tax on Department treatment of PEFs and VCFs are
2002"), the income of persons similar to other entities.
(legal and natural), and
And Income Tax of body corporate.
Rules 2003 (the
Provisions of the ITA, 2002
"ITA Rules  ITA, 2002 provides for
2003") mainly apply to offshore funds
the tax benefits and
on repatriation of the returns
exemptions to the
and investments and also tax
investors investing into
benefits under the double
certain prioritized
taxation treaty, if any.
sectors. For example,
while the regular
corporate tax rate is
25%, hydropower Provisions of the ITA, 2002
projects are taxed only apply to onshore funds on the
at the rate of 20%. overall aspect of income from
the portfolio companies,
 The withholding taxes distribution of such return to the
are deducted at the investors and exit and
source of the payment divestment.
as royalties, dividend,
service fees,
remuneration to
employee, rent, interest
etc.
Value Added Tax  Provides for collection The provisions of the VAT Act
Act, 1997 (2053) and payment of the and VAT Rules generally do
(the "VAT Act") value added tax on the not apply to onshore or offshore
and goods and services that funds. However, the same will
are subject to VAT. apply to the portfolio companies
Value Added Tax if such portfolio companies
Rules, 1997 conduct the transactions which
("VAT Rules") are subject to VAT under the
VAT Act and VAT Rules.
2.4.2. GENERAL LAWS AND REGULATORS

General Law Scope Regulatory Remarks

CompaniesAct,  Provisions regarding Office of the Provisions of the Companies Act

formation of the Company apply to the creation, operation
2006 companies, operation and Registrar and exit of onshore funds and
dissolution. ("OCR") portfolio companies.

 Sets out the rights and Provisions of the Companies Act

redress available to the will also apply to offshore funds in
shareholders relation to the rights and redress of
the offshore funds as shareholder
 Sets out the duties and of the portfolio companies and
liabilities of the directors. representation to the board of
directors of the portfolio
companies.

Contract Act,  Sets out the rules for Not Any If Nepalese Law is provided as to
2000 ("Contract formation, performance, be governing law on contracts and
Act") breach and remedy of the agreement concluded by PE Funds,
contracts. provisions of the Contract Act will
be applicable in the event of
 Provides the rules for dispute.
autonomy of the parties
of the contract

 Also covers the rules for

special types of contracts
such as sale of goods, etc.

IEA, 1992  Classifies the industries Department of

into various types on the Industry
basis of-(a) investment in
the fixed assets, and (b)
sector of business. The Industrial
classification based on the Promotion
sector of business will be Board
relevant for the purpose
of the foreign investments
and; (c) large scale
industries.

 Provides provision for the

 concessions and benefits
to industries in priority
sectors.

BAFIA, 2006  Regulation of Banking Nepal Rastra Under BAFIA, 2006, only licensed
and Financial Bank banks and financial institutions can
Transaction. carry out the "financial
transactions" under Section 47 of
 Defines "Financial the BAFIA. Any loan investments
Transaction" primarily as by the onshore funds in the
a deposit and lending portfolio companies may be
transaction. viewed as "financial transactions"
by Nepal Rastra Bank.

NRB Act 2002  Establishes NRB as Nepal Rastra Any loan investments by offshore
regulator of bank and or onshore funds will require
financial sectors. Bank approval from Nepal Rastra Bank.

 Provides that approval

from Nepal Rastra Bank is
required for providing
loans.
CHAPTER TWO: ENTRY OF PRIVATE EQUITY FUND

2.1. ENTRY OPTIONS: ONSHORE VEHICLE AND OFFSHORE VEHICLE

Fig-1 Structure- Typical Offshore PE Funds or VCFs making equity investment in Nepalese Portfolios.
Fig-2: Typical Onshore PEFs investing in Nepalese Portfolios.

Although there is no specific regulatory framework to deal with the PEFs in Nepal, the PEFs or VCFs can
be set up in Nepal like other regular business entities.

The PEFs or VCFs can take of any of three forms as follows:

(a) Offshore Funds: PEFs or VCFs may be created outside of Nepal and such fund may invest
in various portfolio entities in Nepal;
(b) Foreign Onshore Funds: PEFs or VCFs are created in Nepal under foreign investments and
such foreign onshore funds invest in different targets in Nepal. Such foreign onshore funds
can be fully or partly owned by the foreign investors;
(c) Domestic Onshore Funds: Onshore funds set up by Nepalese nationals or entities registered in
Nepal invest in various targets in Nepal. Such domestic onshore funds are fully owned by the
local investors in Nepal and operate like an investment company. Thus, there is no
requirement for approval for foreign investment.

Unlike India and many other jurisdictions in Asian Region, the law accords no special benefits and
incentives for PEFs or other such investment vehicles. For example, In case of India, SEBI registered
Foreign Venture Capital Funds (FVCFs) can freely price the value of shares at the time of exit whereas
other non-VCFs entities are required to evaluate the price of shares either on the DCF Method of
Valuation or on the basis of method employed by SEBI registered Merchant Banker.

2.2. SETTING UP OF PRIVATE EQUITY FUND

2.2.1. OFFSHORE PEFS

2.2.1.1. APPROVALS REQUIRED

Any investment by offshore funds in any target/portfolio companies in Nepal is considered as

"foreign investments" for the purpose of FITTA, 1992 and FERA, 1962 2 and is subject to
approvals from the relevant government authorities. Approvals from at least 2 different
regulators will be required for offshore funds to invest in the targets in Nepal:
(a) DoI/IPB/Investment Board, and
(b) Nepal Rastra Bank.

Approval from DoI/IPB/Investment Board will depend on-(a) amount of the foreign
investments, and/or-(b) nature of the project/business of the portfolio companies. Following
table sets out the relevant authorities for granting the approval:

Approving Amount of the foreign Relevant Laws

Authority investment/project

DoI3 DoI, upon its own, approves the Section 3 of FITTA, 1992.
foreign investment in projects/
industry with fixed assets less than
NRs. 2,000,000,000. (Two Billion
Nepalese Rupees).

IPB4 IPB decides regarding the approval Section 3 (3) of FITTA, 1992.

2
Section 2 (a) of the FITTA, 1992 defines "foreign investment" as investment by foreign investor in (a) Shares, (b)
reinvestment of the dividend earned from investment in shares, and (c) loan investment in Nepalese Industry.
Section 2 (g1) of the FERA, 1962 defines "foreign investment" as investment by foreign investor in any firm,
company or organization registered in Nepal in the form of (a) Shares (b) Deposits (c) reinvestment of the
investment return or dividend (d) loan or loan facility.
3
DoI is an authority headed by Director General of the Department of Industry and it is tasked with the
responsibility to, inter alia, provide foreign investment proposals to invest in industries having fixed assets of less
than NRs. 5,000,000,000 (Five Billion Nepalese Rupees). However, The DoI can approve the foreign investment
proposal only if the Industrial Promotion Board has decided to grant said foreign investment approval, in case the
industry receiving foreign investment has fixed assets with value more than NRs. 2,000,000,000 (Two Billion
Nepalese Rupees).
 for foreign investment in the projects/
industries with fixed assets above Rs.
2,000,000,000 (Two Billion Nepalese As a matter of law, IPB is
Rupees). required to decide or approve
foreign investment in industries
having fixed assets with value of
more than NRs. 500,000,000.
However in practice, approval for
the foreign investment in
projects/industries having fixed
assets of more than NRs.
2,000,000,000 (Two Billion
Nepalese Rupees) is decided by
IPB.

Investment Foreign Investment in projects listed Section 9 (1) of IBA, 2011.

Board5 under Section 9 of Investment Board
Act, 2011 ("IBA, 2011"). Section 9
of IBA, 2011 includes, among others,
investment in the large infrastructure
projects, hydropower with installed
capacity of 500 MW or more,
medical colleges, hospital or nursing
homes having more than 300 beds,
etc.

FITTA, FERA or Investment Board Act does not provide for blanket or single approval for offshore
funds for investment in multiple portfolio companies. At present, governmental approvals are
required at least for – (a) each investment by offshore fund in each portfolio companies in Nepal,
(b) each increase of investment of offshore fund in each portfolio companies in Nepal. The steps
and timeline for obtaining investment approvals in Nepalese Targets is presented in Annex 3and
Annex 5.

Similarly, the said laws do not provide for automatic approval route allowing foreign investors
including Offshore PEFs to invest in Nepalese Portfolio entities without being required to obtain
governmental approvals. Most of the jurisdictions encouraging Offshore Investments in Domestic

4
IPB is a high level board headed by the Minister or State Minister of Industries whose decision is required for
making foreign investment in an industry having fixed assets of more than NRs. 2,000,000,000 (Two Billion
Nepalese Rupees).
5
Investment Board is a high level board headed by the Prime Minister which provides approval for making
investments (both, domestic and foreign investment) in the projects listed on Section 9 of Investment Board Act,
2011.
 Ventures in certain prioritized sectors allow the Offshore Funds to come and invest through
automatic approval route. For instance, in India, foreign investors including offshore PEFs
investing through automatic approval route in Indian Portfolios or ventures of certain prioritized
sectors recognized by FDI Circular6 are free to invest in targets and portfolios of such sectors
without being required to obtain any investment approval in India. They are only required to notify
the investment details post investment.

2.3. PERMITTED SECTORS

As a matter of general rule, foreign investors can only invest in targets in industrial sector and not in
trading sector. As Offshore PEFs will also be taken as Foreign Investor under the Nepalese Law, their
choice of targets should (a) fall within what is recognized as industrial sector under IEA, and (b) be open
for foreign investment as listed under FITTA. In addition to the negative list and sectoral caps, the
concerned authorities frequently object to provide foreign investment approvals specifying policy
(published and unpublished policy) reasons. The approach in granting approvals is highly ad-hoc and
interpretation and implementation of policy requirement is highly inconsistent. The negative list of
sectors/ target prohibited for foreign investment is presented in Annex 2. The negative list of sectors/
target prohibited for foreign investment is expected to be redefined upon the entry into force of the Draft
Foreign Investment and Technology Transfer Act (The "Draft FITTA"). The negative list for foreign
investment proposed under Draft FITTA is presented in Annex 2A.

In addition to the above negative list, Offshore PEFs cannot invest in Nepalese portfolio entities crossing
sectoral caps or limit (sectoral limits defined in term of ownership interest in portfolio entities) of foreign
investment prescribed for different sectors under different sectoral policies and regulations. The existing
sectoral caps in some of the industries are presented in the table below:

Sectors Ceiling of the foreign

investments

Telecommunication 80%

Insurance 70% (for life insurance)

Air passenger service domestic 49%

Air passenger service international 80%

Consultancy services like accounting, management services, 51%

legal

6
Reserve Bank of India : Foreign Direct Investment Circular, 2013.
Note: The above list of sectoral caps (limit) is indicative and not exhaustive.

The above lists of sectoral caps are expected to be re-marked and redefined upon the entry-into-force of
Draft FITTA. The sectoral cap for foreign investment proposed under the Draft FITTA is presented in the
table below:

Sectors Ceiling of the Foreign Investment

Hotels and Lodges 80%

Travel Agency and Tour Operators 51%

Account and Audit Service 51%

Bank and Financial Sectors 66%

Veterinary Sector 51%

Communication Sector 80%

Research and Development 51%

Construction and Construction Related Engineering 51%

Retail Service 51%

Education Service 51%

Environmental Service 51%

Health Service 51%

Transportation Service 51%

On one hand, the pre-admission regulations on foreign investment by imposing of negative lists
may have its justification on the State's inherent concern to make productive and strategic sectors of
economy free from the control of foreign investors. On the other hand, the restrictive approach
adopted by the Government authorities has virtually limited the permitted sectors of investment by
offshore funds. Also, ad-hoc and inconsistent application of the laws by the government authorities
have added uncertainty for the PE funds.

The Draft FITTA has proposed to introduce a general Minimum Capitalization Requirement
("MCR") of USD 200,000 (Two Hundred Thousand US Dollar) for foreign investment in every
 sector and special MCR for specific sectors such as, Hydropower 7, Transport and Infrastructure
Development8, Agriculture and Herb Processing9, Hotels10, Mining and Production Sectors11.

2.4. INVESTMENT OPTIONS

Offshore Investment Funds can make both loan investment and equity Investment in Shares (Ordinary
and Preferences) in Nepalese Portfolios. However, investment through equity linked instrument like
compulsory convertible debentures, optional convertible debentures are not practiced and the Central
Bank has not set any criterion and requirements to approve investment through equity linked instruments
either. The requirement as to the documentation in obtaining the investment approval from NRB is
presented in Annex 4 and Annex 5.

2.5. PERMITTED FORMS OF OFFSHORE FUNDS AND PORTFOLIO

2.5.1. PERMITTED FORMS OF OFFSHORE FUNDS

The IEA, 1992 as well as FITTA, 1992 does not require the foreign investors to be
registered/incorporated in a particular form in their home jurisdiction in order to be eligible to invest in
Nepal. FITTA 1992, under Section 2 (d) and FERA, 1962 under Section 2 (g3) together defines "Foreign
Investor" as any foreign persons, firm, company or body including foreign government and international
agency making foreign investment and technology transfer in Nepal. Pursuant to the definitions of
"Foreign Investors" in said Section(s) of said Act(s), it is clear that, anyone making foreign investment
and technology transfer in Nepal is foreign investor for the purpose of the Act and there is no compulsion
for foreign investor(s) to be organized in a particular form in order to be eligible to make investment in
Nepal.

PE Funds willing to invest in (a) listed securities (b) government bonds (c) bank deposits (d) money
market instrument are allowed to be organized as Collective Investment Fund under Collective
Investment Fund (Mutual Fund) Regulation, 2010.

7
Under Draft FITTA, only those hydropower projects that have installed capacity above 30 MW are open for
foreign investment.
8
The Minimum Capitalization requirement for foreign investment in Transport and Infrastructure Sectors is set as
10,000,000 USD.
9
The Minimum Capitalization Requirement for foreign investment in Agro and herbal processing industry, export
promotion industry and import substitution industry is set as 2,000,000.00.
10
Under Draft FITTA, only those hotels which are ranked above 3-Stars are open for foreign investment.
11
The Minimum Capitalization Requirement for foreign investment in Mining and production industries is set as
USD 20,000,000.
However, foreign investment in the Nepalese Portfolio of Banks and Financial sector and Insurance sector
is permitted only when the foreign investor is a registered Bank or Financial Institution or Insurance
Company (as the case may be) in the home jurisdiction. This organization requirement is likely to limit
the scope of Offshore PE Funds in Nepalese targets belonging to Banking and Insurance sectors.

2.5.2. PERMITTED FORMS OF PORTFOLIOS

IEA or FITTA does not prescribe any specific criterion for a Nepalese entity, in particular, in terms of its
form or organization to be eligible to receive foreign investment. However, considering the typical nature
of PEFs investment, some practical issues may arise. For example, the equity investment is not possible in
the entity organized as sole-trading concern or Partnership Firm. In addition to this, the Limited Liability
Partnership (s) (LLPs) is not recognized under Nepalese Law. Thus, in practice, the target portfolios must
be organized in the form of Limited Liability Company for it to be able to receive equity investment.

2.6. ONSHORE PEFS

2.6.1. APPROVAL REQUIREMENTS

Onshore PEFs can be registered in two ways – (a) registering an Onshore Fund under foreign investment,
(b) registering an Onshore Fund under direct investment of resident Nepalese Citizen, Non-resident
Nepalese ("NRNs" foreign citizen of Nepalese Origin and/or Nepalese citizens residing abroad) and
entities incorporated in Nepal.

Foreign Investment in Onshore Funds or PEFs registered in Nepal should be routed through the
governmental approval route and the steps, timeline and documentary requirement are the same as that of
investment from Offshore Funds. However, in the case of Onshore Funds, exchange control approvals are
not required for direct investment from Nepalese Citizen, NRNs and other entities registered in Nepal.
FITTA or IEA does not impose any restriction on investment by non-foreign investor. Technically,
Onshore Funds registered in Nepal should be allowed to freely choose its target portfolios. However, in
practice, the Onshore Entities controlled by the foreign investors are not allowed to invest in the sector
not open for foreign investment. For example, the Onshore entities controlled by foreign investors are not
to invest in trading sector as well as other sectors which are not recognized as industrial sector under IEA.
There are also various instances where the authority has restricted the Onshore Funds established on
Foreign Investment to invest on the targets falling under negative list.

2.6.2. PERMITTED FORMS OF ORGANIZATION

As a matter of law, there is no compulsion for Onshore PEFs to be organized in a particular form. As
there is no specific legislative guidance on the regulation of PE Funds, legally; the Onshore PE Funds can
get themselves organized in any form. However, a gazette notification has been published on May 16,
2011, which provides that activities such as making investment and providing consultancy shall be done
through 'Investment Company'. Though much details as to the requirements for such Investment
Company has not made public till date, it is understood that the said gazette has contemplated 'Investment
Company' will have similar nature like of PE Funds. The term 'Company' means a public limited
company or private limited company for the purpose of Companies Act, 2006.

Unlike India, USA and other jurisdictions with well developed legal regime on FEFX, the organization of
the Private Equity Funds cannot take in the form of Trust or Limited Liability Partnership. For instance,
in India PEFs or VCFs can be registered as a Trust, Company; recently, Limited Liability Partnership
(LLP) has also been recognized as permissible form of organization.

As both the PEFs (offshore or onshore) usually invest in the equity of portfolios or target, being
incorporated as a Limited Liability Company is only choice available if the PE Funds wish to make equity
investment, however, such compulsion is not applicable in case PE Funds wish to make loan investment
only.

The investment options available to Onshore Funds and Offshore Funds under the existing Nepalese
Laws are compared on the table below:

Basis of Offshore Fund Onshore Fund

Comparison

Requirement of Regulatory Approval will be required Regulatory approvals will be required only
Regulatory for–(a) each investment in the targets for the formation of an Onshore Vehicle.
Approvals (b) sale of each investment in the target,
and (c) repatriation of dividend or No Regulatory approvals will be required for
investment of such target. investments in the targets. The regulatory
approvals will be required only for – (A) the
sale of the interest of the Onshore Vehicle,
and (B) on making repatriation of the
dividend distributed by the Onshore Vehicle.

Forms of the  Investments can be made in the Investment can be made only in the shares of
Investment in targets in the form of both equity and the target. Investment in the form of loan
the Target. loan. may be prohibited under Bank and Financial
Institutions Act, 2006 as carrying out the
 The loan investment may be subject financial transaction is reserved only to
to such regulatory terms such as rate licensed institutions (which may be taken as
of interest that can be charged and carrying financial transaction under BAFIA)
also policy that NRB adopts from
time to time.

Permitted The Offshore Vehicles will only be able Technically, investments made by Onshore
Sectors of to invest in those targets which are open Funds in the targets should not be construed
Investment for foreign investors i.e. businesses/ as 'Foreign Investment'. However, there are
targets not falling under the negative some known instances in the past, where
list of FITTA, 1992, and within the regulatory authorities had prohibited onshore
limit of sectoral cap foreign investment business vehicles set-up under foreign
 in the particular business. investment from investing into trading
sectors and other prohibited sectors.

However, after gazette notification of May

16, 2011 which included the Investment
Company formed with an objective to carry
investment activities and provide consultancy
in Service Based Industry. On the basis of
this, it is understood that Offshore Fund can
be registered in the form of Investment
Company.

Permitted No statutory restrictions in terms of Normally, foreign investment is not

Form of permitted form of investment vehicle, permitted in the sector which has not been
Vehicle however, may be dependent on recognized as an Industrial Sectors under
inconsistent policies consideration to be IEA. Recent amendment of IEA on May 16,
applied by concerned authority. 2011 has included and thereby recognized
Investment Company with the objective to
carryout investment activities, infrastructure
development activities and counseling
activities as Industrial Sector. From the
wording of the said gazette notification it is
understood that the PE Funds should be
organized in the form of Limited Liability
Company registered with DoI as Investment
Company.
2.7. DEFINITIONS OF RELATED TERMS

The definition of the related terms such as securities, foreign investment and foreign investors as per
Company Act, and Securities Registration and Issue Regulations is provided in Annex 6.

2.8. PERMITTED FORMS OF INVESTMENTS

Companies in Nepal can raise capital through shares and debt. Shares can be in the form of equity shares
and preference shares. Shares of common stock or equity are the fundamental ownership units of the
corporation. The Companies Act, 2063, Section 30, allows companies to issue various classes of shares
with different rights attached thereto that shall be stated clearly in its MoA and AoA. Preferred equity
represents equity of a corporation, but it is different from common stock because it has preference over
common stock in the payment of dividends and in the assets of the corporation in the event of bankruptcy.
Preference means only that the holder of the preferred share must receive a dividend before holders of
common shares are entitled to anything.

FOREIGN INVESTMENT INSTRUMENTS

IN NEPAL

Preference
Equity Shares Debentures Loans
Shares

Typical debt securities that can be issued by companies are called debentures or bonds. Technically
speaking, a debenture is an unsecured corporate debt whereas a bond is secured by a mortgage on the
corporate property however; in common parlance the word bond is indiscriminately used and it often
refers to both secured and unsecured debt. Debenture is an instrument of debt executed by a company
acknowledging its obligation to pay interest on the debt at a fixed rate at regular intervals. Debentures do
not carry any voting rights and are generally secured against property. Additionally, debentures can be
redeemed or converted into equity or a combination of both.
While investing in Nepal, either of the above mentioned instruments or combination of the instruments
could be used. The details of such instruments are provided below:

2.8.1. EQUITY SHARES

Foreign investors can invest in sectors allowed by the government and up to the limits permitted. Equity
shares can be made through investment in new industry or existing industry through share transfer.

Deposit to be made in
Account Section of DOI
Receive
Apply to FORIEGN
Department of
Industry (DOI) on
INVESTMENT
a prescribed APPROVAL
application form letter and JVA
(if Applicable)
Supporting Documents

A) FOREIGN EQUITY INVESTMENT IN A NEW INDUSTRY

Foreign investor/s desiring to invest in Nepal whether as a wholly foreign owned

enterprises or in a joint venture with Nepalese/foreign promoters are required to apply to
the DoI on a prescribed application form12, along with the documents mentioned in .

After the approval of foreign investment, up to a maximum amount (depending upon the
envisaged fixed asset amount) NRs. 20,000.00 must be deposited in the Account Section
of the DoI. The deposited amount shall be refunded (with interest) to the promoters once
the project comes into operation. Once the stated amount is deposited, the promoters shall
receive the foreign investment approval letter and certified JVA, if applicable.

B) FOREIGN INVESTMENT IN AN EXISTING INDUSTRY BY SHARE

TRANSFER:

Share transfer can be done in two ways, that is, by transferring the shares of existing
shareholder or by issuing new shares to a foreign partner, either from the reserved shares
or by increasing the issued capital of the company. The documents required for approval
from DoI are presented in Annex 8.

2.8.2. LOANS

12
Prescribed application form, suggested contents of the project report, JVA, and FCC has been provided in
“Procedural Manual for Foreign Investment in Nepal, 2005” published by Department of Industries, Nepal
Government.
Foreign investors are allowed to avail loan or loan facilities to individuals or companies in the form of
foreign investment.

Mention interest Show that the loans with

rate and principal required volume and
repayment interest rate can’t be availed
schedule from Nepalese BFIs
Investee company Receive
Required to
FORIEGN
Apply to
Department of INVESTMENT
Industry (DOI) on APPROVAL
a prescribed letter
application form (if Applicable)
Supporting Foreign organizations
Documents (lenders) should also present
required documents

If an existing Nepalese company is willing to avail the loan or loan facilities from a foreign lending
agency or individual, the company is required to apply to the DoI on a prescribed application along with
the documents mentioned in Annex 9.

To obtain loans from foreign investors/institutions, Nepalese companies have to show that the loans with
required volume and the interest cannot be availed from Nepalese BFIs. These companies should try to
avail these loans from foreign BFIs. In case, this isn‟t possible, it can avail loans from foreign
companies/organizations.

 These foreign organizations/companies (lenders) should present

o Audited reports
o Source of loan
o Time schedule of repayment of loan
 For international and regional organizations that have members as international
financial organizations like IFC, ADB, World Bank, can give loans to private sector as per
NRBs decision
 Maximum loan interest at One year LIBOR + 5.5%
2.8.3. PREFERENCE SHARES

The Companies Act, 2063, Section 65 allows companies to issue preference shares in pursuant to the Act,
the AoA and MoA of the company. While such preference shares are issued, following matters are needs
to be disclosed:

i) Preference of dividend against ordinary shares

ii) Percentage of dividend to be received
iii) Cumulative or non-cumulative dividends
iv) Preference of paying amount in the event of liquidation of company
v) Issues related to voting rights and excersiable proportion of such rights
vi) Convertible or not (if convertible, conversion ratio, price, period)
vii) Redeemable after certain period or not
viii) Premium at the time of redemption

Thus, preference shares can be cumulative or non-cumulative. If preferred dividends are cumulative and
are not paid in a particular year, they will be carried forward; however, preferred stockholders do not
receive interest on the cumulative dividends. Moreover, such preference shares can be redeemable or
irredeemable. The law requires the company to establish a capital redemption reserve account and a sum
equal to the amount of shares redeemed shall be transferred to that account out of profits which would
otherwise have been available for the dividend.

With regards, to convertibility of preference shares, The Companies Act, 2063 allows companies to issue
convertible preference shares; however, the act is silent whether such conversion can be compulsory or
optional. Hence, the issue of compulsory or optionally convertible can be entertained through contractual
agreements. There is market precedence related to issues of optionally convertible preference shares
issued by one of the leading public company in Nepal. Likewise, Everest Bank Limited has issued 7%
irredeemable convertible preference shares that are compulsorily converted into preference shares (at
certain time frame and in certain tranches).13

2.8.4. DEBENTURES

Onshore PE Funds organized as Public Limited Company can issue debentures for the general public,
however, issuing of Debenture is not allowed unless issued capital is fully paid up and approval to
commence business is obtained.14 Although the law does not impose any specific restrictions to private
company to issue debentures, virtual restrictions do apply to restrict private companies from issuing
debentures. The Issuer of debenture is required to fulfill certain procedural formalities before issuing
debentures. The general procedure to issue debentures is:

13
The preference share is converted in to Ordinary Shares @ 20% on each 3rd year (in 3rd, 6th, 9th, 12th and 15th
year) accordingly all the Preference Share will be converted in to ordinary Share in 15 years
14
Section 34 of the Companies Act, 2006
i) Provision of debenture trustee15
ii) Agreement between trustee and company in matters related to creditor and borrower
iii) Conversion of debentures in MoA or AoA and prospectus

The issue whether the foreign investment is permissible in the debentures issued by Nepali Company is
not clear. NRB has not published anything regarding the foreign investment on debentures of Nepalese
Companies and has only provided the documentary requirements for obtaining exchange control
approvals for loan and equity investment till the date. Although the NRB has not provided anything in
obtaining investment approval to invest in debentures of Nepalese Company, NRB may allow the foreign
investment in non-convertible debentures of Nepalese Companies as loan investment. Offshore PE Fund
may be allowed to invest in dividend of Nepalese Companies as loan if it applies to NRB for the same. In
Nepal, issuance of convertible debenture has not been practiced and almost all of the debentures issued
till date are non-convertibles. Shreeram Sugar Mills is the only company in Nepal that has issued
convertible debenture till date.

2.8.5. SHAREHOLDERS‟ LOAN

Shareholders' Loan is a very common mode of making investment in targets for both Onshore PE Funds
and Offshore PE Funds. However, in the context of Nepal, there are certain caveats which concern the
permissibility of loan investment by Onshore PE Funds. Section 47 of the BAFIA has identified issuance
of loan as "Banking Transaction" and the NRB may take making loan investment as an act of issuing of
loan which is reserved only for licensed Bank and Financial Institutions.

Offshore Funds may make loan investment in Nepalese targets and undertakings subject to certain
restrictions imposed by NRB. Pursuant to the notifications issued by NRB dated January 22, 2013 read
together with circular dated May 06, 2013 and circular dated September 11, 2013, Nepalese entities can
borrow loans from foreign entities only when –

(a) the loan cannot be obtained from domestic banks and financial institutions, and (b) the interest
charged by the foreign lender is lower than the prevailing interest rate in Nepal.

2.8.6. OTHER HYBRID INSTRUMENTS (SUCH AS INCOME PARTICIPATION

CERTIFICATE)

Participation in the targets portfolios or undertaking by way of Income Participation Certificate, Asset
Backed Securities, Mortgaged Back Securities, etc. are not much practiced in Nepal. Nepal does not have
specific law to deal and regulate the Hybrid Instruments.

Foreign Investments in India, Sri Lanka and Bangladesh:

15
The Companies Act, 2063 defines “Debenture Trustee” as a body corporate undertaking the responsibility for
the protection of interests of debenture-holders at the time of issuance of debentures by a company. Such Trustee
has to be licensed by the Securities Board.
 INDIA SRI LANKA BANGLADESH

Automatic route for Foreign investors invest For businesses set up in

investment in certain sectors through Securities export processing zone, get
with blanket approval Investment Account registered with Bangladesh
Export Processing Zones
Authority (BEPZA)

Government route (obtain Resident companies to For investments less than

ENTRY ROUTE
prior approval from obtain approval from the USD 2 million, register with
concerned government ECD (Exchange Control Bangladesh Small and
bodies) for sectors and Department) to issue Cottage Industries
investments requiring shares to foreign investors Corporation (BSCIC)
special permission
Else, register with BOI
(Board of Investment)

BODY Department of Industrial Board of Investment Investment Board promotes

OVERSEEING Policy and Promotion (BOI) industrial investment while
SECTORS AND (DIPP) Bangladesh Small and
FORMS OF Cottage Industries oversees
FOREIGN smaller investments
INVESTMENT

Foreign Exchange Exchange Control Foreign Exchange

FOREIGN
Management Act, 1999 Department Regulations Act, 1947
EXCHANGE
(FEMA) by Reserve Bank of
GOVERNED BY
India

Can make foreign Can make foreign Doesn‟t discriminate

investments in the country in investments in the country. between offshore and
OFFSHORE sectors that open for foreign Lending to Sri Lankan onshore foreign investors
FUNDS investment within sectoral companies not allowed by while defining foreign
caps fixed by RBI. offshore companies via capital and foreign private
ECB Scheme investment.

Single FII cannot invest Up to 100% of the issued 100 percent foreign equity is
more than 10% of equity capital of any Sri Lankan allowed inn Bangladeshi
LIMITS ON
capital or 10% of paid-up company (except in some companies
INVESTMENTS
value of each series of prohibited sectors)
BY FII
convertible debentures
issued by Indian company
 Corpus of at least twenty US$ 250,000 for general -
MINIMUM
crores sectors. For trading
INVESTMENT
activities, this is far
FUND SIZE
higher.

2.9. REVIEW OF ENTRY OF PRIV ATE EQUITY IN INDIA

Until early 2000s, PE Funds focused on IT companies. After the dot-com burst, these funds
looked for diversification into other high potential sectors likes manufacturing, infrastructure, e-
commerce, pharmaceuticals and biotechnology. After 2008-09, PE funds gave priority to
investments in traditional economy. Since 2011, PE funds have been more interested in PIPE
(private investment in public equity) deals.

2.9.1. ENTRY ROUTES

Foreign investors can bring investments in the country via Automatic Route or Government Route. FDI in
most sectors is now under what is known as the automatic route followed by certain post-facto filings
with the RBI. Under government route, the foreign investor must obtain prior approval from concerned
government authority, i.e. Foreign Investment Promotion Board (FIPB), Department of Economic Affairs
(DEA), Ministry of Finance or Department of Industrial Policy & Promotion, for the investment.

Under automatic route, there is a blanket approval for the investment in certain sectors. For sectors and
investments requiring special permissions, government route is prescribed. Under automatic route, a
foreign investor would be able to invest in a sector in India without any prior governmental or regulatory
approval, such as hotel and tourism.

2.9.2. REGULATORY FRAMEWORK

FDI policy formulated by Department of Industrial Policy and Promotion (DIPP), Ministry of Commerce
and Industry, Government of India (GoI) discusses the allowed sectors and form of foreign investment
into Indian businesses. Apart from this, sector-specific policies are issued by concerned ministries.

Foreign Exchange Management Act, 1999 (FEMA) by Reserve Bank of India (RBI) regulates foreign
investment in India.

The issuance of shares and dealings in shares are governed by the Foreign Exchange Management
(Transfer or Issue of security by a person resident outside India) Regulations, 2000 (the “FI
Regulations”). Sub-regulation 5 of the FI Regulations (Error! Reference source not found.) lays
down the conditions subject to which foreign investors would be permitted to invest into Indian securities.

The RBI has also issued Master Circular No. 15/2012-13 on July 2, 2012 (the “RBI Master Circular”)
consolidating its rules governing foreign investment in India.
2.9.3. OFFSHORE FUNDS

A private equity investor may invest in India either directly through an offshore entity, or through an
Indian subsidiary, using FDI Scheme. A foreign investor could also seek registration of their Category-I
Alternative Investment Fund with SEBI to enjoy additional benefits and incentives available to Venture
Capital Funds and Foreign Venture Capital Funds. Some notable incentives are SEBI registered VCFs can
enjoy tax through status for taxation purpose and be exempt from the taxation. This would typically be
done through a wholly-owned subsidiary of an offshore entity. But Overseas Corporate Body (i.e.
registered outside India, with more than 60% of shares held by NRIs or by trust which has no less than
60% of shares by NRIs) are derecognized as a class of investors as of September 16, 2003.

2.9.4. ENTRY PROCESS

 PE approaches potential company

 Basic document, such as MoU, letter of intent or term sheet executed between the parties
 PE conducts legal and financial due diligence. Often followed by business due diligence and
background check on promoters
 Negotiate investment documents, such as share subscription agreement, share purchase agreement
and shareholder‟s agreement
 Investment made

2.9.5. LIMITS ON INVESTMENT S BY FOREIGN INSTITUTIONAL INVE STORS (FII)

A single FII is permitted to invest not more than 10% of the equity capital of an Indian company or 10%
of the paid-up value of each series of convertible debentures issued by the Indian company. The total
holdings of all FIIs put together should not exceed 24% of the paid-up equity capital or paid up value of
each series of convertible debentures. However, this limit may be increased by the Indian company, up to
the sectoral cap as applicable, by a resolution of the board followed by a special resolution of the
shareholders, to that effect.

Private Equity Funds cannot invest more than twenty five percent of the corpus in one Investee Company.

Further, the investment should not be in a company which is engaged in the activity of manufacture of
items listed in Annexure A to Schedule I of the FI Regulations.16 Also, the investment should not be in a
company that requires an industrial license under Industrial Development (Regulation) Act, 1951 or under
the locational policy notified by GoI under Industrial Policy of 1991.

2.9.6. PRICING METHODOLOGY

16
http://www.welcome-nri.com/info/project/FIIregulationstext.htm#AnnexureA
The price at which foreign investment is made or divested is required to be in accordance with the pricing
guidelines specified under the FI Regulations. For subscription to shares of an unlisted company, the
minimum price to be paid by the non-resident investor is linked to the valuation of the company,
determined as per the discounted cash flow method of valuation (“DCF Value”).

In case of transfer of shares of a listed company (where the shares are being transferred by a resident to a
non-resident), then the minimum price shall be as prescribed under the applicable Securities and
Exchange Board of India (“SEBI”) Regulations such as the SEBI (Issue of Capital and Disclosure
Requirements) Regulations, 2009 (“ICDR Regulations”), SEBI takeover code, etc.
2.9.7. MODALITY OF PE FUND AS PER AIF ACT

As per the AIF Act, (Error! Reference source not found.) Private Equity Funds fall in Category 2 AIFs
and can invest in equity or equity linked instruments or partnership interests of investee companies. The
Alternative Investment Funds willing to work as Venture Capital Funds by investing their corpus
primarily in unlisted securities of start-ups, emerging or early stage venture capital undertakings involved
in making of new products, and delivering new services and technologies, enjoy tax and other benefits
and are required to be registered as Category 1 AIFs. These funds should be close ended and the tenure of
fund or scheme should be determined at the time of application. Minimum permissible tenure of these
funds/schemes is three years. Each scheme of this type of fund should have corpus of at least twenty crore
rupees.

PE Funds are mandated to invest primarily in unlisted securities or in units of other Alternative
Investment Funds as may be specified in the placement memorandum.

2.9.8. PERMITTED INSTRUMENTS FOR PRIVATE EQUITY FUNDS UNDER THE FDI
SCHEME

Governing Characteristics Interest/Returns Lock-In

Scheme

EQUITY Under FDI Option to issue - 1-year in general.

SHARES Scheme shares with But, this is subject
differential voting to sectoral
rights, preferential regulations.
dividends, or
structured as
liquidation
preference

CCPS Under FDI Compulsorily and Cannot be in excess of

Scheme mandatorily 300 basis points over
convertible the Prime Lending
preference shares are Rate (“PLR”) of the
to be issued to State Bank of India
foreign investors

CCDS Under FDI Fully and FDI Scheme is silent

Scheme mandatorily on this
convertible
debentures are to be
 issued to foreign
investors

Under the Indian law, foreign investors may only subscribe to equity or equity-linked
instruments under the FDI route. Under this, investments in equity and compulsorily
convertible preference/debentures are allowed. After December 30, 2013, the equity and
CCPS instruments can have optionality clause, which will oblige the buy-back of securities
from the investor by the investee companies at the price prevailing/value determined at the
time of exercise of the optionality so as to enable the investor to exit without any assured
return.

The permitted instruments can be categorized as:

A. Equity Shares

The investor may wish to have differential voting rights, i.e. voting rights that are
disproportionate to their economic interests.

The investor may wish to receive a periodic return on their investment (in the form of
preferential dividend or interest).

The investor may wish to receive a preferential return on the investment at the time of
exit (structured as a liquidation preference).

B. Compulsorily Convertible Preference Shares ("CCPS")

Under the FDI Scheme, only preference shares which are fully and mandatorily
convertible into equity shares are eligible to be issued to foreign investors. The RBI has
prescribed that the rate of dividend payable on convertible preference shares issued to
non-resident parties cannot be in excess of 300 basis points over the Prime Lending Rate
(“PLR”) of the State Bank of India prevailing on the date of the board meeting approving
such issuance.

C. Compulsorily Convertible Debenture Shares ("CCDS")

Under the FDI Scheme only debentures which are fully and mandatorily convertible into
equity shares are eligible to be issued to foreign investors. The debenture holder is
entitled to receive interest from the company till the maturity date of the instrument, after
which the debentures would be converted into equity shares.

As far as the rate of interest on the debentures issued to non-residents is concerned, the
FDI Scheme is silent. Drawing similarity with dividend on preference shares as discussed
above, maximum permissible rate of interest on debentures for FIIs would be 300 basic
points over the PLR of the State Bank of India.
2.9.9. PERMITTED INSTRUMENTS FOR FOREIGN INVESTORS UNDER ECB
SCHEME

Governing Characteristics All-in-cost Minimum

Scheme Ceilings over 6 Average
month LIBOR Maturity

OCPS Up to USD 20 350 basis points 3 years

million
NCPS

OCDS Under ECB

Scheme
NCDS Above USD 20 500 basis points 5 years
million to USD 750
Shareholder million
Loans

2.9.10. CONVERSION PERIOD

For normal issuance, the time-period of conversion of convertible securities is 60 months (i.e. 5 years).
For preferential allotment, the time-period of conversion of convertible securities is 18 month.

2.9.11. LOCK-IN

Under the ICDR Regulations, the entire pre-issue share capital (other than certain promoter contributions
which are locked in for a longer period) of a company conducting an IPO is locked for a period of one-
year from the date of allotment in the public issue. But, this is subject to sectoral regulations. E.g. for
defence and construction development sector investment, the lock-in period of three years has been
prescribed.

For preferential allotment or private placements by a listed company, there is no lock-in on such allotted
securities (as long as they are traded on the stock exchange).

2.9.12. GAIN FROM S ALE OF CCDS

Gain from sale of CCDs will be taxed like on same rate applicable on interest payments.
2.9.13. PERMITTED INSTRUMENT S U NDER ECB

Optionally convertible or non-convertible preference shares or debentures, or shareholder loans are

permitted as investment instruments for foreign investors in India in accordance with the guidelines
applicable for External Commercial Borrowings (ECBs).

However, as PE Funds fall under Category II of AIF – governed by FDI Scheme, it may be understood
that these funds cannot be invested via ECBs. However, non-resident lenders can lend to Indian
companies via ECBs.

2.9.14. EXTERNAL COMMERCIAL BORROWINGS (ECB), (INDIA, 2012)

a. The maximum amount of ECB which can be raised by a corporate other than those in the
hotel, hospital and software sectors is USD 750 million or its equivalent during a
financial year.

b. Corporate in the services sector viz. hotels, hospitals and software sector are allowed to
avail of ECB up to USD 200 million or its equivalent in a financial year for meeting
foreign currency and/ or Rupee capital expenditure for permissible end-uses. The
proceeds of the ECBs should not be used for acquisition of land.

c. NGOs engaged in micro finance activities and Micro Finance Institutions (MFIs) can
raise ECB up to USD 10 million or its equivalent during a financial year. Designated AD
bank has to ensure that at the time of drawdown the forex exposure of the borrower is
fully hedged.

d. SIDBI can avail of ECB to the extent of 50 per cent of their owned funds including the
outstanding ECB, subject to a ceiling of USD 500 million per financial year.

e. ECB up to USD 20 million or its equivalent in a financial year with minimum average
maturity of three years.

f. ECB above USD 20 million or equivalent and up to USD 750 million or its equivalent
with a minimum average maturity of five years.

g. ECB up to USD 20 million or equivalent can have call/put option provided the minimum
average maturity of three years is complied with before exercising call/put option.

h. All eligible borrowers can avail of ECBs designated in INR from „foreign equity holders‟
as per the extant ECB guidelines.

i. NGOs engaged in micro finance activities can avail of ECBs designated in INR, from
overseas organizations and individuals as per the extant guidelines.
All-in-cost ceilings:

All-in-cost includes rate of interest, other fees and expenses in foreign currency except
commitment fee, pre-payment fee, and fees payable in Indian Rupees. The payment of
withholding tax in Indian Rupees is excluded for calculating the all-in-cost. The all-in-cost
ceilings for ECB are reviewed from time to time. The following ceilings are applicable upto
March 31, 2013 and subject to review thereafter:

Average Maturity Period All-in-cost Ceilings over 6 month

LIBOR*

Three years and up to five years 350 basis points

More than five years 500 basis points

* for the respective currency of borrowing or applicable benchmark

In the case of fixed rate loans, the swap cost plus margin should be the equivalent of the floating
rate plus the applicable margin.
2.10 REVIEW OF ENTRY OF PRIVATE EQUITY IN SRI LANKA

The private sector has major investment in finance, exports, tea, apparel, IT, and tourism. Investments
with an export dimension have the most potential with rapid infrastructure development and free trade
agreements with India and Pakistan.

But, multinational and foreign investors complain that special preference is given to large local operators
as the government procurement and project approval decisions favor large local operators. (State, 2013)

2.10.1. REGULATORY FRAMEWORK

The Board of Investment of Sri Lanka (the "BoI"), an autonomous statutory agency, is entrusted to
regulate the foreign investment and grant foreign investment approvals. BoI has been promoting the
following sectors as priority sectors for FDI: tourism and leisure; infrastructure; knowledge services;
utilities; apparel; export, manufacturing; export services; agriculture; and education. Specialized diisions
representing these sectors are tasked with providing services to foreign investors through the entire
investment process.

The principal law governing foreign investment in Sri Lanka is the Board of Investment Act, 1978
(Amended 2012) (the "BOI Act"). The BOI Act provides for two different types of investment approvals:

 Foreign Investment Approval under Section 16 of the BOI Act, where the projects receiving foreign
investment would not be provided any type of fiscal concessions.

 Foreign Investment Approval under Section 17 of the BOI Act for those projects where the projects
receiving foreign investments normally will enjoy fiscal incentives and fewer exchange control
restrictions.

The Strategic Development Project Act of 2008 (SDPA) provides generous tax incentives for large
projects that the Cabinet identifies as Strategic Development Projects. Other laws affecting foreign
investment are the Securities and Exchange Commission Act of 1987 as amended in 1991 and 2003, the
Takeovers and Mergers Code of 1995 (revised in 2003), and the Companies Act of 2007. (State, 2013)
2.10.2. OFFSHORE V EHICLES

In Sri Lanka, a Resident Company can issue its Shares to Non-Resident Companies without having to
take any prior approvals from Exchange Control Department17 subject to certain restrictions and
limitations.18

In addition to this, nine (9) different types resident companies19 in Sri Lanka which are classified as
specified business entities under Sri Lanka Accounting and Auditing Standards Act, 1995 can issue and
transfer both convertible and non-convertible, redeemable and non-redeemable debentures denominated
in Sri Lankan Rupees to foreign institutional investors, corporate bodies incorporated outside Sri Lanka.

However, offshore companies are not permitted to lend to Sri Lankan companies on ECB basis.

2.10.3. ENTRY PROCESS

Foreign Investors can make investment in resident companies through SIA (scheme of account titled
Securities Investment Account) as USD. One Million (USD 1,000,000) in trading sector and USD. Two
Hundred When the foreign investors don‟t make investment via SIA, the resident company should obtain
approval from the ECD As a matter of present, MCR for foreign investment has fixed Fifty Thousand
(USD 250,000) for other sectors.

17
In Sri Lanka, Exchange Control Department of Sri Lanka is entrusted to administer Exchange Control Regime.
18
Gazette Notification No.1232/14 dated 19/04/2002 and 1248/19 dated 08/08/2002 issued by Exchange Control Department of Sri
Lanka.

19
The nine different types of resident companies having specified business entities are : licensed Banks, licensed
Insurance Companies, company carrying leasing business, companies carrying factoring business, companies
licensed to operate unit trust, companies licensed to operate as stock brokers or stock dealers, companies licensed
to operate stock exchanges, companies whose shares are listed in licensed stock exchanges, and other companies
whose annual turnover turn over exceeds LKR 500 Million. (1 USD = 130.31 LKR)
2.10.4. SECTOR S O PENED FOR FOREIGN INVESTMENT

Foreign investors can purchase up to 100% of equity in Sri Lankan companies in numerous permitted
sectors however there are sectoral caps in a few sectors.

The government allows 100% foreign investment in almost all of the commercial, trading, or industrial
activities save for few sectors which are either prohibited or capped with foreign investment limit.

2.10.5. SHARE TRANSACTION AND PRIVATE PLACEMENTS

i) Issue and Transfer of Shares of Companies to Non-residents:

Sri Lankan law requires that every transaction (wire transfer, remittance of dividends, transfer of
sales proceeds of securities) in connection with the issue and transfer of Shares to non-residents
to be done through Security Investment Account (SIA) opened in Commercial Banks.

ii) Private Placements in listed companies (for trustees):

Foreign Investors can acquire the shares in Sri Lankan Companies by way of Private Placement.
However, the acquisition of shares by way of private placement should be within a limit of fifteen
(15) percent of the total shares that are issued.

2.10.6. PERMITTED INSTRUMENTS FOR FOREIGN INVESTORS

Characteristics Maximum Limit Interest Conversion

Period

EQUITY Payment to be Maximum of 15% - -

SHARES made out of SIA of shares issued
via private
placements

BONDS Permitted to Up to 10 % of the - -

purchase, sell or total outstanding
transfer Treasury Treasury bonds at
bonds with any any given time
maturity period

DEBENTURES Purchase Up to 100% of the Shall not Period of

convertible or exceed the five redemption or
 non-convertible, listed debentures year conversion to
redeemable or secondary ordinary shares
non-redeemable market shall not be
debentures Treasury bond less than five
denominated in Sri rate plus 200 years.
Lankan Rupees basis points

PREFERENCE Tenure not less - Conversion

SHARES than 3 years and may be
redemption not effected at
before one year of anytime
issue

LENDING Offshore Allowed to lend - -

MONEY TO SRI companies not USD 30 million or
LANKAN allowed to lend to its equivalent
COMPANIES Sri Lankan value in any other
companies via foreign currency
ECBS under the ECBS to
a company

Apart from the equity shares in the companies, foreign investors can also invest in the following
securities:

a) Bonds:

Foreign investors can purchase up to 10 % of the total outstanding Treasury bonds at any given
time. FIs are permitted to purchase, sell or transfer Treasury bonds with any maturity period. 20

20
www.cbsl.gov.lk/pics_n_docs/07_af_2pdm/_docs/.../invguide1.doc , p. 2 (accessed on June 25, 2014)
 b) Debentures:

Permission has been granted for the issue and transfer of convertible or non-convertible,
redeemable or non-redeemable debentures denominated in Sri Lankan Rupees in a company
subject to following conditions:

 All debentures issued shall be listed in the Colombo Stock Exchange, while such issue may
be made either by private placement or initial public offer.
 The period of redemption or conversion to ordinary shares, of the debentures issued shall not
be less than five years and such conversion should be subject to the exclusions and limitations
stipulated in the Government Gazette Notification No. 1232/14 of 19/04/2002.
 The debentures issued shall have a current credit rating from a local rating agency or
international rating agency acceptable to the Securities and Exchange Commission of Sri
Lanka.
 The rate of interest on the debentures shall not exceed the five year secondary market
Treasury bond rate published by the Central Bank of Sri Lanka plus 200 basis points at the
date of issuance of the debentures.

Further foreign investors have permission to invest up to 100% of the listed debentures in the
Colombo Stock Exchange. (Tiruchelvam Associates, 2011)

c) Preference shares:
 The tenure of a preference share should not be less than three years from the date of
issue.
 Redemption of the shares shall not commence earlier than one year from the date of issue
and shall be phased out proportionately throughout the balance period.
 If the shares so issued are convertible into ordinary shares, such conversion may be
effected at anytime and shall comply with the exclusions and limitations specified in the
Government Gazette extraordinary No. 1232/14 of 19.04.2002 as amended (Lanka C. B.,
2013)

d) Lending Money to Sri Lankan Companies:

Lending money to Sri Lankan companies is regulated by the External Commercial Borrowing
Scheme (ECBS). However, this permission shall not apply to a company limited by guarantee
or an offshore company.

A borrower may obtain USD 30 million or its equivalent value in any other foreign currency
under the ECBS provided that the maximum amount of borrowing per company per each calendar
year shall be USD 10 million or its equivalent value in any other foreign currency.

2.10.7. LOCK IN PERIOD

 Shares held by promoters and all other shareholders prior to an IPO is locked in for a period of 9
months from the date of listing of shares in Colombo Stock Exchange (CSE)
 For the shares allotted within a period of one year prior to the date of Initial Listing Application, lock-
in period of 12 months from the date of listing on the CSE. (Lanka, 2012)

2.10.8. INCENTIVES OFFERED ON INVESTMENTS

i) Investment Incentives for Strategic Development Projects:

The Strategic Development Project Act of 2008 provides tax incentives for large projects that the
Cabinet identifies as Strategic Development Projects (SDP). SDPs are defined as investments that
are in the national interest, likely to bring economic and social benefits to the country and change
the landscape of the country through the provision of goods and services, substantial inflow of
foreign currency, generation of employment and income, and transfer of technology. Information
regarding projects selected as SDPs and incentives is published in the official gazette and needs
to be approved by the Cabinet and Parliament. The incentives become operational upon
parliamentary approval. Projects are exempted from taxes for up to 25 years. The exempted taxes
include corporate income tax, Value Added Tax, Economic Service Charge, Debit Tax, Customs
Import and Export taxes, Port and Airport Tax, and the Nation Building Tax.

ii) Incentives for Other Projects:

The BOI provides the following incentive regime:

 Small-Scale Enterprises: A 4-year tax holiday for small-scale enterprises in agriculture,

animal husbandry, fisheries, and creative work, including art work and information
technology. Minimum investment of Rs 25 million (US$219,000). A 5-year tax holiday for
fishing, fish processing, and the production of agriculture seeds.

 Medium-Scale Enterprises: A 4 to 6-year tax holiday for medium-scale enterprises in

manufacturing, agriculture, agro processing, animal husbandry, fisheries, fish processing,
IT/BPO, health care, education, beauty care, cold rooms/storages, tourism, sports and fitness
centers and creative work, including art work. Minimum investment of Rs 25 million to Rs
200 million (US$192,000 to US$1.5 million).

 Large-Scale Enterprises: A 6 to 12-year tax holiday for large-scale enterprises in agriculture

or forestry; manufacturing or processing of non-traditional goods for exports; manufacturing
of boats, pharmaceuticals, tires, tubes, motor spare parts, furniture, ceramics, glass ware or
other mineral based products, rubber based products, cosmetic products, edible products,
construction materials; services provided to a person or partnership outside Sri Lanka;
tourism or tourism related projects; infrastructure projects including construction of
commercial buildings and warehouses, internal waterways, related transport (passenger or
freight), renewable energy, industrial estates or knowledge cities, urban housing or town
 centers, sanitation or waste management systems, water services, hospitals and health care
services; maintenance of maritime vessels/ aircrafts; sporting services; software development;
light or heavy engineering industry; dairy development; education services. Minimum
investment of Rs 300 million to over Rs 2.5 billion (US$2.3 million to over US$19.2
million).

 Import Replacement Industries: A 5-year tax holiday followed by a concessionary tax rate of
12% for strategic import replacement industries (i.e., cement, steel, pharmaceuticals, fabric,
and milk powder). Minimum investment levels apply.

2.10.9. REVIEW OF ENTRY OF PRIVATE EQUITY IN BANGLADESH

Bangladesh has seen huge surge in foreign investments in private sector over the past decade. Most of the
investments are aimed at manufacturing industry, primarily in the garment industry. Investors have also
put significant investments in country‟s telecommunications and banking sector. (Statistics Department,
2009)

2.10.10. REGULATORY FRAMEWORK

Foreign Exchange Regulations Act, 1947 regulates the payments and dealings in foreign exchange and
securities. The Foreign Private Investment Act, 1980 promotes and protects foreign private investments in
Bangladesh.
The Investment Board promotes industrial investments and offers facilities and assistance necessary for
the establishment of industries in the non-governmental sectors.

While the Securities and Exchange Commission regulates the public issue market, separate notification
regarding private placements is present in Bangladesh.
2.10.11. OFFSHORE VEHICLES

The Foreign Private Investment Act, 1980 doesn‟t discriminate between offshore and onshore foreign
investors while defining foreign capital21 and foreign private investment.22

2.10.12. ENTRY PROCESS

All FDI needs to be registered. If the business is to be set up in an export processing zone (EPZ) or
industrial estate, registration must take place with Bangladesh Export Processing Zones Authority
(BEPZA) or Bangladesh Small and Cottage Industries Corporation (BSCIC – if investment doesn‟t
exceed USD 2 million / Tk 100 million). If the business is to be set up elsewhere, it must register with the
BOI.

A manufacturing firm employing ten or more workers must also register with the Chief Inspector of
Factories and Establishments. Pre-registration clearance is required for investment in the following areas:
ready-made garments, banks, insurance companies, and other financial institutions.

The Investment Board Act of 1989 outlines the process of making foreign investment in private sector in
Bangladesh:

1)Registration:-All industries established in non-governmental sectors except industries under the control
of the Bangladesh Export Processing Zones Authority, the Bangladesh Small and Cottage Industries
Organization, textile industries set up on their own capital and industrial undertakings licensed by the
Board shall be registered in the prescribed manner.

2) License: These industries shall make an application to the Board in the manner and form prescribed by
the Board.

* the Government may from time to time, by notification in the official Gazette, on recommendation of
the Board, exempt any industry or industrial undertaking from the application of this section.

3) Approval: Where on consideration of an application, an undertaking has been considered fit for
approval, the Board shall, under the strict conditions of its consideration, approve the scheme and grant a

21
“foreign capital” means capital invested in Bangladesh in any industrial undertaking by a citizen of any foreign
country or by a company incorporated outside Bangladesh, in the form of foreign exchange, imported machinery
and equipment, or in such other form as the Government may approve for the purpose of such investment –
Foreign Private Investment Act, 1980
22
“foreign private investment” means investment of foreign capital by a person who is not a citizen of Bangladesh
or by a company incorporated outside Bangladesh, but does not include investment by a foreign Government or an
agency of foreign Government – Foreign Private Investment Act, 1980
license to the applicant, and shall determine in such license the period within which to implement the
scheme and to start production

2.10.13. INVESTMENTS SECTORS

Bangladesh allows foreign investment in all sectors of economies except the following four sectors:

 arms and ammunition and other defense equipment and machinery,

 forest plantation and mechanized extraction within the bounds of reserved forests,
 production of nuclear energy, and
 security printing and mining

2.10.14. LIMITS ON INVESTMENTS BY FII

For foreign direct investment, there is no limitation pertaining to foreign equity participation, i.e. 100
percent foreign equity is allowed. Non-resident institutional or individual investors can make portfolio
investments in stock exchanges in Bangladesh.

2.10.15. GENERAL INCENTIVES

In addition to incentives for the private investor, foreign investors are also entitled to the following
(Betelco):

 Tax exemption on capital gains from the transfer of shares by the investing company;

 Avoidance of double taxation in case of foreign investors on the basis of bilateral agreements

 No restriction in issuing work permits to foreign nationals in Bangladesh

 Facilities for repatriation of invested capital, profits and dividends

 Provision for transfer of shares held by foreign shareholders to the local shareholders/investor with
the permission of the BOI and the Exchange Control Department of the Bangladesh Bank.

2.10.16. MODALITY OF PE FUND

Foreign institutional investors (FIIs) can simply open a non-resident investor‟s taka account with a bank,
and then invest directly in listed securities and pre-IPOs. (FinanceAsia, 2012)
2.10.17. INVESTMENT INSTRUMENTS UNDER FDI

Under Foreign Direct Investment, foreign investors can invest up to 100% in the investee companies in
Bangladesh.

Characteristics Lock-In Period Interest Repayment

Period

EQUITY Can invest up to 100% 3 years for directors - -

in the investee and those who hold
and companies in 5% or more shares. 1
Bangladesh year for others
DEBT

FOREIGN For customized loans, - Should not Shouldn‟t be

LOANS obtain approval from exceed less than 7
BOI LIBOR+4% years

a) Equity and Debt:

There is no general restriction on equity participation, acquisition of property or management

control by a foreign firm. It is not clear on the instruments type and other features. But,
Bangladesh asserts to be welcoming foreign investors in any form and type. Documents only
talk of ownership of companies and not the method of ownership.

b) Foreign Loans:

Foreign loans falling within the following guidelines aren‟t required to obtain prior approval
from BOI.

 The effective rate of interest should not exceed LIBOR+4% (effective interest is the
sum of the stated annual rate of interest and the annualized fees such as commitment fee,
syndication fee, front-end fee, project appraisal fee etc.).

 The down payment, if any, in case of suppliers‟ credit should not exceed 10% of the
credit amount.

 The repayment period should not be less than 7 years.

* Foreign investors cannot buy national savings bonds. They also cannot sell their shares
through public issues.
 ** Foreign investors can invest in listed securities. They can also invest in new private placements of
the shares of industrial enterprises. There are no restrictions on the transfer of shares to other non-
residents. (Commerce, 2000)

2.10.18. LOCK-IN PERIOD

The security (except debt security without conversion feature) including the equity security issued in part
or in full against any convertible security by a listed company for which the consent is accorded under
these Rules shall be subject to a lock-in of

(a) 3 (three) years in case of directors and those who hold 5% (five percent) or more shares, and

(b) 1 (one) year in case of others, from the date of issuance of such security, or from the date of issuance
of consent, whichever is later

Provided that the time involved in between the issuance of convertible security and converted equity
security shall be counted for the lock-in period:

Provided further that the said lock-in shall also be applicable in case of issuance of equity security against
loan or debt security having no predetermined conversion feature if such equity security is not issued at a
price equal to last 6 (six) months‟ weighted average market price at the stock exchange. (SEC, 2001)
CHAPTER THREE: OPERATIONAL ASPECTS OF THE PRIVATE EQUITY FUND

3.1. RIGHTS OF MINORITY SHAREHOLDERS

In most investment scenarios of PEFs, the investor is a minority shareholder in the company23, except in
case where the PEFs is set up under the bulk investment from high net worth individual and institutional
investors. In venture capital funds or PEFs, the protection aspect of minority shareholder is the most
vulnerable part as most of their contributions are invested in high risk projects or undertakings. Beside the
minority investors do not have substantial degree of control in making investment decisions. In case of
PEFs registered in Nepal (Onshore PEFs), Minority Shareholders can exercise the rights that are
recognized as the right of Minority Shareholders under Companies Act, 2006. Apart from the limited
protection afforded by the statute, minority shareholders investing in the PE Funds can also extend their
rights through Shareholders' Agreement after negotiating with the existing Shareholders of the Company
and the Company. For example, a minority shareholder through a Share Holder Agreement with the
Venture Fund Company can exercise his right to be consulted through or his right to exercise the put
option by negotiating the same on Shareholders Agreement. Companies Act, 2006 under Section 30(1) of
Company Act, the Minority Shareholder of Company can elect to acquire shares of different class.
Similarly, the Minority Shareholders can extend their rights through Agreement with other Shareholders
of the Company.

The Shareholders' Agreement between Minority Shareholder and the Company is enforceable at the court
of law, provided that the provisions in the Shareholders' Agreement are not inconsistent with the Articles/
Memorandum of Association of the Onshore Fund. As per court practice and precedents laid down by the
Supreme Court of Nepal, the provision in Articles/ Memorandum of Association supersedes the
provisions of the shareholders agreement.

As there is no special framework to deal with PEFs, minority shareholders should seek the remedy against
the operations by majority shareholders or controlling shareholders under the regular minority protection
provision of the Companies Act, 2006.

Certain redress is available under the Companies Act, 2006 to Minority Shareholders against the
oppression and exploitation by Majority Shareholders. The redress available under the Companies Act is
presented in the table below.

Nature of Oppression/ Authority to Percentage (%) of Redress Available

23
As a matter of general understanding, PEFs creates a dedicated pool of investible funds from large number of
Investors and the such large number of minority investors do not have control in the day to day affairs and making
of investment decision in PEFs.
Redress receive shareholding required to
Complaint/ file complaint.
hear
grievances

Unauthorized Act of To Appellate Not specified. Injunction against the

Directors or Officials Court unauthorized act.
of the Company prescribed.

Act against the right To Appellate Not specifies/ any single  Injunction Order
and interest of the Court shareholder.
Shareholders prescribed.  Order to file civil suit
The shareholder has onus to against the person
prove 'act against the interest responsible
of shareholder',
 Cancellation of registration
of Company

 Order to buy the shares of

the victimized shareholders

 Order responsible officials

or directors to compensate
the loss.

File suit against the To the Court Five Percent (%)

any director, officials of Appeal as
or third party to prescribed in
enforce the interest of the Gazette.
the company.

Oppression of Office of the Five Percent (%) The OCR will direct the
Minority Company investigators to produce an
Shareholders and Registrar investigative report.
Mismanagement of (OCR).
Company. The OCR may order the
needful on the basis of such
investigation report.

Requisition of Office of the Shareholder holding 10% of The OCR may, upon itself,
Extraordinary Company total paid up shares or 25% of call the EGM of the
General Meeting Registrar. the shareholders. Company.
(EGM)

Invalidate the decision Office of the Any single shareholder can The OCR can invalidate the
of General Assembly Company make complaint to OCR to decision of the General
invalidate the decision taken Assembly in the case of
of Private Company. Registrar. in General Assembly of receiving proof that any
Private Company in case he Shareholder of the Private
was not given opportunity to Company was not given the
be present in General opportunity to be present in
Meeting of the Private the General Assembly.
Company.

The complaint should be

made within 3 months of the
General Meeting.

3.2. QUALIFICATION FOR BOARD OF DIRECTORS

Companies Act, 2063 of Nepal does not list out the qualifications required to be a director of the
company, be it private or public except for the independent directors of a public company. However,
Directors of the public company are disqualified from the post on grounds like committing an offense
resulting into moral turpitude, being insolvent, in case of mental instability. Independent directors
(directors having no ownership interests in the company) should possess certain qualifications like 10
years' experience and expertise in fields of law, economics, management, accountancy, etc. and a person
who does not have conflict of interest, etc.

There is no restriction to foreign shareholders or foreign institutional shareholders to appoint a non-

Nepalese national as a nominee director. Relatively fewer degree of restriction in eligibility of directors
caters a good working environment for operation of PE Funds.
3.3. REPRESENTATION OF PORTFOLIOS AND DIRECTORS‟ LIABILITIES

Representation in Portfolios is open for Venture Capital Funds under the existing Companies Act, 2006.
A Private Equity Fund or Venture Capital Fund investing in the equity of domestic Venture Capital
Undertakings (Portfolios) has the right to appoint an institutional director for Portfolio Company in
proportion to their shares in the undertakings or portfolios. Minimum shareholding requirement is not
applicable in the case of Institutional Director so appointed. Such Institutional Director may also appoint
an Alternative Director to represent him/her in case he/she cannot be present in person at the meeting of
Board of Directors of Venture Capital Undertakings or Portfolio Company.
The provision in the present FITTA24 along with the Draft FITTA25 guaranteeing/safeguarding the right of
Business Visa to the Foreign Investors and their representatives provides a comfortable working situation
to foreign institutional investors and investors.

However, the thing is not free from caveats. An important issue that may arise is related to the potential
conflict of interest that may be faced by investor-appointed/ nominee directors. Statutorily, Directors owe
a fiduciary towards the company – to act in the interest of the company. However, the institutional
investor of PE Funds wishes that their appointee / nominee directors acts in the interest of the fund. This
conflict results in nominee directors having to tread a thin line between the investors and the company. As
a consequence, veto rights are often exercised directly by the investing entity rather than the nominee
directors; the exercise of Veto may not be in the interest of the investee targets or undertakings
sometimes.

Directors face numerous other risks in relation to the operation of the company and can even be held
criminally liable in some circumstances. It is important therefore for the appointee/ nominee directors that
they are sufficiently indemnified and that the company maintains an appropriate directors' and officers'
liability insurance policy.

3.4. DELEGATION OF AUTHORITY

As per the law, the Board of Directors of a Company can delegate its managerial and decision making
authority to any individual director or any other person. However, the law imposes certain restrictions on
it.

Decisions making in relation to (a) demanding the payment of due amount of subscribed shares from
shareholders, (b) issuing debentures (c) borrowing loans or credits by other ways than debentures (d)
making investment from the fund of the company (e) providing loans is reserved for the meeting of Board

24
Section 6(2) of the FITTA provides that the Foreign Investors, dependent family member of foreign investors or
their authorized representative will be granted Business Visa so long as they have foreign investment in Nepal.
25
Section 8 of the Draft FITTA provides that the institutional shareholders, their dependent family member, their
representative and their representative subject to the foreign investor fulfilling certain terms and conditions.
of Directors . Such restrictions, particularly, making investment and providing loans may not be
compatible with investment practice in a PEFs investment regime.

Customarily, In every Private Equity Investment Regime, Investment Manager appointed on a contractual
basis and registered with the regulatory bodies (for example, say, Security and Exchange Board may be
regulatory in the context of Nepal) makes the decision to invest or make loan to the targets from the
amount on fund.

Alternatively, it is not always possible for the directors of the PE Funds to be present in person every time
the investment decisions needs to be made and customarily the Directors of the PE Funds are passive
actors in the context of making of investing decisions. Companies Act, 2006 under Section 95 (7) has
exempted the Bank and Financial Institutions to comply with the said restrictions, considering the
practicality and business nature of Bank and Financial Institutions. So, in view of creating a comfortable
working environment to PE Funds, while investing in targets, Company's Advisory Board may exercise
its authority under Companies Act and relax such restriction (like it has been given to licensed Bank and
Financial Institutions) by issuing clarification or otherwise.

3.5. BLACKLISTING

Nepal has a robust regime on Blacklisting of defaulter. Before the recent amendments in NRB's provision
on Blacklisting of defaulter, the institutional shareholder and the nominee director having 15% or more
equity stake in the defaulter company26 were blacklisted at Credit Information Centre Limited.

The said provision creates a substantial degree of risk to both Offshore PEFs and Onshore PEFs.
However, the recent amendment in the Blacklisting provision of NRBs has exempted (a) foreign investors
investing in equity of defaulter after obtaining foreign investment approval (b) Foreign Diplomatic
Mission (c) Donor Agency and (d) Development Partner enjoys immunity from blacklisting if the
investee company to which they are investors defaults in loan repayment and debt service. However, this
facility or exemption may not be available to Onshore Venture Capital Funds.VCFs has been customarily
investing in risky projects or undertakings and default to service debt by high risk projects can be
genuinely expected. Such blacklisting provisions may deter the PE Funds or VC Funds to invest in high
risk undertakings and ultimately limiting the growth prospect of high risk but promising projects. Given
the robust regime on Blacklisting, Offshore PEFs may be an desirable option than Onshore PEFs while
making investment in high risks undertakings and high risk start up projects.

The said provisions posed an enormous degree of threat to Foreign Investor, until recently. However, as
per the recent amendment in the Blacklisting provision of NRBs, foreign institutional investors, such as:
(a) foreign equity partner who has come under approval route (b) Foreign Diplomatic Mission (c) Donor
Agency and (d) Development Partner are exempted from blacklisting in the situations where there's
investee in Nepal defaults to service debt to licensed Bank and Financial Institutions. However, this

26
Here, Defaulter Company means the company defaulting in loan repayment and debt service to licensed
institutions.
facility or exemption may not be available to the Onshore Venture Capital Funds. So, creating Offshore
VCFs or PE funds can be a desirable option to prevent the blacklisting risk.

3.6. VISA AND WORK PERMIT

Under section 6 (2) of FITTA 1992, the foreign investor (with the exception of individual investor)
investing in excess of USD 200,000 (Two Hundred Thousand US Dollar) per investment year and their
dependent family members and the authorized representative of the foreign investor has the right to obtain
5- year Business Visa in Nepal, till the time such investments retains in Nepal.

3.7. DISPUTE SETTLEMENT

Section 7 of FITTA 1992 provides that the disputes between the foreign investor27, domestic companies
should be settled through mutual consultations in the presence of Department of Industry. In case the
parties to the dispute remain unable to settle their dispute even after the mutual consultation, then the
dispute shall be referred to an arbitration panel in Kathmandu and the governing law of arbitration will be
the prevailing Arbitration Rules of the United Nationals Commission on International Trade Law
(UNICTRAL). In the event of dispute between foreign investors and domestic companies, matters such as
nationality bias may put foreign investor in jeopardy.

Parties to the Investment (the foreign investor and investee) are free to choose the governing law of
arbitration on their own only when the amount of investment under the Investment Agreement exceeds
Rs. 500 Million. This threshold of Five Hundred Million, which determines the ability of the parties to
choose the governing law on disputes, is not workable in the context of PE Funds investing in the Small
and Medium Scaled Enterprise and Start-up undertakings.

3.8. FILING AND REPORTING REQUIREMENT

Onshore PEFs and also the targets or undertakings (entities/ undertakings receiving investment from
Onshore PEFs and Offshore PEFs) are required to file copies of several of corporate documents,
including, Annual Financial Statement, Board Resolutions, Minutes of Annual General Meetings,
Minutes of EGMs etc to Office of Company Registrar. The failure to file and report the foregoing will
make directors and other key officers of the onshore PEFs and the portfolios liable to pay fines under
Section 81 of Companies Act, 2006.

The filing and reporting requirements are highly penalty driven and penalties get cumulated every year.

27
For the purpose of PEFs, the term "foreign investor" should mean as offshore investor investing in Onshore PEFs
or Offshore PEFs investing in Nepalese target ventures or undertakings.
3.9. INVESTMENT LIMIT

PEFs are typically a capital fund that have dedicated pool of investible funds and the main objective
behind establishing/ setting up such fund is to make investment in the target portfolios. Although, PEFs or
funds of similar nature has been given a legal recognition as an Investment company after the recent
notification of May 18, 2011, there are some restrictions under the existing laws potentially impeding the
functioning of the PEFs as an investment fund. As investment companies have not clearly been exempted
from the restriction provided under Section 176 of the Companies Act, Section 176 may also interpreted
that the onshore fund cannot make investments in or provide loan to the portfolio companies in excess of
its-(a) 60% of the sum total of the paid up capital and free reserve, or (b) 100% of the free reserve
whichever is higher. The said provision will not allow the PEFs to invest beyond 60% of its investible
corpus.
CHAPTER FOUR: EXIT AND REPATRIATION

4. EXIT

Regulatory issues concerning the exit of the PE Funds are equally as important as the issues that concern
the entry of the PE Fund. PE Funds usually have a limited lifespan of 8-10 years. Due to their limited and
relatively short life span, the regulatory issues concerning the exit highly affect the implementation of
their strategic interest.

This chapter will highlight the exit options available to the PE Fund vis-a-vis the existing regulatory
constraints impeding the speedy and efficient exit of the PE Fund. The issues concerning the repatriation
after the exit of the Offshore PE Fund from the targets have also been separately dealt hereunder.

PE Fund investing in the Nepalese targets has an option to exit from at least two different routes: (a)
Public Route, and (b) Private Route. The exit mode which involves the selling of securities to general
public is taken as public route and those which does not involve the selling of the securities to the public
is taken as the Private Route in this report. Opting for the Public Route necessarily involves the process
before the Nepal Stock Exchange whereas the Private Route does not necessarily involves the process
before the Nepal Stock Exchange.

The PE Fund can exit from so-called Private Route by following ways-(a) recover the loan with interest
post the maturity of loan period or earlier, (b) sell the security up to 50 number of shareholder, (c) buy
back of the unlisted securities, (d) exercising put options, (e) capital reduction, (f) redemption of preferred
shares, etc.

Similarly, the PE Fund can exit from so-called Public Route by following ways- (a) public sale of the
securities through stock exchange, (b) redemption of listed preferred shares, (c) buyback of listed shares,
(d) redemption of non-convertible debentures. Sale of security through Public Offerings,
buyback/redemption of the listed securities, Repatriation of Dividend, repayment to the debentures and
other equity linked instrument etc can be classified as exit under the Public Route.

The available exit routes and their classification are presented in the table below;
Fig.1 Illustration of exit routes available to Offshore Funds
4.1. EXITS THROUGH PRIVATE ROUTE

PE Fund can exit through the Target in Nepal by adopting private placement route. Compliance to
regulatory requirements is relatively lesser while adopting private route than public route. The
different types of private route s and the issues concerning thereof has been briefly discussed in the
paragraphs below;

4.1.1. BUYBACK OF UNLISTED SHARES

Buy back is a scheme wherein the companies re-purchase their own shares from its shareholders. Buy
back can be a very good exit strategy where the PE Investors could agree to exit via buy-back of shares at
a mutually agreed internal rate of return.

Buy- back is generally prohibited under the Companies Act, 2006; however, it is allowed subject to the
satisfaction of certain conditions. Following key conditions will need to be satisfied for the buy-back of
shares: -(a) subscribed capital till the date of buyback to be fully paid (b) listing of the shares in securities
board if the company is a public company, (c) buy back being consistent with the articles of association,
(d) certainty that the ratio of the debt to sum total of paid up capital and general reserve fund [total debt:
(paid up capital + free reserve)] will not exceed the ratio of two-to-one (2:1) after buyback transaction
(f) amount to be used for buy-back will not exceed twenty(20) percent of sum total of free reserve and
paid up capital, etc.
Pursuant to Section 61(2) of the Companies Act, the companies can fund the buyback of shares only out
of the amount available in the company as a distributable profits.

Onshore PE Fund and Offshore PE Fund cannot exit from Investee Company that is operating in loss; for
the obvious reason that the Company operating in loss will not have any distributable dividends.

The onerous condition on redemption makes it impossible for the PE Fund to exit through Investee
Company by way of buyback operating in loss even if wish to sell its holding to the investee at a rate than
in the time of acquisition or purchase, which results in trapping of capital inside the investee company.
This will not allow the PE Fund to implement its strategic interest to exit within the predefined time
period.

To overcome the possibility of fund trapping reasonable, amendment should be made in the Companies
Act, particularly considering the case of investors like PE Funds, so as to allow the PE Fund to exit from
the investee company which is operating in loss.

4.1.2. EXIT EXERCISING PUT OPTION

"Put Option" is an option available to the investor, wherein the investor has an option to sell the
subscribed/ acquired shares at a mutually agreed price (agreed price at the time of Share Subscription/
Acquisition Agreement) after certain period from the date of the investment. The Put option has not been
explicitly recognized under the provision of the Nepalese Companies Act, therefore, the arrangement for
'put option' is done through the Shareholder's Agreement or separate put option agreement.

In practice, approval from DOI and NRB are obtained by the investors to enter into the put option
agreement in order to avoid any risks at the time of repatriating the sale proceeds.

The agreed rate of return will be normally higher than the value of the acquiesced/subscribed shares or
will be in a premium rate. The requirement of valuation report might operate as an obstacle for the foreign
investor to exit through the put option right in a situation where the agreed put option price is higher than
the price derived from the valuation.

4.1.3. CAPITAL REDUCTION

The PE Fund can exit from the target by reducing the capital structure of the target equivalent to its
holding there. Section 57(2)(a) of the Companies Act permits the companies to reduce its capital by
refunding the paid up capital after taking requisite approval from the court. The capital reduction can be a
very convenient way for exit; however, the requirement of the approval from the court and restriction on
refunding the capital on premium rate may create some practical complexity.
Pursuant to Section 57 read with Section 58 of Companies Act, the companies are not allowed to reduce
its capital by refunding the capital at a premium rate even if the assets of the companies has sufficiently
increased and the assets and receivables of the companies exceeds the liabilities; while the valuation and
subsequent price adjustment requirement are mandatory while the companies liabilities exceeds the assets
and receivables. Amendment to Section 57 of the Companies Act appears to be necessary in order to
allow the convenient exit of PE Fund from its investee company.

4.1.4. REDEMPTION OF THE SECURITIES

Both Onshore and Offshore PE Fund participating in the investee company by way of preferred equity
can exit from the investee company by redeeming their preferred equity at a rate that was agreed during
the time of subscription.

However, as per the provision of the Companies Act, the redemption of the preferred shares can be
funded only out of the amount available as distributable profits or amount collected in the redemption
account through fresh issue of securities. The said conditions restrict the PE Fund to exit from the
investee company by redeeming their equity , where , investee company - (a) is operating in loss (b)
does not have any sum left as distributable profits for other reason than loss, for instance, company
undertaking ventures of longer gestation period but in stage of commercial operation and shows potential
future return.

The PE Funds investing in the investee company undertaking the projects having relatively longer
gestation period cannot redeem their redeemable equity within their life span. Restriction in funding the
redemption from paid up capital or through debt should be lifted particularly in case of PE Funds.

4.1.5. LOAN REPAYMENT

The PE Fund participating in the investee company by way of loan or other related instrument can exit
from the investee after securing the loan repayment upon the final maturity of loan period or earlier on the
consent of the borrower. While Onshore PE Fund may not face serious issues while routing its exit
through loan repayment, there are certain issues which concerns the ability of the Offshore Fund to secure
its loan investment.

Pursuant to the NRB notification September 11, 2013, a borrower in Nepal cannot repay the foreign loan
if -(a) it is blacklisted before Credit Information Centre Limited, or (b) any it has any payable debt to
local banks and finance Company. The said provision puts the interest of the Offshore PE Fund to
recover the foreign loan in a situation of absolute jeopardy. Apart from this the said conditions also
overlooks the modern practice of loan investment through subordinated debt function and the consortium
partnership of foreign lenders and local Banks and financial institutions.
The NRB's protective approach in treating the local banks and financial institutions is likely to deter the
foreign lender including the Offshore PE Fund to make loan investment in ventures and undertakings of
Nepalese Companies.

4.2. EXITS THROUGH PUBLIC ROUTE

The PE Fund can exit from the investee companies placing its securities in public for subscription. Public
Placement is mandatory when the securities of the Investee Companies are listed in Stock Exchange and
on Private Placement through circular method. The different types of exit route available under public
placement along with the possible issues that PE fund may face have been discussed below;

4.2.1. INITIAL PUBLIC OFFERINGS ("IPOS")

Initial public offering (IPO) or stock market launch is a type of public offering where shares of stock in a
company are sold to the general public, on a securities exchange, for the first time.

The private companies are not allowed to raise any money through public subscription. Only those
companies which are registered as the public companies and satisfy certain qualification requirement
under the Security Laws are eligible to raise money through public subscription and IPOs.

PE Funds or VC Funds who have participated in the undertakings organized/incorporated in the form of
private companies by way of equity investment cannot exit directly through IPOs as Private Companies
are not allowed to opt for IPOs under existing Nepalese Laws. However, PE Funds or VC Funds may
exit from the investee through IPO after the investee converse itself into Public Limited Company.

A private company can process the conversion to the public company after -(a) obtaining authorization
from the general meeting through a special resolution for conversion, and (b) fulfilling other
requirements to be a public company; for e.g. Rs. 10 million paid up capital, minimum seven number of
directors etc.

Apart from the issue like delays, the PE Funds will face numbers of issue while exiting from their
investee through IPO route. The issues concerning the PE Funds exit from the investee will be briefly
discussed hereunder. The procedures for IPO is presented in Annex-10 attached to this report.

4.2.1.1 RESTRICTION ON FIXING THE VALUE OF SHARES ON MARKET

PRICE
 (a) Security Issue Regulation states that generally, security (share) must have a face value
equal to 100 rupees.28 In addition to this, Rule 24 of the Regulation states that shares
must be issued at the face value, unless the conditions in the companies are fulfilled
(the conditions in Companies Act are that the company should have made profits for
three years and have a net worth exceeding its liabilities) and that the share premium
does not exceed the net worth per share). The company also has to justify the
methodology for calculating the share premium.

(b) These provisions are simply inappropriate. The value of the shares will be based on a
number of factors concerned with past performances and future prospects. Past
performance is essentially a credible factor that can predict the future prospects of a
company but it does not hold good to be reliable every time. For example, in the case
of a long term infrastructure investment project or Research and Development
project, there may be substantial initial borrowings and therefore minimum net worth
and obviously no history of profit distribution, but goods prospect for future.

(c) The fixed pricing norms undermine the rights of the investor to make their own
assessment as to the existing and future value of the shares. The profit history of a
company is surely of relevance to an investor but there is no justification for setting a
requirement of three years of profit as a basis for allowing the issue of new shares at
the market price (rather than face value). Investors should be permitted to make their
assessment.

(d) The restriction on fixing of price at the time of issue has serious impact on the PE
Fund than other companies. PE Fund has to wait for more than three (3) years post
the commercial operation date (and, sometime post the breakeven point) to exit from
PE Fund securing profit. Selling shares at the premium rate is the only option
available to the PE Fund which typically has a very short and limited lifespan. PE
Funds will be force sell their security (share) at much lower price even if the true
market price of a security is many times above the face value.

4.2.1.2. MINIMUM PROMOTER'S HOLDING

Security Issue Regulation under Rule 7(4) requires the promoters of the company to
maintain a holding of at least fifty one (51) percent of the offering companies' equity post
the IPO. This requirement that promoters should always have a majority shareholding
does reduce, to some extent, the problem that the management of company may have
interests that differ from those of shareholders. However, the provision operates to restrict
the exit of PE Funds having majority stake in the investee through promoter's shares, by
offloading all of their holdings in a single public offer. SEBON may relax the said

28
Rule 20 of Security Issue Regulation, 2007 (2065)
requirements on post IPO holdings particularly in the case of PE Fund considering their
relatively short and limited lifespan through amendment in said Rule 7(4).

4.2. 1.3. LOCK-IN PERIOD ON IPO ISSUE

(a) Section 10 (1) of the Security Issue Regulation, 2008 states that pre-IPO shares of
the promoters are subject to locked-in period for three (3)years post the IPO, which
implies, sell of promoter share is restricted for a minimum period of three (3) years
after the first public offering.

(b) Section 7 of the Security Issue Regulation, 2068 states that body corporate should
have undertaken the necessary works to meet its objective and completed one year
life. The post-IPO lock-in and minimum time frame requirement for floating
altogether makes up a lock-in period of four (4) years.

(c) The lock in period up to four (4) years is too onerous to process exit for PE Fund
which have limited and pre-determined lifespan of 8-10 years. Considering the
limited lifespan of PE Fund, India and several other jurisdictions has relaxed the
norms on lock in especially for PE Funds and VCF funds making lowering it to six
(6) month to one (1) year.
4.2.2. PUBLIC SALE OF SECURITIES IN SECONDARY MARKET

PE Fund can exit from the investee companies through secondary sales at a market if the securities are
listed in Stock Exchange subject to the terms and conditions mentioned in Rule 7 of the Security Issue
Regulation, 2007. Conditions such as requirement to maintain 51% promoter's capital post the issue, pre-
IPO lock in of more than one year from the date of operation etc makes it difficult for the PE Fund to plan
one-time exit offloading all of its holding to general public. Apart from this, the fixed pricing of the
premium shares is also an issue which creates an utter discomfort forcing the PE Fund to exit without
being able to realize the exact value of their interest in Investee Company.

4.2.3. REDEMPTION OF DEBENTURES

PE Funds participating in the investee companies by way of non-convertible debentures can realize the
value of debentures at a predetermined and agreed rate after expiry of certain period of time. However,
this option is available only to the Onshore PE Fund. The restrictive approach of NRB on treating foreign
loans makes it practically impossible for the Offshore Funds to make the investment in the debentures
issued by Nepalese Companies. .

4.2.4. BUYBACK OF LISTED SHARES

PE Fund can exit from the investee company by selling its shares which are listed in Stock Exchange back
to the investee Company. The same conditions applicable in Buyback discussed on paragraph 4.1.2
applies (needs to be satisfied) while opting for the buyback of listed shares. Although Section 61(4)(a) of
the Companies Act, 2006 provides that Company may buy back its shares from secondary market, there is
no provision in existing laws, inter alia, SEBON's Security Issue Regulations, 2007 and SEBON's
Security Issue Guidelines, 2007 regarding the applicable procedures and conditions for buyback of shares
from secondary market. This creates confusion in the PE Fund to implement their strategic exit plan.
4.2.5. DISPOSAL OF SHARES BY WAY OF PRIVATE PLACEMENT

PE Funds can exit from the investee companies by privately selling its holdings to fifty (50) numbers of
investors29 A company has an option to sell its shares by way of private placement up to fifty (50)
number of investors, however, will need to float the shares in public if the sale of shares is intended for
more than fifty (50) number of investors.

PE Fund can exit from investee companies by selling its holding to certain number of people through
circular or offer method. Approval of the SEBON is a mandatory compliance requirement that needs to be
fulfilled while opting for this method. Section 8 of the Security Issue Regulation, 2007 specifies the
procedurals for this method. Pursuant to said Section, the issuer is required to submit the copy of General
Meeting resolution, details as to the number of securities that will be issued, targeted investors, allotment
procedures etc while making application to SEBON for private sell of securities.

Although Section 5 of the Issue Regulation allows the sale of security by private placement, the said
regulation fails to outline the procedural requirements in details. SEBON may clarify the steps and
procedures to obtain private placement approval and rule and procedures for issue, subscription, allotment
post the approval.

4.3 . OTHER RELEVANT ISSUES

Apart from the issues that PE Fund will face while adopting a particular exit route, there are certain other
issues and regulatory constraints impeding the comfortable exit from the investee company. They are
briefly discussed in paragraphs below;

4.3.1 . VALUATION METHOD FOR PRICING OF SECURITIES

NRB and other authorities like Inland Revenue Department has not prescribed any pricing norms that
would be applicable in the valuation of the security. This creates uncertainty on the method of valuation
as different types of valuation method are practiced. Pursuant to the notification of NRB dated March
20, 2013, the valuation report of the assets and liabilities of the company selling its shares and interest
should be submitted to NRB while obtaining the approval for repatriation of the divestment proceeds.

Notable economy in the SAARC region, including India has fixed the pricing norms on different basis
for the listed securities and unlisted securities. While the price of the listed securities is based on
average weekly price on the recognized stock market, the unlisted securities are valued/ priced on

29
Pursuant to Section 29 of the Securities Act, 2003, a body corporate can sell its securities to fifty (50)
number of on private placement and if it intends to sell its shares to more than fifty (50) person the
shares should be floated for public sell.
 negotiation. (Not less than the fair value as determined by registered Chartered Accountant or merchant
banker registered with the security regulator.

In absence of any valuation norms, the regulator like the NRB may object to a valuation report prepared
employing particular method of valuation showing the over pricing issue taking account of weak
foreign exchange reserve. Similarly, a particular method of valuation may be objected with an intent to
recover higher capital gain tax. For example, NRB may object the repatriation of the sale proceeds
where securities are valued at Rs. 300 stating that if other valuation method were used the price per unit
of security will be Rs.310 with an intent to recover maximum capital gain tax.

It is suggested that the NRB and other stakeholder should co-ordinate to prescribe the appropriate
pricing norms for the valuation of the listed and unlisted security.

4.3.2 . PROMOTER'S LOCK-IN

(a) Section 10 (1) of the Security Issue Regulation, 2008 states that pre-IPO shares of the promoters are
subject to locked-in period for three (3)years post the IPO, which implies, sell of promoter share is
restricted for a minimum period of three (3) years after the first public offering.

(b) Section 7 of the Security Issue Regulation, 2068 states that body corporate should have undertaken
the necessary works to meet its objective and completed one year life. The post-IPO lock-in and
minimum time frame requirement for floating altogether makes up a lock-in period of four (4)
years.

(c) The lock-in conditions virtually restricts all available public routes for the exit of PE Funds from
the investee company within its short lifespan.

(d) The lock in period up to four (4) years is too onerous to process exit for PE Fund which have limited
and pre-determined lifespan of 8-10 years. Considering the limited lifespan of PE Fund, India and
several other jurisdictions has relaxed the norms on lock in especially for PE Funds and VCF funds
making lowering it to six (6) month to one (1) year.

A. Repatriation:

Repatriation of the dividend, interest, repayment loans, royalties, sale proceeds are important
issues that concerns Offshore PE Funds after the exit. The convenience in the repatriation of the
investment returns determines the entry of Offshore PE Funds in several ways.

The FITTA 1992 permits the foreign investors making investments in foreign currency are
entitled to repatriate investment returns and incomes from Nepal30. However, there are some
practical issues that concern the repatriation process in Nepal and severally affect the Offshore
PE Funds. Foreign Investors including the Offshore PE Funds are required to obtain

30
Section 5 of the FITTA states that the foreign investors investing in Nepalese company can repatriate
the interest, dividend, amount of loan repayment and sale proceed from Nepal.
recommendation from the Department of Industry and approval from the NRB before they can
repatriate the income and investment returns (service fee, royalties, loan repayment, interest,
sales proceeds etc) .

The requirement to undertake process before more than one authority does not have any sense.
While the requirements for obtaining repatriation approvals may have its own justification on
the right of the central bank to have control over foreign exchange reserve, the requirement to
obtain recommendation of DOI does not have any justification.

Obtaining the approval for repatriation of the dividend, divestment proceeds may take as much
as ninety (90) days even after lobbying and continuous follow up. The delayed process gives a
sense to the Offshore PE Funds the fund will be trapped once it comes in. Offshore PE Funds
willing to test the water in Nepal will not come to invest in Nepal.

Repatriation of Loan and Interest to the Foreign Lender (including Offshore Fund) is the area
seriously plagued by the protectionist approach of NRB. Pursuant to the NRB circular dated
September 11, 2013, a borrower in Nepal cannot repay the foreign loan if - (a) it is blacklisted
before Credit Information Centre Limited, or (b) any it has any payable debt to local banks and
finance Company. The said provision puts the interest of the Offshore PE Fund to recover the
foreign loan in a situation of absolute jeopardy. Apart from this the said conditions also rescind
the modern practice of loan investment through subordinated debt function and the consortium
partnership of foreign lenders and local Banks and Financial Institutions.

The restrictive conditions may also be used by the Investee Company in Nepal to avoid the
repayment of loan to Offshore PE Fund. For example, an investee company in Nepal may avail
the recurring loan facility with local banks or financial institution to assert that it has the debt
payable to loan facility.
 CHAPTER FIVE: TAX ASPECTS OF THE PRIVATE EQUITY IN NEPAL

The matters related to income tax and capital gains are dealt with by-(A) Income Tax Act, 2002 (2058)
(the "ITA, 2002"), and (B) Income Tax Rules, 2003 (2059) (the "ITR, 2003"). The Inland Revenue
Department (the "IRD") is the government authority which is tasked for tax administration. The
Partnership Act 1964 provides provisions only for formation of partnership with unlimited liability and
partnership as a business vehicle with limited liability partnerships is not available. The Partnership Act
further limits the number of members to 20 and only natural persons can firm partnerships. The
Companies Act provides deals with incorporation of limited liability companies and provides for
incorporation of private limited companies, public limited companies and not for profit companies. The
number of shareholders is limited to 50 in case of private limited companies.

The ITA, 2002 does not provide a pass through of taxes for partnerships as common in other jurisdictions
and imposes tax on both the partnership firms and companies in a similar manner. The taxable income is
subject to the corporate tax (normal corporate tax currently being 25%) and any distributions made to
beneficiaries (or shareholders) are subject to tax at the rate of 5% on withholding basis. Section 56 of the
ITA, 2002 however, exempts the dividend income from further taxation so that it prevents taxation when
the dividend is paid further towards the holding level.

The ITA, 2002 imposes tax both on the basis of (a) residence and (b) source principal. Most of the
payments are subject to withholding tax at various rates. Following provides certain payments made by
resident entities in the form of interest.

The ITA, 2002 does not provide any specific exemption or benefit to the VCFs. Following is
recommended to address some of the issues related to VCFs:

5.1. TAXATION IN CHANGE OF OWNERSHIP

a) Section 57 of the ITA, 2002 provides that if the ownership of any entity changes by 50% or more
within a period of 3 (Three) years, then such entity will be deemed to have disposed of its assets
or liabilities. Pursuant to Section 57 of the ITA, 2002, change of ownership by 50% or more will
trigger the following:
i. separate accounts will have to be prepared for the period up to the change in ownership
and after the change in ownership,
ii. the assets and liabilities of the entity will have to be evaluated at market price and the
entity will be subject to tax on any gain amount (at the rate of the tax applicable on
business income), and
iii. the entity will not be able to carry forward the losses, and such other restrictions outlined
in Section 57(3) of the ITA, 2002 will be applicable.
b) VCFs will need to be provided specific waivers from the requirement of Section 57 of the ITA,
2002. It may be noted that the Government of Nepal had introduced targeted waiver for banks
 and financial institutions from the requirement of Section 57 to encourage merger and consolation
of financial sector.

5.2. DOUBLE TAXATION TREATY

a) Nepal has entered into double taxation treaty with ten countries. It is also understood that the
Government of Nepal is working towards covering double taxation treaty with additional
countries.

b) In practice, however, the intended beneficiaries under the DTA are not able to receive the double
taxation benefits provided under the DTA due to wrong application of the DTA by the IRD. The
IRD should set-out the written guidance on applicability of the DTA and situation where
payments from Nepal will not be subject to the withholding tax requirement.

5.3. GUIDANCE ON TAXATION OF HYBRID INSTRUMENTS

a) It is expected that with development of VDFs and new investment opportunities in Nepal, the use
of hybrid instruments are likely to increase. The use of hybrid instruments in Nepal is not
common and their tax treatment does not have any legislative or regulatory guidance. ITA, 2002
provides substantial difference in treatment of interest and equity. While the ITA, 2002 follows
the common principle that interest can be charged as expenses and distribution of equity not
chargeable as expenses, it subjects payment of interest to withholding tax at the rate of 15%
(except where the payment is made to licensed banks and financial institution) and that for
distribution for equity is 5%.
b) The financial impact for re-characterization of any transaction from equity to debt or debt to
equity is likely to be substantial. The IRD should set-out a written guidance its view for tax
treatment so as to provide predictability for use and structuring of the hybrid instruments which
should meet the commercial objective of the investors and need of the investee entities.

5.4. FINALITY OF WITHHOLDING TAX

a) Section 92 of the ITA, 2002 provides final tax treatment for certain payments on which tax has
been withheld. The payment falling under Section 92 of the ITA, 2002 are treated as finally taxed
and no additional tax is incurred. Pursuant to Section 92(f) of the ITA, 2002, payments made to
the non-resident which are subject to withholding tax under Sections 87, 88 and 89 shall be
regarded as finally taxed. Section 88 of the ITA, 2002 covers, amongst others, withholding tax for
payment of service fees and interest. Therefore, payments made to the Fund in the form of service
fees, interest will be regarded as finally taxed under ITA, 2002.

b) The provision related to withholding of tax on capital gain tax is provided by Section 95A of the
ITA, 2002. Section 92 of the ITA, 2002 which provides list of payments which shall be treated as
final, does not include payments made under Section 95A.

c) The VCFs should be provided finality of taxes.

CHAPTER SIX: ISSUES AND RECOMMENDATION

The key issues that are hindering the effective and smooth entry, operation and exit of the PE Funds are
listed below along with the identification of the area of the reforms:

Issues Problem Implications Reform Instrument of Authorities

Responsibl
Reform e to

carry out

Reform

A. ENTRY

A.1 Short Term Reforms

1. No As per the  Increases Formulate the NRB

blanket prevailing costs of rules/circulars on
approval practice, investments blanket Approval Policy decision IPB and
for government and modality for foreign by IPB on such DOI
foreign approvals are divestments investments and blanket
direct required at least and delays divestments by approval and
investme for- the overall specifying the implementation
nt investment permissible sectors, by DOI by
(a) each and total investment, making
investment by divestment minimum and necessary
the Offshore processes. maximum thresholds provisions in
PE Funds in on one-time the Procedural
each portfolio  Not investment or Manual for
companies in compatible divestment. Foreign
Nepal, with the Investment.
limited life
(b) each instances
span of the
of increase in
Offshore PE Introduction of
investment by
Funds. the new
the Offshore
circulars by
PE Fund in  Impedes
Nepal, NRB to specify
convenient
the necessary
sale and
(c) each instances requirements
purchase of
of exit and and conditions
Portfolios
divestment of for blanket
and interest
the offshore approval
owned by PE
fund from each process (up to
 portfolio funds in their certain limits)
companies in targets. by way of
Nepal; notification or
circular under
(d) each instances Foreign
of reinvestment Exchange
of dividend- (Regulation)
return by the Act 1962
Offshore PE (2019).
Funds.

2. Approvals for  Increases Reform the present NRB

Duplicati foreign investment costs of One-Window-Practice
on in or divestment are investments to facilitate the Making One-
approval required from at and potential foreign necessary Window-
s least -(a) approval divestments investors by providing provisions in Committe
from and delays them with the the NRB e
DOI/IPB/Investme the overall opportunity to -(a) circulars
IPB/DOI
nt Board, and (b) investment obtain investments Decision by
approval from and and divestments IPB
NRB for each divestment approval (b) tax
instance of processes. registration (c)
investment or environment clearance
divestment  Potential PE (d) company
Funds formation, at a single
investors will place.
lose their
confidence
for investing
Implement the
in Nepal
provisions pursuant to
fearing the
which-(a) an approval
cost of
from DOI only be
divestments
required for making
and delay in
investments, and (b)
the approval
notification to NRB
process.
about such inflow
foreign capital should
be sufficient.

Implement the
provisions pursuant to
which –(a) an
 approval from NRB
only be required for
divestment and
repatriation of the
returns and exit
proceeds, and (b)
notification to DOI
about such outflow
foreign capital should
be sufficient

3.  Both of the The minimum Withdraw the IPB may make a.DOI
Minimu FITTA, 1992 capitalization Minimum decision in this
m and FERA, 1962 requirement Capitalization regard.
Capitaliz does not provide restricts the Requirement
ation the minimum Offshore PE identifying the
Require amount of Funds to invest prioritize sectors
ment foreign in Small and including SMEs and
("MCR" investments that Medium Scaled PE Funds investment
) a foreign Enterprise in Venture Capital
investor is along with Undertakings and
required to make start-up start-up companies in
in Nepal. ventures capital Nepal.
undertakings.
 However, MCR
at the present
has been fixed as
The Offshore
NRs. 5 million
PE Funds will
irrespective of
not be able to
the sector of
freely
business.
determine the
 In view of such amount to
requirement, the invest in the
offshore fund targets/
will need to portfolios in
make investment Nepal.
of at least of Rs.
5 million in each
portfolio Onshore PE
companies. Funds will not
able to attract
and pool the
amount below
Rs. 5 million
 from foreign
investors and
may not be able
to work as an
investment
vehicle.

4.  As per the law,  Only few and Prepare consolidated Publication of IPB
"Negativ foreign limited and exhaustive list of the Gazette
e List" investment is sectors are areas of business open notification
and permissible in open for and closed for foreign clarifying that
"Positive all sectors of foreign investment. the industries
List" businesses investment in classified under
except the reality when the IEA 1992
sectors falling only few are illustrative
under negative sectors are only and
list of FITTA, restricted as a foreign
However, as per matter of law. investments is
the prevailing permissible in
practice,  This has all sectors of
foreign rendered the industries
investment is foreign except those
allowed only on investment specifically
those sectors regime of restricted by the
which have been Nepal FITTA 1992 or
identified and completely other sector
categorized as unpredictable. specific laws.
the industrial
sector under the
Industrial
Enterprise Act
 1992 (the "IEA
1992").

 In addition, the
authority has
been taking
inconsistent
approach in
dealing with
foreign
investment
approval by
invoking
different policy
requirements in
different cases.

5. NRB and Offshore PE Permit the foreign Amendment to NRB

Investme Insurance Board Funds will be investments by the the existing
nt in permit foreign restricted from offshore PE funds in licensing policy Insurance
micro entities to make making the micro finance and and notification Board
finance investment in the investment in micro insurance by the NRB and Ministry of
and micro-finance and Micro Finance services. introducing the Finance
micro insurance and Micro directive by the
insuranc businesses Insurance Insurance
e sectors respectively only sectors. Board
if the foreign
entity is
registered/
licensed as a
financial
institution or
insurer in their
country of
incorporation/oper
ation.

6. Taxation on Gains Institutional Taxation on gains Amendment in

Different from short-term (private equity from long-term Tax Act of
ial and long-term funds) as well investments at lower Nepal to
Taxation (over 3-5 years) as individual rate than that on gains differentiate
on Gains investments isn‟t investors aren‟t from short-term taxation on
on long differentiated. incentivized to investments. gains on long-
term go for long term and short-
Capital term term
Investme investments. investments
nts Bottleneck in
long-term
capital
formation.

7. Sectors Gazette The ambiguity The existing Clarifications IPB

open for Notification dated in the area to be ambiguity may be by the IPB by
Onshore May 16, 2011 has covered under resolved by Industrial publishing
Funds included the the -(a) Promotion Board notice in the
Investme "Investment investment through clarifications. Nepal Gazette
nt Company having activities, and
objective to carry (b) business
out investment activities may Such clarifications
activities, lead to multiple
should exhaustively
investment interpretations list out the investment
business, and limiting the options for Investment
development of scope of the Company in the form
infrastructure and offshore funds
of 'permitted
industrial sector" and onshore investment options '
as a service investment and 'restricted /
industry under the vehicles to prohibited investment
Industrial sector of carry out options'.
IEA 1992. investment
activities and
investment
business. Such clarifications
There is no should also cover the
guidance in the investment
said notification instruments that both
and other existing the offshore PE fund
laws as to clarify and onshore PE fund
what particular may use for making
activities were investments in the
contemplated to be multiple targets.
covered under (a)
investment
activities (b)
investment
business.
8.  a. Obtaining of Domestic Revise the existing Amendments to NRB
Regulatio Foreign Loans: borrowers must circulars/notifications the existing
n of NRB has been resort/ approach on the foreign loan circular/notifica
Foreign taking restrictive to the local and interest rate in tion issued by
Loan by approach to allow banks and order to allow the the NRB
NRB and the companies in financial domestic borrowers to
Limited Nepal to avail institutions for avail foreign lenders
Investme foreign loans. A borrowing loans including the Offshore
nt company in Nepal and be rejected PE Funds.
Instrume can obtain before they can
nts approval for approach/resort
foreign loans only to foreign
when -(a) the loan lenders as well
cannot be obtained as the Offshore
from domestic PE Funds.
banks and
financial
institution, and (b) Offshore PE
the rate of interest Funds may not
is lower than the invest in
interest rate in portfolios and
practice of ventures of
domestic banks Nepalese
and financial targets by way
institutions. of the
Shareholder

Loan.

 b. Repayment of Local Bank Revise the existing Amendments to NRB

foreign debt: and Financial circulars/notifications the existing
Institutions in a on the foreign loan circular/notifica
 The resident superior and interest rate in tion issued by
borrower availing position than order to ensure the the NRB
foreign loans are the foreign equal treatment to
not allowed to lenders to in both the local and
service their securing loan foreign lenders and to
foreign debt so repayment fix the payment
long as they are - putting the priority consistent
(a) blacklisted for interest of with the terms of the
default of any loan foreign lenders loan and security
obtained from in absolute documents entered
local banks and jeopardy. This between the
 financial discriminatory local/foreign lenders
institutions in treatment to the and the borrower.
Nepal, (b) they foreign lenders
have matured loan will operate as
payable to banks an effective
and financial deterrent to the
institutions in foreign lenders
Nepal. including the
Offshore PE
Funds investing
through loan in
portfolios of the
targets in
Nepal.


This also
impedes the
practice lending
of sub-ordinate
debts among
borrowers and
foreign lenders
and domestic
lenders.
  c. Limited This has Exempt investment Issue and NRB
Investment restricted the company in Nepal implement the
Options available use of the debt along with Onshore circulars
to Nepalese instruments by PE Funds from the permitting
Companies: the onshore restriction to invest in
funds. 31 the targets by way of
 Section 47 of the loan and grant the
BAFIA has approval for loan
included 'lending' investments in the
within the targets.
meaning of the "
Financial
Transactions".
Similar provision
is also provided in
the NRB Act.

 Carrying out or
undertaking
financial
transaction is
reserved only for
the licensed Banks
and Financial
Institutions under
Section 28 of the
BAFIA.

 NRB has currently

been restricting
the onshore funds
to provide loan or
use debt
instruments in the
targets.

A2. Long Term Reforms

31
However, the government owned Hydropower Investment and Development Company Limited ("HIDCL") has
been allowed by NRB to invest loan in the Hydropower Companies in Nepal.
1.Comp The requirements Absence of the Issue and NRB, DOI, IPB (a)Council
rehensiv and laws applicable comprehensive implement a along with of
e in the context of regulatory comprehensive other concerned Ministers
Framew setting up, framework to deal regulatory regulatory can
ork for operation and exit with PE Funds has framework which study and (b) Leg
Regulati of the PE Funds, created the sets out the legal recommend islative
on of are scattered practical problems provisions relating about the Parliame
the PE throughout various and has also been a to entry, operation permissible nt
Funds. Acts, Rules, source of and exit of the PE areas,
Notifications, and uncertainty and Funds. All the permissible
Circulars etc. unpredictability to short terms entry and exit
the investors. The reforms identified routes etc to the
issues like in the above law ministry.
restriction in section should also
making matter of be incorporated in
foreign loans, such legal
repayment of instruments.
foreign debt, and
ambiguity within
the meaning of so-
called permitted
Investment
Company lies as
caveats which
concern the
successful
operation of PE
Funds.

2.Allow Companies can As infrastructure Allow larger Amendment in

Issuance only issue projects are capital infrastructure Regulations
of secondary intensive, projects (Capital concerning
Debentu instruments after companies need to size over 10 secondary issue
res by the first instrument raise capital apart billion) to issue by
compani issued is fully paid from the initial debentures after infrastructure
es and the company is share equity put in getting approval companies by
without making profit. by the promoters. for the project Company Act/
limitatio Forlarge These companies from concerned SEBON to
n to companies, are forced to go for governmental allow them to
subscrib especially loans as debt bodies. issue
e 100% infrastructure financing rather debentures
of companies, cannot than issuing from Day-1
equity make profit for debentures during
shares initial years, it is the initial years.
 impossible to raise This has led to lack
money via of growth in
debentures during debenture market,
this period. which in turn bars
companies as well
as private equity
funds from
alternative
investment
instrument.

3.Allow Only two categories The lock-in period Allow creation of Amendment in
ance of of shares: promoter for promoter different Company
Flexible and ordinary. without additional categories of Act/“Securities
Capital Minimum of 51% benefit in IPO shares within the Registration
Structur promoter share pricing creates promoter and and Issue
e holding. For large reluctance among ordinary share Regulation” to
companies, institutional groups. Treatment define various
especially investors like of these categories categories of
infrastructure private equity in terms of share
projects, getting funds to participate minimum investments and
51% promoter in these projects as percentage allow flexible
holding at existing promoters. This in holding, lock-in equity structure
scenario is very turn limits the size period, board using these
hard, especially due of projects, composition and categories of
to the three year especially accountability of share
lock in period and infrastructure operations should instruments.
absence of issuance projects, that can be
of shares at market be undertaken by identified/amende
pricing. private sector. d.

In absence of With flexible

flexible capital capital structure,
structure companies company can
are not able to form source required
different capital as per need
shareholder and also introduce
structure with Employee Stock
differential rights Option to
 that are necessary incentivizing
to attract funds at working employees
different level of
project
development

B. Operation

B.1. Short Term

1. As investment The restrictions OCR

Restricti companies have not in making
on clearly been investment Clarify that the Issuance of the
under exempted from the above 60% of "company with Directive by
Section restriction provided the paid up the main objective OCR for the
176 of under Section 176 capital of buying and clarification
the of the Companies seriously selling securities" pursuant to
Compan Act. Section 176 impedes the also includes the Section 16(2)
ies Act may also be working of the PE Funds. of the
interpreted that the PE Funds. As Companies
onshore fund the amount Act
cannot make pooled in PE
investments in or Funds are
provide loan to the usually higher
portfolio than the
companies in amount shown
excess of its-(a) as paid up
60% of the sum capital in the
total of the paid up time of
capital and free incorporation,
reserve, or (b) the restriction
100% of the free in making of
reserve whichever investing
is higher. beyond 60% of
the paid up
capital will
However, the resulting into
proviso to said the freezing of
section exempts the the amounts
Investment collected in the
Company with PE Funds.
objective to
purchase and sell
securities.
However, lack of
any clarifications There is no
on the meaning of guidance on
'investment existing law as
company with the to whether the
objective to PE Funds
purchase and sell qualifies to be
securities' has taken as
added confusion 'Investment
and PE Funds Company with
cannot find objective to sell
themselves and purchase
comfortable. securities'.

This has lead to

confusion
whether the PE
Funds can
operate inside
Nepal as an
Investment
Company and
be exempt from
said Section
176 restriction.
2. As per the  Increases Formulate the NRB
Approva prevailing practice, costs of rules/circulars on
l government investments blanket approval Policy decision a. IPB and
require approvals are and modality for further or by IPB on such DOI
ment for required at least divestments "add-on" foreign blanket
each for- and delays investments by approval and
instance the overall specifying the implementatio
of (a) each investment investment permissible sectors, n by DOI by
further/ by Offshore PE and total investment, having
addition Funds fund in divestment minimum and necessary
al each portfolio processes. maximum thresholds provisions in
investme companies in on one-time the Procedural
nt Nepal,  Not investment or Manual for
compatible divestment. Foreign
(b) each instances Investment.
with the
of increase in
limited life
investment by
span of PE
the Offshore PE
Funds. Introduction of
Fund in Nepal,
the new
 Impedes
(c) each instances circulars by
convenient
of exit and NRB to
sale and
divestment of specify the
purchase of
the offshore necessary
Portfolios
fund from each requirements
and Interest
portfolio and conditions
owned by PE
companies in for blanket
funds in their
Nepal. approval
targets.
process (up to
(d) each instances certain limits)
of reinvestment by way of
of dividend- notification or
return by the circular under
Offshore PE Foreign
Funds. Exchange
(Regulation)
Act 1962
(2019).

3.Blackli Provision on PE Funds Exempt the Onshore Amendment to NRB

sting blacklisting in typically invest PE Funds from the the existing
NRB's Unified in portfolios of blacklisting risk Directive on
Directives provides diverse sectors. considering the Blacklisting.
that - (a) directors, The risk of the investment nature of
CEO and body investee targets the PE Funds, like it
corporate holding being in default has been given to the
more than 15% to service debt Foreign Missions,
share in the to the licensed foreign
defaulter company banks and firms/corporation
(b) body corporate financial partnering under
having less than institutions can foreign investment,
15% shareholding be expected. foreign donors and
in the defaulter development partners
company, While a single etc.
however, having PE Fund
the controlling invests in more
interest (c) than 100
directors including numbers of
nominee directors portfolios there
in the defaulter is always a
company -must be possibility of 1
recommended for or 2 portfolios
blacklisting. out of 100s
being in default
to service the
debt.
The Directive on
the Blacklisting has
exempted the
"foreign investor" An entity will
from the be left with
blacklisting. limited or
However, the virtually no
blacklisting option after
provisions will being black
apply to the listed in
onshore funds. business, it can
neither avail
any further loan
nor can it raise
money from
public.

While these
rigorous
provisions to
 the defaulter
may have its
own
justification in
case of regular
business, it
poses a serious
risk to the PE
Funds which by
its very nature
and purpose
invest in
portfolios and
undertaking of
diverse sectors
and one or two
wrong choice in
selecting the
portfolios/
undertakings
will end the
business of
total PE Funds.

Even the
investor
investing in the
PE Funds by
way of loan,
equities or
other
instruments
will be in
constant risk of
losing their
money for a
single or two
wrong
choice(s) of PE
Fund.

B2 Long Term
4. Penalty Directors and The multiple Simplify the filing and Amendment to Council of
driven officers of the filing and reporting the Companies Ministers
filing companies which reporting requirements Act 2006
requirem fail to submit the requirements especially the PE Legislature
ent annual returns and Funds and targets Parliament
and other consequential registered as a private
compliance personal company.
documents are liability of the
personally liable directors and
to pay fine to the officers for
OCR prescribed non-compliance
on the basis of-(a) is likely to
amount of the deter the
paid up capital, offshore funds
and (b) time of and onshore
delay. fund to
nominate the
As the companies appropriate
are subjected to individuals to
multiple filing act as a director
and reporting in the onshore
requirements fund/portfolio
annually, amount companies and
of the fine would participate in
be higher. the
Further, the court management
can also convict activities.
the directors and
officers with a
fine of up to NRs.
50,000 and
imprisonment for
up to 2 years or
both for non-
compliance with
the periodic filing
and reporting
requirements.

5. Strict The Companies Companies Act Rationalize the Amendment to Council of

liability of Act provides for restricts any liability of the the Companies Ministers
the strict personal company to directors especially Act 2006 Legislature
directors liability of the indemnify those appointed in the Parliament.
directors for non- directors targets which are
compliance with against the registered as a private
the provisions of personal company.
the Companies liability.
Act. The sanction Moreover, the
provisions range director's
from fine of NRs. liability
50,000 to insurance
imprisonment up policy cannot
to 2 years. be easily
purchased from
local market.
Strict liability
on the part of
directors and
absence of any
cushion may
impede the
taking of
strategic-yet-
risky decisions
and some
qualified
directors may
find it difficult
to seat in the
Board.

Both Offshore
and Onshore
PE Funds may
find it difficult
to find qualified
persons willing
to represent
themselves in
the portfolios of
their targets.

6. Any decisions on Customarily, Exempt the Onshore Amendment to Council of

Limitatio investing of the the decision to PE Funds from such Section 95(6)
n on funds of the invest in the restriction. of the Ministers
Delegatio company or portfolios or Companies Act
n of providing loan targets by way Legislative
Authority should be made of loan or Parliament
(Restricti by the Board of equity out of
on under Directors and amount
Section 95 such authorities available in PE
(6) ) cannot be Funds is taken
delegated to the by qualified
management by investment
the Board of manager and
Directors. making of
investment
decision to
The Companies invest money in
the PE Funds
carrying out
banking and day to day
financial affairs in PE
transactions are funds.
exempted from
this restriction.
However, the
restriction will
apply to the It is practically
board of directors difficult for the
of the onshore Board of
funds.. Directors of the
PE Funds to
pass the
resolution to
invest out of
the amount
available on the
PE Funds.

7.Develop Limited This limitation Inclusion of Amendments

ment of investment tools makes development of by SEBON in
different in the market for institutional different investment its regulations
investmen investors to investors like tools for institutional for allowing
t tools diversify risk and PE funds investors like income and developing
which expected returns. reluctant to participatory these different
include enter the instruments and investment
forming market, thereby securitized tools.
securitiza depriving the instruments by
tion of market with an SEBON in its policy.
cash flows essential
that can market maker.
provide
investmen
t
instrumen
ts for
general
public

8. FITTA s restricts Even the Revise the minimum As the present Council of
Settlemen the parties to the arbitration foreign investment FITTA is Ministers
t of foreign proceedings in threshold applicable to expected to
Disputes investment Nepal are determine the choice Replace the
agreement in plagued with of law. Draft FITTA, Legislature-
choosing the delays and revision in the Parliament.
governing law in formalities. Draft FITTA
the event of Allow Offshore PE can be done by
dispute. The Appeal against law ministry
the verdict of Funds to choose the
parties to the governing law before tabling
foreign arbitral panel the bill in
are brought and considering the
investment legislature-
entertained in limited life span and
agreement are time-consuming parliament.
free to courts defeating
the very arbitration practice in
independently Nepal.
choose the purpose of
governing law arbitration. In
only if the addition to this,
amount to be the risk of
invested under the nationality bias
foreign cannot be out
investment ruled.
agreement
exceeds Rs.
500,000,00032 The higher

32
1 USD = Rs. 96.42
 (Five Hundred threshold for
Million Nepalese the foreign
Rupees). Draft investor to be
FITTA which is able to choose
expected to the governing
replace the law on
present FITTA arbitration and
has even the delayed
proposed to arbitration
increase the said proceedings in
threshold to USD Nepal can be
10,000,000 (Ten taken as threat
Million US by the Offshore
Dollars) which is PE Funds
equivalent to Rs. investors to
964,200,000 invest in
(Nine Hundred portfolios and
Sixty Four ventures of
Million Two Nepalese
Hundred targets as the
Thousand life of PE
Nepalese Rupees) Funds are
at the current usually short
exchange rate. and the
prolonged
dispute
settlement
proceedings
can continue
can exceed the
lifespan of PE
Funds.

9. Clarity Company Act has Preferred Clearly stipulate terms Addition of

on issues allowed issuance shares are of offer of preferred terms of issue
regarding of Preferred widely used shares and procedure of preferred
accountin Shares but has not instruments for for its redemption shares in
g/redempt clearly stated Private Equity either in cash or vide Company Act/
ion/conve terms for fund that can in kind. Also stipulate clarity on tax
rsion of convertible and demand fixed terms of payment of implications by
preferred cumulative payment from accrued preferred Tax Act/and
shares preferred shares the target divided either in cash respective
(plain as especially the company but or in kind after the provision in the
well as case of settlement also ensures conversion/payment Securities
convertibl of accrued such company of principle of Regulations
e and cumulative is protected preferred shares
cumulativ preferred from default
e) dividends and subsequent
bankruptcy

C. Exit

C1. Short Term

1. Government An Offshore PE Formulate the Policy decision NRB

Duplica approvals are Fund investing rules/circulars on by IPB on such
tion in required for each in multiple and blanket Approval blanket IPB and
Approv exit and divestment diverse modality for foreign approval and DOI
al of the offshore fund portfolios is divestments. implementation
Process from each portfolio required to file by DOI by
company in Nepal. for and obtain having
several necessary
Offshore PE fund approvals to provisions in
cannot obtain a divest its the Procedural
single/in principal investment and Manual for the
approval for the exit take back. Foreign
and divestment for Investment.
multiple portfolios
in diverse sectors.
The
requirement to Introduction of
obtain the the new
approval for circulars by
divestment NRB to specify
does not have the necessary
any requirements
justification and conditions
and it is not for blanket
necessary in approval
practical sense. process (up to
certain limits)
by way of
This has notification or
increased the circular under
costs of Foreign
divestments Exchange
and delayed the (Regulation)
Act 1962
 overall (2019).
divestment
processes and
will be treated
as caveats by
Offshore PE
Funds while
investing in
portfolios of
Nepalese
Targets.

2. Pursuant to a public Absence of Issuance of the details Issuance of the NRB

Valuati notice issued by valuation guidelines on method Circulars by
on NRB dated May 29, guidelines has of valuation of listed NRB and IRD
require 2012, a valuation created and unlisted security IRD
ments report of the assets uncertainty as should be published
and liabilities is to the valuation by NRB. IRD should
required to be method to also be made involved
submitted to NRB ascertain the as revenue stakeholder
for repatriation of value of per while preparing the
the foreign unit of security. guidelines for
investment/sale valuation of the
proceeds. security.
As more than
one popular
However, no method for Specify the threshold
detailed valuation valuation of the of the amount of
processes and security and repatriation which are
criteria have been method of not subject to
set out yet. valuation is not valuation
prescribed till requirements.
date, the
regulator like
NRB may
object to
particular
method of
valuation
taking
protective
approach taking
in account the
limited foreign
 exchange
reserve (.

3. All pre-IPO equity This will Lower the lock in Amendment to SEBON
Relaxat investors in non- severally limit period for pre-IPO the Security
ion in financial the exit option shares may be Registration
Lock- institutions are and timing of lowered to one (1) and Issue
in- unable to exit their the fund as year or six (6) month Regulation,
period investments for promoter of the particularly in the case 2065 and
norms. three years post- portfolio of the PE Funds. Security Issue
IPO, regardless of companies. The Guidelines,
whether they are pre-IPO lock in 2065.
promoters or purely for three (3)
financial investors years and post
such PE Funds. IPO lock-in for
three years to
promoters
forbids the PE
Funds to exit
from their
portfolios for a
minimum
period of six
(6) years will
severely
hampers the PE
Funds which
typically have
short lifespan.

C2 Long Term

4.  A listed company Move to a market- Amendment to Council of

Restrict cannot issue pricing mechanism Section 29 of Ministers
ion on shares above the Due to said such as book building the Companies
Issuanc net worth per restrictions, the SEBON would still Act, 2006. Legislature
e of share determined company need to approve Parliament
Shares on the basis of the cannot publicly valuation before IPO,
at financial audit of issue its shares thus they retain
premiu the company. at premium rate control over the issue
m Further, the even if the of inflated pricing
distribution of return on equity being a danger to
dividend for 3 of its shares retail investors.
 consecutive appears to be Further, specific
financial years is promising for exemption for
another criterion substantial issuance to
that both the listed period of time. sophisticated investors
and other should be provided as
companies are such investors do not
required to satisfy While the 3- need such level of
for the issuance of year track regulatory protection
the shares at record for This will require
premium. distributing amendment to Section
profits may be 29 of the Companies
In case of the listed Act 2006 (2063) in
company, the a condition
necessary to long run.
current regulation
forces many firms protect the Amend Section 29 of
to issue IPO shares interest and the Companies Act to
at a fixed value (e.g. also serve the apply the provision
Rs100), or as per assurance of only to the listed
the proposed general public, companies.
regulation at a the said
maximum of 2.5 conditions/restr
times Net Worth of ictions does not
the company. holds good in
every
companies.

PE funds
investing in
ventures capital
undertaking
cannot exit
from targets
even if target is
matured
enough to
operate on its
own and both
the PE funds
and the targets
may not be able
to derive the
maximum
return.
If the company
shares are
worth more to
the market than
the price cap
imposed,
founders and
other
shareholders
would need to
sell shares at a
discount to
their real
market value.
Very few
entrepreneurs
are prepared to
do this which
limits the
variety of
sectors and
companies
listed, and
minimizes the
benefit of
having more
companies
comply with
the reporting
and
transparency
requirements of
a listing. It also
penalizes
companies with
low fixed assets
but high growth
(e.g. a software
or service
company)
whose
valuation on a
multiple of net
worth would be
 small, but may
be high value
job generators
for the Nepal
economy.

5.Allow IPO is considered Institutional Allow divestment of Categorize

Divestm only with issue of investors like holding up to certain divestment of
ent to new shares. PE funds limit by institutional existing shares
public However, company cannot divest investment funds like to public also
may plan to go their PE funds via offer as IPO.
public without any investments to document or through
need to raise capital public before IPOs to public.
but bring potential the end of lock-
source of in period, even
investments for though there
future projects. maybe potential
investors. This
severely limits
the exit options
Initial investors
may wish to of institutional
liquidate portion of investment
their holdings by funds like PE
selling their shares funds.
to public. So, that
capital becomes
liquid and Initial
investors
(promoters) can
undertake further
entrepreneurial
investments.

6.Buyba The Companies Act Limitation on Allow buy back of Amendment in

ck of states that buy back exit options for shares of institutional The Companies
Shares of shares can be PE funds. PE investment funds like Act on
done only with the funds have to PE funds by the restrictions
free reserves of the wait for companies through made for buy
companies to asset sale as or back of shares
 company. make through leverages by companies.
cumulative based on Allow to buy
profit before capitalization plan and back shares
Only existing buyback of on agreement from the through LBOs
promoters can buy their shares by lenders even if the
shares of another the company. company isn‟t
promoter but not making
the company itself. cumulative
Or, need to profits but is
depend on the promising.
other promoters
to buy their
shares

7. The Companies Act If the portfolio Permit the targets/ Amendment to Governmen
Limitati permits the companies are portfolios that have Section 65 (5) t of Nepal
on on redemption of the not operating in received issued of Companies
the redeemable profit and is in redeemable Act. Legislature
source preference shares loss, then such preferential shares to Parliament.
of the only from-(a) portfolio the PE Funds to
fund for distributable profits, companies redeem their
redemp or (b) share money would not be preference shares to
tion of received from the able to redeem an extent of 100% of
the fresh issue of the the redeemable their paid up capital
prefere shares which is preference out of sale proceeds of
nce specifically issued shares investment and assets
shares for the redemption subscribed by and not necessarily
of the shares. the offshore out of free reserves or
fund or onshore security premium
fund. account in view of
easing the exit of PE
Funds from targets.
This will block
the exit of the
PE Funds from
their portfolios
which are in
loss.
BIBLIOGRAPHY

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(2012). SECURITIES AND EXCHANGE BOARD OF INDIA (ALTERNATIVE INVESTMENT FUNDS)

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ANNEXURE
Annex 1

Rate of Withholding Tax

S.N Heads of Withholding Tax Rate of Withholding Tax

1 Interest Payment having source at Nepal, Payment for use 15%

of Natural Resources, Royalty, Service Fee, and
Retirement Payment from Approved Retirement Fund.

2 Gratuity and Provident Fund Payment from approved 6%

Retirement Fund.

3 Dividend, Profit from Investment Insurance, and Profit 10%

from Unapproved Retirement Fund.

4 Payment for Construction Contract and Contract. 1.5%

Annex 2

Negative List for Foreign Investment

Schedule A (which can be Schedule B (which can be amended by the Government)

amended by the Parliament)

1. Cottage industries 1. Retail business except those retail businesses operating as an

international chain in more than 2 foreign jurisdictions

2. Personal service business 2. Tobacco Leaf (Bidi) industries (except those industries
(such as hair cutting, beauty exporting more than 90%
parlor, tailoring, driving
training etc)

3. Arms and ammunition 3. Domestic courier service

industries

4. Explosives, Gunpowder 4. Atomic energy

5. Industries related to Radio- 5. Poultry farming

active materials

6. Real estate business (except 6. Fisheries

construction industries)

7. Motion picture industries 7. Bee-keeping

(produced in national
languages)

8. Security printing industries 8. Consultancy services and other businesses such as

management, accounting, engineering and legal businesses
except the consultancy services having maximum 51%
foreign investment.

9. Currencies and mint 9. Beauty Parlor

industries

10. Local catering services

11. Village tourism

Annex -2A
Negative List of Foreign Investment under Draft FITTA
-Micro Enterprises and Traditional Cottage Industries

- Arms and ammunition industries

-Real Estate Business (except the Construction)

-Mint and Coin Business

-Multi Brand Retail Business having less than Rs. 5,000,000,000 (Five Billion Nepalese Rupees)

-Hotels with less than three (3) star status

-Tour Guide and Operation

Annex 3

Details and Steps for Approval to Invest by Offshore Funds

X: Date of Application given to the DOI for Foreign Investment Approval. The timeline is only indicative.
Step Particular Relevant Laws Timeline Government Fee
(upto
)

One Obtaining approval from FITTA 1992 x+ 75 days Deposit of up to Rs. 20,000,
DOI/IPB for foreign refundable
investment

Two Obtaining approval from FERA 1962 x+90 days Not applicable
NRB for foreign
investment
Annex 4

Documentation Requirement in obtaining Foreign Investment Approval from NRB

Loan Investment Equity Investment

 Approval Document from Department of  Approval Document From Department of

Industry ( or Industrial Promotion Board Industry ( or Industrial Promotion board or
or Investment Board) Investment Board)

 Copy of Loan Agreement between  Copy of Board Decision of Investee

Borrower and Lender Company.

 Commitment letter assuring that the  Tax Clearance Certificate, Updated Details of
inflow of Loan Investment in Nepal will be Tax Payment and Incorporation Document of
through Banking Channel. the Borrower, if any.

 Copy of Board Decision of Lender  Document evidencing that the Investee is not
Company. blacklisted by Credit Information Centre
Limited.
 Letter of Consent from the concerned
regulatory of the lender in lender's home  Audited Financial Statement of the Investee
jurisdiction. Company.

 Tax Clearance Certificate, Updated  Commitment Letter from Investor assuring

Details of Tax Payment and Incorporation that the amount invested will not be
Document of the Borrower, if any. repatriated within 1 year from the period
date of investment.
 Document evidencing that the Borrower is
not blacklisted by Credit Information  Document evidencing the source of income
Centre Limited. and Time-Schedule.

Note: As per NRB's policy on external commercial borrowing, the annual interest on the loan
should be within (prevailing libor rate for year + premium interest). In case where the
lenders are the organization like, IFC, ADB, World Bank, the interest rate shall not exceed
(prevailing LIBOR rate + 5.5%).
Annex 5

Details and Steps of Registration of the onshore fund with foreign investment

X: Date of Application given to the DoI for Foreign Investment Approval

Step Particular Relevant Laws Timeline Government Fee

(upto)

One Obtaining approval from FITTA, 1992 x+ 75 days Deposit of up to Rs. 20,000,
for foreign investment refundable

Two Obtaining approval from FERA, 1962 x+90 days Not applicable
NRB for foreign investment

Three Registering the Company Companies Act, x+97 days As per the authorized
with the Office of the 2006 capital33
Company Registrar (OCR)

Four Registering as an industry Industrial x+104 days Not applicable

with DOI Enterprise Act,
1992

Five Tax Registration ITA, 2002 x+105 days Not applicable

(Permanent Account
Number) with Inland
Revenue Office

33
For example; if the amount of authorized capital is from NRs. 50,00,001 to NRs. 1,00,00,000, registration
fees of NRs. 12,000 is applicable, for authorized capital above NRs. 1,00,00,000 registration fee of NRs.2.00 for
every NRs. 100,000 of the authorized capital is applicable.
Annex 6

Securities:

As per Company Act:

 Section 2 (x) of the Companies Act defines “Securities” to mean as any Shares, bonds,
debentures or stocks issued by a company, and this term includes the receipt relating to deposits
of securities and the rights and entitlement relating to securities.
 Section 2 (o) of the Companies Act defines “Preference Share” to mean as a Share issued as a
preference share pursuant to this Act
 Section 2 (p) of the Companies Act defines “OrdinarySshare” to mean as a Share other than a
preference share.
 Section 2 (s) of the Companies Act defines “Debenture” to mean as any bond issued by
accompany whether putting its assets as collateral or not

As per Securities Registration and Issue Regulations, 2008:

 Section 2 (c) of the Securities Registration and Issue Regulation defines “Securities" to mean as
shares, stocks, bonds, debentures or debenture stocks issued by the body corporate or certificates
related to collective investment schemes or loan certificates, saving certificates or bonds issued
by the government or that issued by the body corporate under the guarantee of the government
and this word shall also mean other securities designated by the Board to be tradable or
transferable though Stock Exchange or the rights and entitlements relating to the securities.

As per Foreign Exchange Regulation Act, 2019 (1962:

 Section 2 (g1) of the Foreign Exchange Regulation Act defines “Foreign Investment” to mean as
investment in any firm, company or organization in the form of shares, deposit, earnings from
above two (reinvested) and loan/loan facilities by foreign investor.
 Section 2 (d) of the Foreign Exchange Regulation Act defines “Foreign exchange” to mean as
foreign currency, and deposits, loans, borrowings, foreign securities, and instruments like cheque,
draft, travelers cheque, credit card, etc which are cleared with foreign currency, and other
instruments as published by NRB
 Section 2 (d1) of the Foreign Exchange Regulation Act defines “Foreign Exchange Transaction”
to mean as act of buying/selling forex, giving/taking loans or other methods where forex is
taken/given
 For foreign exchange transaction (even deposits, loans), foreign investors need to get approval
from NRB and use the exchange rate given by the NRB for the transactions.
Annex 7

Documents required to be submitted to DOI for Foreign Equity Investment in New Industry

 Project Report 2 copies

 Joint Venture Agreement (JVA), in case of more than one investor 2 copies
 Citizenship certificate of local party or Certificate of Incorporation including Memorandum of
Association and Articles of Association, if local party is a company 1 copy
 Copy of passport of foreign party/or Certificate of incorporation, including Memorandum of
Association and Articles of Association, if participant is a company 1 copy
 Bio-data / Company profile of the foreign party 1 copy
 Financial Credibility Certificate (FCC) of the Foreign Investor provided by a home country bank
or domiciled country bank 1 copy
 Authority letter from the concerned companies or individuals to carry out any necessary work on
their behalf, if applicable
Annex 8

Share transfer from an existing shareholder to a foreign investor

To get approval from DOI in Foreign Investment in an Existing Industry by Share transfer, the following
document will be required.

 Request from the share transferor

 Request from the share transferee

 Share Transfer agreement

 Copy of minute of the Board meeting of Nepalese company regarding inclusion of

foreign investor into the company

 Copy of minute of Board meeting, certificate of incorporation and company profile of the
foreign party if the participant is a company.

 Copy of passport and Bio-date of foreign party, if participant is an individual

 Financial credibility certificate of the Foreign Investor provided by a bank.

 Current Shareholders' list as certified by the Company Registrar's office

 Audit Report

 Tax clearance certificate

 Authority letter from the company concerned to sign on behalf of the companies

Share transfer from reserved shares or by increasing the issued capital of the company to a foreign
investor:

The industry is required to apply to the DOI on a prescribed application form with the following
documents (in addition to above mentioned documents).

a) Request letter from share transferor

b) Request letter from share transferee

Note: At the time of approval the share transferor shall be present in person at the DOI. If the industry is
not operational as of the date of application, the application should be accompanied with the Project
Report too.
Annex 9

The documents required to be submitted to DOI for approval of loan investment.

 Loan Agreement 2 copies

 Certificate of Incorporation, including Memorandum of Association and Articles of
Association of the lending agency 1 copy
 Company profile of the lending agency 1 copy
 Industry Registration Certificate 1 copy
 Copy of the minute of the Board of the recipient company regarding the loan to be
acquired 1 copy
 Authority letter from the concerned companies or individuals to carry out any
necessary work on their behalf, if applicable.

However, it must mention, inter-alia, the interest rate and payment schedule of the principal
amount.
Annex 10

IPO Process in Nepal : Procedure:

1. Issuing company going public approaches merchant banks

Issuing company approaches the merchant banks, licensed to provide public issue services as
per Merchant Banker Regulations, 2008. Merchant banks submits written proposal
accompanied by tentative budget of the issue management process. After the terms and
conditions are met, issuing company appoints an issue manager and a formal agreement is
signed.

2. Registration of securities

A company incorporated as a public limited company to offer securities to public has to

register its securities to Securities Board of Nepal. For the purpose the company has to make
an application to the SEBON in a prescribed format given in Schedule 1 of Securities
registration and Issue Regulation, 2008 along with the cash receipt voucher charged as
securities registration fee. SEBON would issue a securities registration certificate as part of
approval of registration of securities

3. Preparation of prospectus

Upon signing of the agreement, issue manager acts on behalf of the issuing company and
drafts a prospectus in a format specified by the Securities Registration and Issue Regulations,
2008.

4. Agreement with the underwriters

Fifty percent of every issue has to be mandatorily underwritten by a qualified underwriter or

group of underwriters. After the approval of underwriters list, a separate MOU is to be made
and signed by the issue manager on behalf of issuing company with the individual
underwriters underwriting the securities issued.

5. Obtain letter from Stock Exchange Ltd.

The issuing company via issue manager should submit one set of documents(prospectus and
other documents being registered in SEBON) to Stock Exchange Ltd. to obtain its letter
stating that the securities to be issued is qualified to be listed in Stock Exchange as per
prevalent listing bylaws. The stock exchange is required to submit its rebuttal against the
proposed issue to the board within seven working days from the submission of documents if
any in reference to existing exchange by laws. If no such response is received by the board
within the stipulated time, board assumes the consent of Stock Exchange to list the securities
being offered to the public from the applied prospectus.

6. Registering Prospectus with SEBON

 After preparing the prospectus, the prospectus with the required documents and fees need to
be registered in the SEBON for the consent and registration. The prospectus registered needs
to be signed by all the board of directors implying their responsibility as matters written in
the prospectus to be true.

7. Finalizing the approval of issue

Issue managers should update any changes as directed by SEBON in the prospectus. Upon
completion of all the disclosure needed as per the Securities Registration and Issue
Regulations, 2008, the SEBON grants the registration of prospectus and approval to issue the
shares based on the information provided in the prospectus. After receiving registration letter
from the SEBON, issue manager should get the prospectus registered with the company
registrar‟s office and if the company has a separate regulatory authority, get the prospectus
registered with the same as well. All registration has to be completed before the orientations
of the intermediaries and publicity to the public are carried out.

8. Orientation of intermediaries

The issue manager/s in the mean time should appoint bankers to the issue and the collection
centers. Issue manager should make sure that intermediaries selected for the issue process
know the job assigned to them. For this, issue manager might require to prepare and give
proper guidelines to them. In short issue manager should make sure that they work as directed
by the issue manager.

9. Finalizing the date of issue opening

The issue manager should communicate the approval of prospectus to the issuing company
and the Issuing Company should decide on the date on which they wish to open the public
offerings process and inform the same to the issue manager.

According to Securities Issue Guidelines 2008, the issue has to be publicly sold within two
months from the date of receiving approval from SEBON.

10. Publishing announcement letter

After all the provisions have been made, issue manager willing to publish offer document or
prospectus has to publish announcement in the format prescribed by Securities Registration
and Issue Regulations, 2008 Schedule-12 in at least one daily newspaper minimum one
week prior to the opening of the issue and the board has to be informed regarding it.

11. Opening of the Issue

The issue has to be opened for at least five working days from the date of opening. Issue can
be opened for only four days if the issuing company has at least a total of ten collection
centers in five development regions

12. Share Allotment

 Under former Securities Allotment Guidelines, 2051, more weight was given to small
applicants. However, the new directive (Share Allotment Directive, 2068) has made
provisions to allot shares under proportionate basis to ensure equal weight to all applicants
irrespective of amount of application or volume of oversubscription. The change in the
allotment guideline will encourage application by institutional investors or high net worth
individual for large number of shares in one name. Such investors were largely discouraged
under previous allotment model where applicants applying for large number of shares were
used to be allotted relatively less number of shares. After the change in the allotment
guidelines, Janata Bank is the first major IPO in the country.

Under the current allotment guideline, Investors applying for shares less than NRs. 50,000 are
categorized as retail investors, and 40% of the issued securities have to be mandatorily
allocated for them. Remaining 60% are to be allotted under pro rata basis of allotment.
However, if total applications by the retail investors represent more than 40% of total
applications receive, all shares will be allotted proportionately.

13. Refund of non allotted share application money

According to Securities Issue Guidelines 2065, Issue manager should start the process of
distributing allotment slips and refunding within five days of allocation of shares.

14. Distribution of Share Certificate

As per Section 33 of The Company‟s Act 2063 the share certificate has to be issued to the
share holders within two months from the date of allotment of shares

15. Listing of shares with Nepal Stock Exchange Ltd.

The issuing company should apply for the listing of the issued securities with the stock
exchange through an application within thirty days from the date of allotment of shares. The
shares can be traded only after the application is approved by NEPSE, which might require
further time. Securities could be traded in the secondary market only after seven days after
the listing of securities in NEPSE.