Update: The Indian Government has decided not to allow companies with foreign direct investment (FDI) to sell their products through the Internet in India. The Indian Government which allowed Foreign Direct Investment up to 51% in multi brand retail trading last week has decided not to allow companies with foreign direct investment (FDI) to sell their products through the Internet in India. 

However, if FDI was allowed in ecommerce, the funding situation would have been as follows:

The Indian Government has allowed up to 51 per cent foreign direct investment (FDI) in multi-brand retail. Though it means that foreign biggies like Amazon can to start operating in the country, what it also confirms is that ecommerce startups in India wouldn’t have to adopt a two-pronged strategy to raise funding for their businesses.

Till date, ecommerce firms used to raise funds from foreign Private Equity and Venture Capitalist firms showing that the money was raised to power the backend logistics of the business venture and the ecommerce. As the FDI norms are eased, startups can have a single corporate entity for which they can directly bid for funds.

The funding scenerio that existed till now:

Department of Industrial Policy & Promotion (DIPP), on 1st April 2012, issued the “Consolidated Foreign Direct Investment Policy” to clarify the cloud surrounding foreign investments in ecommerce by allowing 100% foreign investments in 100% FDI in business to business e-commerce ventures, but not in retail trading ventures.

The circular defined ecommerce activities as: ecommerce activities refer to the activity of buying and selling by a company through the ecommerce platform. Such companies would engage only in Business to Business (B2B) ecommerce and not in retail trading, inter-alia implying that existing restrictions on FDI in domestic trading would be applicable to ecommerce as well. This means FDI upto 100% through automatic route in ecommerce ventures is legal, provided that the venture is a B2B and not B2C.

Legal experts argued that if the Indian ecommerce firms are into B2B trading activities they are safe and qualify for 100% automatic FDI route, but the fact is that in India, the bulk of the e-tailing business are centred around selling to the consumer, and not B2B.

But ecommerce firms in India have been raising capital from foreign investors and by doing so, are these companies flouting norms? Since the nature of the back-end was not clearly defined, many of these companies attracted funding by creating a wholesale logistics or warehousing arm where 100% FDI could be used. These logistics / warehousing companies would not have a website and they technically became the sourcing arm for the ecommerce business.

The Funding Scenerio that now comes in:

With the new FDI ruling, experts argue that there will be even more investor interest now, as financial investors can now invest and take stake unto 51%, which gives them a lot of rights and ownership and the companies get a lot of capital.

Moreover, startups, which might not have the deep-pocket to own or build a warehouse, will find it less complex to approach a VC for the frontend of the business, rather than the backend.

What Experts say:

Nikhil Pahwa, Editor and Publisher, MediaNama, was of the view that it was wrong to not allow foreign investment in ecommerce. “The laws of the land need to be more progressive, and allow businesses to raise money (whether from internal or external sources) to build large, scaled businesses that provide better goods, services and customer experience to customers. Large businesses need large amounts of funds to build scale, and their investors need exits, as an incentive to invest. If Indian companies cannot afford to provide exits to these businesses, then we must allow foreign companies to buy them. 100% FDI in e-commerce needs to be allowed,” said Pahwa.

Venture Capitalist Mahesh Murthy, in one of his tweets, said that FDI in multi-brand retail ensures that foreign VCs can now legally invest in Indian ecommerce without shady dual-company manoeuvre.

The Takeaway:

We are not going into the details of whether the ecommerce funding strategy adopted by Indian ecommerce start-ups so far was legal or they had a loophole, but what the new norms affirm is that Indian ecommerce start-ups will definitely find it a notch easier to raise funds from foreign VCs without being worried about owning a warehouse business first.