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Mid-market blooms: Opportunities in the Indian SME space

By Nusrat Hassan & Santosh Pai
Posted: 22nd June 2011 11:48

Small and Medium Enterprises constitute almost 90% of the industrial enterprises in India.  Together they contribute 45% of the country’s industrial output and 40% of its total exports.  This vast segment is comprised of private enterprises which report annual turnover figures between Rs. 10 crore (US$ 2.2 million) and Rs. 700 crore (US$ 155 million).  They are active in diverse fields such as manufacturing, precision engineering and design, food processing, pharmaceuticals, textiles and garments, retail, IT and ITES, to name a few. 

This segment was dominated by ‘small scale’ units which were nurtured through protective measures in the pre-1991 socialist era of India politics.  For example, several products were reserved for this sector and larger players were not permitted to compete with small scale units.  Post-liberalisation, these small scale enterprises had to ‘compete or perish’ as the number of products reserved for the small-scale industry were reduced from 842 in 1991 to 239 in 2007.  This has resulted in the weeding out of inefficient units and dramatically improved competitiveness of SMEs over the last two decades. 

Despite their growing economic stature, flourishing SMEs have found it difficult to harness opportunities and maximise their growth potential in recent years.  Two primary obstacles have stemmed their flow - a) lack of access to technology; and b) efficient means to raise funds.

In recent months, a string of policy announcements and legal developments appear to suggest a change of fortunes for SMEs in India.  We will take a look at some of these developments which might make the mid-market segment in India more attractive for foreign investors and domestic players alike.

A) No prior approval in case of existing joint ventures/technical collaborations

Foreign investors who had an existing joint venture or tie-up in India on or prior to January 12, 2005 were prohibited from making investments into new ventures that could be construed as being in the “same” field as the existing one unless they obtained governmental approval.  In most cases, they needed to obtain the consent of their existing Indian partner.

These restrictions protected the interests of the few Indian partners who had an existing joint venture but prevented the rest of the field from gaining access to valuable foreign technology or investment which could hold the key to their growth.

In April 2011, the Government abolished these restrictions while noting that it will promote India’s competitiveness and be instrumental in attracting higher levels of foreign investment and technology inflows.

B) Pricing of Convertible Instruments

Debt-like securities convertible to equity at a later stage have been the security of choice for foreign investors in many parts of the world.  The price and ratio at which such conversion takes place is often a function of the company’s performance post-investment.  Nonetheless, in India, prior to April 1, 2011, the price and the number of shares arising upon conversion of convertible instruments issued to foreign investors were required to be determined “upfront” i.e. at the time of issue.  Furthermore, the conversion price could not be set lower than fair value determined as per Discounted Cash Flow method (for unlisted companies) or market quoted prices (for listed companies) (such ‘fair value’ is popularly referred to as ‘floor price’).

This requirement offered no flexibility to the company or the foreign investor to dynamically align pricing of an instrument with future performance.

Starting April 1st 2011, this restriction has been eliminated by allowing parties to agree to a price/conversion formula at the time of issuance; provided that price at the time of conversion should not be lower than the fair value worked out, at the time of issuance of such instruments. The positive implications are – firstly, parties can now negotiate a pricing formula, instead of fixing an absolute price; secondly, fair value norms will apply with reference to the date of issue of convertible instruments.  This policy change brings the Indian legal framework closer to market practice around the world and makes investing in Indian companies more attractive to foreign investors.

C)     Issuance of shares to foreign investors against non-cash consideration

Until recently, shares in Indian companies could be issued to foreign investors only against cash remittances subject to a few exceptions that included payment obligations towards repayment of external commercial borrowings or lump-sum fee or royalty payments in technical collaborations.

With effect from April 1st 2011, the number of exceptions, to this rule have been increased. Indian companies are now also allowed to issue equity shares against - (i) import of capital goods/ machinery/ equipment (including second-hand machinery); and (ii) pre-operative/ pre-incorporation expenses (including payments of rent etc.).

Although such issuance is subject to specified conditions and regulatory approvals it provides a new avenue for SMEs to enter capital intensive industries which otherwise would have required them to raise funds through expensive collateralized borrowings from banks.  For manufacturers of heavy machinery and equipment around the world this provides an opportunity to expand the market for their products in India and participate in the growth of their customers in a high-growth economy such as India.

D) Guidelines to set up SME Exchanges

SEBI, the securities regulator in India has long been toying with the idea of setting up an exclusive exchange for SMEs.  SEBI intends to create a simplified listing platform modelled after the Alternative Investment Market (AIM) of the London Stock Exchange for Indian companies with post-issue paid-up capital of less than Rs. 250 million. The two national stock exchanges, NSE and BSE, have now received ‘in-principle‘ approvals to set up  SME platforms and are looking to operationalize them by the end of this financial year.

SMEs seeking a listing on these bourses will benefit from a more relaxed regulatory framework.  They will not be required to file their offer documents with SEBI but only with the SME exchange and Registrar of Companies.  Detailed annual reports will not be required and half-yearly financial reporting will suffice.  

The launch of the SME exchanges will provide a huge impetus to SMEs in India as it will offer them an opportunity to raise funds from the public at a very low cost compared to existing alternatives.  This will in turn allow them to embark on ambitious strategies for growth such as domestic and overseas acquisitions which might be out of bounds today on account of insufficient access to funds.

As a result of these measures, it is expected that SMEs in India will experience a surge in their growth momentum and will attract a lot more foreign investment and technology than they have received in the past.


D. H. Law Associates is a full-service Indian law firm headquartered in Mumbai which is well-positioned to support foreign clients looking to identify and tap mid-market opportunities in India.

Nusrat Hassan is a Partner at D.H. Law Associates.  Nusrat commenced his legal career in 1993 with one of the largest law firms in India.  He has also worked at a large London law firm on a chevening scholarship at College of Law, UK.  He then qualified as a Solicitor with the Law Society of England & Wales (NP).  He co-founded D.H. Law Associates in 1997 and has since been instrumental in the firm’s prolific growth within a relatively short time span. Nusrat has advised several international clients on their investments in India.  He has provided extensive support to multinational clients on their corporate transactions and commercial arrangements in India.  He has been advising clients from the post liberalizations days on foreign direct investment in India including structuring their entry strategies into India.  Mr. Hassan can be contacted at

Santosh Pai is a Partner at D.H. Law Associates.  He obtained his law degree from NLSIU, Bangalore, India’s most reputed law school.  He commenced his legal career with a top-tier Indian law firm in Mumbai where he was involved in advising several multinational and blue-chip clients on mergers, acquisitions, joint ventures and technical collaborations.  Santosh then moved to London and worked at the headquarters of an international law firm where he was involved in providing transactional and regulatory support to FTSE listed corporate clients and private equity investors across Europe.  With his experience, knowledge and wide network of business contacts, Santosh is well positioned to support foreign clients in India and domestic clients on their expansion plans overseas.  He assists several private equity investors and funds in identifying, screening and executing deals in India.  He also mentors start-ups and early stage businesses looking to attract investment.  Mr. Pai can be contacted at


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