Lesson from Flipkart raising $1 bn: Govt needs to clear its stance on e-commerce quickly

Flipkart recently surprised everyone after announcing that it had raised a billion dollars. A billion dollars is not a small amount and this was a first for an Indian internet company.Flipkart’s valuation has been going up rapidly with every successive round of investment, and an announcement that it had raised a record $ billion dollars or Rs 6,000 crores is another feather in the cap of an internet company that is growing by leaps and bounds.

The interesting details that surface now, thanks to some investigative reporting by N Sundaresha Subramaniam here , shows how the funding has been raised. The report shows that Flipkart has raised funding through its Singapore-based holding company Flipkart Private Ltd (FPL).

FPL is the primary recipient of the millions of dollars private equity money that has been flooding the company of late. Private equity players, along with 40 such entities, own preferential shares worth a billion dollars in the company.

FPL is an investment holdings firm for its Indian firms - Flipkart India Pvt Ltd (FIPL) and Flipkart Internet. FIPL is the Indian entity that runs the cash-and-carry and wholesale business in India.

While Flipkart Internet runs the marketplace business on the internet, it does not come under the ambit of FDI in retail. Whereas FIPL’s businesses come under the Indian regulations for FDI in retail.

Now why does FPL have to raise funds through preferential shares and not through common equity shares? This is because they have to keep the holding of Sachin Bansal and Binny Bansal, both Indians, at the current levels. These two continue to hold 46.02 percent and 45.98 percent stake, respectively. Both are Indians and it is necessary for them to continue as majority shareholders to comply with FDI regulations.

The preferential shares allow them to raise capital and still maintain the holding of the founders. This way the company bypasses the Indian regulations on FDI in retail which says that foreign investors cannot have majority or 100 per cent holding in Indian retail companies. In 2012, Flipkart shifted its holding company from India to Singapore, the earlier holding company Flipkart Online Services Ltd sold all its business to FPL.

Also apart from the benefit of regulatory bypass, there are other benefits that Flipkart can pass on to its institutional investors. It can offer these institutional investors cumulative returns via dividends. This is a very attractive proposition for investors looking at sustained returns. Basically, the returns are fixed for the duration of the issue period, and if the company is not able to pay them in the initial years then they accumulate to be payable later.

Preferential shares also have a conversion clause where they can be converted into ordinary equity shares. If in the future India allows FDI in retail and the investors see a higher upside on the conversion, they can convert.

The issue is that due to the government not making its stance clear on the FDI in e-commerce novel financial instruments are being used for funding instead of funds coming in directly into the country. As the holding company, FPL, is registered in Singapore it might be the vehicle for even going public. The announcement by Flipkart about raising funds is known to Indian regulators and they know the way it has been done. The regulations should be clarified so that companies do not have to operate in this grey area.