Demystifying the Dematerialization Mandate for Foreign Investors in Indian Private Companies

PNN
Pune (Maharashtra) [India], March 4: Have you ever wondered what happens when the paper trail of shares turns digital? If you're a foreign investor in Indian private companies, significant changes are coming your way. The Indian government has introduced a mandate that could change how you hold and manage your investments. In this article, we'll break down everything you need to know about dematerialization--from the new rules to the steps you must take. Keep reading to find out how you can stay ahead of the curve and comply with the latest regulations without the headache.
What Is the Dematerialization Mandate?
In 2023, the Ministry of Corporate Affairs (MCA) issued a new rule. It requires private limited companies in India, beyond the prescribed threshold, to dematerialize their shares. Simply put, this means that companies must convert their physical share certificates into digital form, and any company that breaches the prescribed threshold in future, will also need to dematerialize their shares whenever they breach this threshold.
Before this, dematerializing shares was only necessary for public and large private firms. But now, private companies have to do it, too.
Most companies impacted by this regulation are either in the process or have already converted their shares into digital form. And it is expected more and more companies will go demat once they breach the revenue and paid-up capital thresholds prescribed. But that is not all, there's a catch: once a company has dematerialized its shares, all shareholders, including foreign investors, need to have a demat account to hold and transact in their investments. For many investors, especially foreign ones, this can be tricky.
Challenges for Foreign Investors
Foreign investors, such as venture capitalists, angel investors, and investment companies, now face the challenge of opening demat accounts in India, which takes time and effort. It requires going over extensive paperwork and adhering to strict regulatory standards. Despite these hurdles, demat accounts are crucial as they make the securities market more transparent and reduce risks like forgery or loss of physical share certificates. Once a company has dematerialized their shares, all future transactions will need to be in demat format, and hence any shareholder who does not have a demat account will not be able to enter into any new transaction including sale of his investment without a demat account.
However, the difficulties arise due to several factors. First, obtaining a PAN (Permanent Account Number) is mandatory for opening a demat account, and with it, foreign entities can proceed. Additionally, investors must choose a Depository Participant (DP), such as a bank, to help manage their digital shares. Lastly, the documentation process is thorough, requiring detailed information, including company ownership details and compliance with Know Your Customer (KYC) norms.
One of the significant difficulties is the extensive documentation required, including board resolutions, directors lists, shareholding patterns, and more. This can be overwhelming, particularly for those unfamiliar with Indian regulations. Additionally, unlike in many other countries, India mandates physical forms and wet signatures, which can be a hassle for foreign businesses accustomed to using e-signatures. Another common challenge is that certain documents stipulated by the Indian regulators for proof of identity and proof of address may not be applicable or available with foreign investors, leading to confusion and delays.
Step-by-Step Guide to Opening a Demat Account
To open a demat account, foreign investors must first obtain a Permanent Account Number (PAN) in India, which is essential for proceeding. Once the PAN is acquired, the investor must select a Depository Participant (DP), typically a bank or financial institution, to manage the demat account. Choosing the right DP is crucial for ensuring smooth operations later. The next step involves completing the necessary paperwork, including authority letters, board resolutions, a list of directors and ultimate beneficial owners, and tax identification, financial and bank statements. After filling out these forms, the documents are submitted to the DP. The processing time can vary but usually takes between 3-5 weeks.
If you are a foreign investor who regularly invests in the start-up ecosystem in India, it is highly recommended that you get your demat account as early as possible. Not having a demat account might impact your ability to hold or transact in shares of companies you have already invested. You will also not be able make any new investments in companies impacted by this mandate, since these companies will have to issue shares only in demat format.
Conclusion
The dematerialization mandate is a big step toward modernizing India's securities market, but it's not without its challenges, especially for foreign investors. By setting up a demat account, investors can ensure they comply with the new regulations and continue holding shares in Indian private companies without any hiccups. The regulators should take positive steps to make it easier for the foreign investors to get demat accounts, especially since this mandate is likely to impact a sizable number of companies in the start-up ecosystem which thrives on angel investors and boutique VC firms for capital.
About Accounti
Accounti is a full-stack fractional CFO, accounting and finance operations services company helping start-ups and mid-market companies build robust and scalable finance processes. Accounti also provides a fully managed, concierge service to help foreign investors get a demat account in India and successfully got demat accounts for various VC funds, fund administrators, angel investors and others through this service. For more information visit : www.accounti.ai
Rohit Kapoor, Co-founder
Harsha Baisya, Co-founder at Accounti
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