Whalesbook
SEBI Limits Force Complex Deal Structures
Indian Alternative Investment Funds (AIFs), key for investing in growing companies, face a major hurdle: SEBI's limits on overseas investments are full. This forces AIFs to avoid investing directly in the foreign parent companies of Indian startups, a common setup for global fundraising. Although SEBI increased the overseas investment limit to $1.5 billion in May 2021, overall limits for the Indian market were hit in 2022 and 2024, stopping new investments for many funds. This bottleneck requires complex workarounds, like the common call and put option structure, to maintain similar economic and governance benefits without direct foreign ownership. The urgency is increased by a booming Indian VC market that reached about $16 billion in 2025, showing strong demand for investment capital.
How Options Add Costs and Risks
This call and put option setup lets AIFs invest in the Indian subsidiary, which is a domestic deal. Contractual rights are used to mimic direct investment benefits. This includes a call option for the foreign parent to buy back shares at a price linked to global events, using a swap ratio. It also gives the AIF a put option for downside protection. A swap right allows conversion to foreign shares later, if the RBI approves. However, making these contracts truly match direct investment adds significant complexity and risk. Enforcing purely contractual rights across borders is slow and costly, often requiring arbitration clauses in other countries to reduce risk. There's also a risk that regulators might see a put option guaranteeing returns as debt, which breaks foreign exchange rules (FEMA). If the Indian operating company goes bankrupt, AIFs hold a riskier position compared to direct foreign investors. Disputes over valuations and tax issues at exit further complicate matters.
Global Comparison and India's Options
Compared to easier investment environments, India's rules for AIF overseas investments create more friction. Financial centers like Singapore offer strong regulations, including the Variable Capital Company (VCC) structure, and tax benefits that help direct investment under MAS oversight. Hong Kong also faces questions about fund tax exemptions, potentially affecting its appeal. Dubai's free zones like DIFC and ADGM provide flexible rules for funds. India's own GIFT City offers a way around SEBI's overseas limits by allowing direct investment in foreign entities with tax benefits, though setting it up takes time. SEBI has made some changes, like removing the need for overseas companies to have an Indian link and shortening approval times, but the main overseas investment limits remain. New RBI Directions in July 2025 also add rules to prevent 'evergreening' by entities investing in AIFs, introducing more governance for certain investments.
Why Workarounds Hinder India's Startup Growth
The widespread use of call and put options shows cleverness but points to major flaws in India's investment rules. This workaround significantly increases the cost and risk of investing in Indian startups. Because AIF rights are based on contracts rather than direct ownership, enforcing them across borders is difficult. The risks of regulatory changes and higher loss if a company fails make it even more challenging. Negotiating these complex deals takes time and money away from evaluating companies and helping them grow. This inefficiency in deploying capital might discourage global investors looking for simpler, clearer investment routes. This regulatory friction could lead to two kinds of markets: one that is fast and efficient, using global structures, and another stuck with complex, risky domestic methods. This could cause investors to misjudge risks and lead to capital being poorly allocated, ultimately slowing down the growth of India's startup sector.