The short answer
Foreign investment into an Indian company is governed by the Foreign Exchange Management Act, 1999 (FEMA), the rules made under it, and the government's foreign direct investment policy published by DPIIT. In general terms, these rules decide whether the investment can proceed under the automatic route or needs prior government approval, set pricing guidelines for transfers and issues of shares between residents and non residents, and require the transaction to be reported to the Reserve Bank of India through an authorised bank. Plan for all three from the term sheet stage.
The situation
A Pune SaaS founder has an offer from a Singapore based software company to buy a majority stake, with the founder keeping a minority and staying on as chief executive. Part of the price would be paid on closing and part a year later, depending on revenue. The founder's CA has said "FEMA will apply" and the founder wants to understand what that means for the deal.
Entry routes
Automatic route
In many sectors, foreign investment up to the permitted limit can be made without prior government approval. The investor and the company still have to follow the pricing, documentation and reporting rules.
Government route
Some sectors need prior approval from the government, and some have caps on the percentage of foreign holding or are closed to foreign investment altogether. The consolidated FDI policy and the Foreign Exchange Management (Non-debt Instruments) Rules, 2019 list the sectors and conditions. Software and IT services are generally open under the automatic route, but always check the current policy against the target's actual activities.
Investors from countries sharing a land border with India
Since 2020, investment from an entity of a country that shares a land border with India, or where the beneficial owner is from such a country, needs government approval regardless of sector. This applies to indirect and beneficial ownership too, so the buyer's ownership chain needs checking early. Our sample buyer in Singapore would need to confirm who its ultimate owners are.
Pricing guidelines
FEMA sets pricing rules for transactions between residents and non residents in shares of an Indian company. In general:
- when a non resident buys from a resident, or the company issues new shares to a non resident, the price should not be less than the fair value
- when a resident buys from a non resident, the price should not be more than the fair value
- for an unlisted company, fair value is determined by an internationally accepted pricing method and certified by a qualified valuer, such as a chartered accountant or a SEBI registered merchant banker, as the rules require
- listed companies follow pricing based on SEBI rules
These rules sit alongside the Income-tax Act, which has its own fair market value rules for share transfers and issues. The two valuations do not always agree, so your CA should look at both together. Our guide on valuation methods explained describes the common methods.
Deferred payments, escrow and earn outs
FEMA permits part of the price for a share transfer between a resident and a non resident to be deferred, held in escrow or paid against an indemnity, within limits on the portion and the period that the rules set. An earn out has to fit inside those limits, and the total price, including later payments, still has to meet the pricing rules. The Pune founder's revenue based second payment would need to be structured with this in mind. See earn outs in Indian deals.
Reporting
Foreign investment transactions are reported through the RBI's FIRMS portal, via the authorised dealer bank that handles the funds. Different forms apply to a fresh issue of shares and to a transfer of existing shares, and each has a deadline. Late reporting can lead to compounding or late submission fees. The company's CA or company secretary usually prepares these filings, and the SPA should say who is responsible.
Other points that often come up
Downstream investment
If the Indian company is itself owned or controlled by non residents after the deal, investments it makes into other Indian companies may be treated as indirect foreign investment and follow similar rules.
Tax
Payments to a non resident seller, or by a foreign buyer to a resident seller, raise questions of capital gains, withholding tax and tax treaty benefits under the Income-tax Act. These affect the net amount each side receives.
Merger control
A foreign buyer's worldwide group assets and turnover count for the Competition Act tests. See merger control in India.
Corporate approvals
Board and shareholder approvals, changes to the articles and filings with the Registrar of Companies on the MCA portal follow the Companies Act, 2013 as in any share deal.
A checklist for the term sheet stage
- Confirm the target's sector and whether the automatic route applies
- Map the buyer's ownership chain, including beneficial owners
- Commission a valuation that meets FEMA and Income-tax Act requirements
- Structure deferred or contingent amounts within the FEMA limits
- Agree who files the RBI reports, and by when
- Check whether a merger control filing is needed
How the Pune founder proceeds
In this sample case, the founder's CA confirms the SaaS business falls under the automatic route, the buyer confirms its ownership chain in writing, and a valuer certifies the price. The second payment is reshaped so that it fits within the permitted deferral period, with a smaller revenue linked portion. The term sheet records who files each RBI report.
Where Synerger fits
On Synerger, regulatory approvals and filings can be tracked as conditions on the deal record, each with an owner and date, and the valuation report and RBI filings sit in the due diligence data room. Our financial and risk practice covers cross border finance, working with your CA.
General information; FEMA rules change often, so confirm current requirements with your CA, lawyer or authorised bank.