Private equity (PE) and venture capital (VC) investments in India operate within a well-defined legal framework that balances investor flexibility with regulatory oversight. Understanding this structure, founded upon the SEBI (Alternative Investment Funds) Regulations, 2012, the Foreign Exchange Management Act (FEMA), 1999, and the Companies Act, 2013, is essential for any foreign investor considering the market.
Market Context and Recent Reforms
India’s private equity and venture capital (PE-VC) market rebounded strongly in 2024, with total investments rising about 9% year-on-year to roughly $43 billion. Venture and growth-stage deals drove this recovery, as VC funding surged nearly 40% to $14 billion, positioning India as the second-largest PE-VC destination in the Asia-Pacific region after China, with around 20% of regional capital. Investment was concentrated in high-growth sectors, notably technology-driven businesses especially consumer Internet and IT/ITeS startups, where funding jumped to $6 billion along with strong inflows into financial services and infrastructure or real-estate projects.
Recent policy reforms have further strengthened India’s investment climate. The Union Budget 2024 abolished the “angel tax” for all investors from FY 2025–26, easing startup fundraising. The long-term capital gains tax on unlisted shares was also cut to 12.5% (from 20%) under the new regime effective July 2024, improving post-tax returns.
Additionally, SEBI’s September 2024 overhaul introduced a fixed-price delisting routeoffering a minimum 15% premium and reducing the acceptance threshold from 90% to 75%making exits clearer and more predictable. Supported by these measures and strong GDP growth, India enters 2025 with a cautiously optimistic PE-VC outlook, led by sustained investor confidence in financial services, healthcare, and real estate.
Core Regulatory Framework and Investment Structuring
The Alternative Investment Fund (AIF) Regime
PE and VC funds are primarily structured as Category II AIFs under the SEBI (Alternative Investment Funds) Regulations, 2012. These are close-ended funds with a minimum tenure of three years and are strictly prohibited from using leverage except for temporary funding needs. Key requirements include achieving a minimum corpus of ₹20 crore, a mandatory minimum investment of ₹1 crore per investor (with exceptions for staff), and a sponsor commitment of at least the lower of 2.5% of the corpus or ₹5 crore. To mitigate risk, investment in a single company is capped at 25% of the total investible funds. The SEBI Amendment Regulations, 2025, clarified that these funds primarily invest in unlisted securities and/or listed debt rated ‘A’ or below.
The Specialized Foreign Venture Capital Investor (FVCI) Route
Foreign entities focused on early-stage investment may register as a Foreign Venture Capital Investor (FVCI) under the SEBI (Foreign Venture Capital Investor) Regulations, 2000. FVCIs must commit significant capital to genuine venture activity by investing a minimum of 66.67% of their investable funds into unlisted equity or equity-linked instruments of Venture Capital Undertakings (VCUs). FVCIs enjoy operational exemptions, including relief from certain pricing guidelines and a reduced post-IPO lock-in period.
Foreign Capital Flows and Exchange Control (FEMA)
Distinguishing Investment Channels
Cross-border investment is governed by the Foreign Exchange Management Act (FEMA), 1999, and the Reserve Bank of India (RBI). Foreign capital flows primarily through two routes: Foreign Direct Investment (FDI), used for long-term stakes (10% minimum equity) in listed or unlisted companies; and Foreign Portfolio Investment (FPI), for passive investment (less than 10%) in listed securities, requiring SEBI registration. Investment is subject to sectoral caps and routes (Automatic vs. Government approval). Notably, Press Note 3 of 2020 mandates government approval for investments from countries sharing a land border with India.
Mandatory Pricing Guidelines and Reporting
The Non-Debt Instruments (NDI) Rules require that the price of equity instruments issued or transferred to a non-resident must not fall below the Fair Market Value (FMV), enforced by the RBI to prevent capital flight. This FMV must be certified using internationally accepted pricing methodologies, determined for unlisted companies by a Chartered Accountant, a SEBI-registered Merchant Banker, or a Cost Accountant.
For startups, Convertible Notes (₹25 lakh minimum tranche) offer flexibility but remain subject to FEMA pricing guidelines and sectoral conditions. Post-investment compliance involves mandatory and timely reporting through the streamlined Single Master Form (SMF) on the FIRMS portal. FVCIs are subject to dual-channel reporting to both SEBI (quarterly) and the RBI (monthly).
Corporate Governance and Transaction Execution
Investor Rights and Enforceability
The Companies Act, 2013, sets governance standards, including fundamental shareholder rights. Since statutory rights are often insufficient, investors rely on Shareholder Agreements (SHAs) to secure protective provisions like Affirmative Voting Rights, Exit Rights (tag/drag-along), and Anti-dilution Protection. Crucially, for these contractual rights to be enforceable against the company itself under the Companies Act, they must be explicitly incorporated into the company’s Articles of Association (AOA). If not incorporated, the investor is limited to a private contract remedy against the counterparty under the Indian Contract Act, 1872.
Acquisition of Control and Compliance
For listed entities, the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (Takeover Code) mandate a public open offer when an acquisition exceeds the 25% shareholding threshold. Additionally, the SEBI (Prohibition of Insider Trading) Regulations, 2015, impose a strict regime against misusing Unpublished Price Sensitive Information (UPSI) obtained during due diligence.
Taxation under the Income Tax Act, 1961
Pass-Through Status and Exemptions
Category I and II AIFs benefit from pass-through status under the Income Tax Act, 1961, meaning income (excluding business income) is taxed only at the investor level, retaining its original character (e.g., LTCG). Conversely, Category III AIFs are generally taxed at the fund level on any business income. Non-resident investors in Category I or II AIFs are also specifically exempt from the applicability of the complex Indirect Transfer Provisions upon redemption of interests, provided the income is otherwise taxable in India.
Tax Incentives and Uncertainty
AIFs established in the IFSC at GIFT City receive substantial fiscal advantages, including a 100% tax holiday on business income for 10 out of 15 years, exemptions from capital gains and dividend taxes for non-resident investors, and waivers of transaction taxes like STT and stamp duty.
However, the taxation of ‘carried interest’, the fund manager’s disproportionate profit share, presents significant uncertainty. Historically treated as lower-taxed capital gains, recent Tax Tribunal rulings have re-characterized this income as service fees. This shift could subject fund managers to significantly higher ordinary income tax rates and raise retrospective GST liabilities, necessitating a comprehensive review of compensation structures.
Recent Legal and Regulatory Developments
Effective September 2024, amendments to the Competition Act, 2002, introduced a deal value threshold, requiring transactions exceeding INR 2,000 crore (approximately $230 million) to be notified to the Competition Commission of India (CCI) if the target has a substantial business presence in India.
Separately, the Ministry of Corporate Affairs (MCA) introduced a fast-track route for inbound mergers between a foreign parent and its wholly-owned Indian subsidiary, significantly reducing procedural delays. Furthermore, the RBI clarified in January 2025 that Foreign Owned and Controlled Companies (FOCCs) can use flexible mechanisms like share swaps, escrows, and deferred consideration in their downstream investments, placing them on par with other foreign investors.
Conclusion
The legal framework for private equity and venture capital in India is sophisticated and continuously evolving. For institutional investors, success rests on a firm comprehension of the rigorous compliance requirements governed by FEMA for foreign capital flows and pricing rules, SEBI for fund structuring and governance, the Companies Act for corporate execution, and the Income Tax Act for efficient capital deployment and repatriation. Strategic attention to specific updates, such as the new Competition Law thresholds and the evolving taxation of Carried Interest, allows investors to fully realize the substantial opportunities in India’s vibrant economy.