The financing options for your Indian subsidiary: capital, ECBs or a bank loan

As the Indian operations of European companies grow, foreign shareholders often struggle with how best to finance the operations, given India's restrictive regulations. We therefore cover three strategic options for financing your subsidiary in India.

European companies in India have 3 options to finance their subsidiary

1. Share Capital

You can raise capital by issuing additional shares in your Indian company. Increasing share capital is a relatively sustainable and institutionalized way to grow the Indian subsidiary. Moreover, it signals to the outside world that the parent company is serious about developing the subsidiary's services or products in India.

There are two drawbacks to this route. Issuing new shares is a bureaucratic and time-consuming process and thus cannot be arranged at short notice. Thus, in the event of acute cash flow problems, it offers no solace. It can also affect ownership of the company, especially in joint ventures with Indian partners.

2. External Commercial Borrowing (ECB).

Your Indian subsidiary can borrow from the parent company in Europe, but this is only possible under the so-called External Commercial Borrowing construction (ECB). Applying for an ECB is a bureaucratic and time-consuming process, but it has a big advantage: the interest rate on an ECB loan to an Indian party is based on LIBOR + a premium of up to 300 basis points.

3. Bank loans

Indian Banks: Your subsidiary can apply for a loan from a local bank, but the enormously high interest rates rarely make this option attractive or feasible. Interest rates on credit from local Indian banks start at 10-12% and can easily exceed 15%. Only with a cash deposit as a guarantee can a lower rate be negotiated in some cases. In addition to sky-high interest rates, Indian banks routinely ask for collateral if you want to apply for a loan. To organize the paperwork with the bank, you need a local consultant. In addition, you pay the bank another administrative fee of 1% on average. With local banks, you can raise a maximum of 1-2 million euros this way.

If you need more capital, you can apply to several banks at the same time that can provide a loan as a consortium. Of course, this only makes obtaining the loan more complex and expensive.

International development banks: For projects supported by the Indian government, you can turn to development banks, such as IFC (World Bank) and the Asian Development Bank. In addition, Chinese banks may be an option, although these often impose the condition that the loan be spent on products or services from Chinese (state-owned) companies.

A comparison of the 3 financing options for your Indian subsidiary

CONSIDERATION	SHARE CAPITAL	EXTERNAL COMMERCIAL BORROWING (ECB)	LOAN AT LOCAL BANK
Interest expense	Not applicable.	Maximum: 500 basis point + acceptable reference rate. 3-4% interest rate would be ideal based on our experience and can be justified as arm's length.	Flexible structure with fixed and variable interest rates that can be negotiated with the lending bank. The average interest rate is about 10%.
Other costs	There are legal and filing fees associated with issuing new shares.	Exchange rate fluctuations for borrowers and monthly compliance costs for reporting data to the Central Bank of India.	Costs related to corporate guarantees or letters of credit issued by foreign banks of the parent company.
For- charges	Benefit from Income Tax Act -20% + surcharge & Cess.	Benefit from Income Tax Act -20% + surcharge & Cess.	Not applicable.
Corporate Income tax	Parent company must pay tax in the country of establishment. Tax deduction for taxes paid in India is applicable.	Parent company must pay tax in the country of establishment. Tax deduction for taxes paid in India is applicable.	Not applicable.
Payment terms	Repayment of capital occurs upon business termination. Dividend payment according to the rules of the Indian entity.	Average maturity requirements (ranging from 3 to 10 years) must be met, which provides flexibility in terms of repayment of interest and principal.	Strict payment terms and defaults affect credit scores and interest rates for future loans.
Regulatory considerations	Foreign lenders must meet tax liability through PAN registration, Form 10F and filing of Indian tax returns (only in case of dividend income).	Foreign lenders must meet tax liability through PAN registration, Form 10F and filing of Indian tax returns (only in case of dividend income).	Less hassle with regulations because established procedures are used.

Special guide for CFOs with operations in India

India can be a challenging country for European CFOs. Therefore, to give you a better understanding of the complex tax and financial system that every CFO in India faces, consulting firm IndiaConnected has created an insightful guide that addresses the most frequently asked tax questions.

We can, of course, support you at all times in such matters. From choosing the right financing option to helping you apply for ECB or bank loans, so you can always focus fully on your business in India. Contact us here.

Meyn had to invest for 30 years in India, but now has 50% of the market share

Meyn is one of the largest chicken processing companies in the world and is active in more than 100 countries. Yet it took the company from Oostzaan more than twenty years to gain a firm foothold in India. "We had to sow a lot of seeds in India before we could start harvesting, but it was worth it," says Karel de Waal, senior sales manager India for the meat processing specialist. "Because of our patience, we now have over 50% of the market."

Third from left: Karel de Waal with the Indian team on the right

Until 2018, Meyn employed only one agent to represent the multi-billion dollar company in India. "With Alok Raj, our agent, we were extremely lucky at the time. Before we started working with him, we had a few less smooth collaborations that didn't yield much. But when we got in touch with Alok, there was an immediate click. He broke up the market for us." 

According to Karel, this was mainly due to Alok's strategy. "In the 20 years he worked for Meyn in India, he was more of a consultant than a salesman. In India, building a personal relationship is extremely important when doing business with each other. He would work with the entrepreneur to see how the production process could be made more efficient or even help start-ups design entire factories," says Karel with a smile. "And those factories actually came about, because the entrepreneurs felt they could always count on us and that was the turning point when we could start charging for our service."

Subsidiary in India

After working with their agent for twenty years and gaining a solid foothold in the Indian market, it was time for Meyn to start a wholly owned subsidiary in India. "Before we had the office, we actually arranged everything from the Netherlands. From sales to installation and after-sales. But as a company we want to be as close to our customers as possible. That is our global strategy. We have a total of 16 after-sales offices, where we work in the local language and currency and sell spare parts. But especially in India, this kind of quick after-sales service is very important."

On the advice of Meyn's owner, the Berkshire Hathaway group, a law firm that the Berkshire Hathaway group already had experience with was used to set up the Indian office. "But in retrospect, they may not have been the best party. It was a very big firm, which didn't want to make metres for us. We were led to believe that setting up would be a matter of months, but it ended up taking two years." According to Karel, the medium-sized full service accountancy firm they now work with could have carried out this process within a year. "As an international company, you shouldn't focus on size and international experience. It is more important that such a law firm has the right contacts in India and can focus its full attention on you."

Warren Buffet

But it was not just the lawyers who delayed the process. "They say the bureaucracy situation has improved a lot in India, but you still have to be patient. We got the strangest requests from the Indian authorities, which we as a multinational company simply could not comply with. For example, they asked us for a copy of the passport of our largest shareholder. In our case, that is Warren Buffet."

Inspection of the spare parts store in Delhi by Meyn's global sales director, Robbert Birkhoff

The recruitment of staff, on the other hand, went like clockwork, and that, too, was to the credit of agent Alok. "Our office is small, we have a team of three people who all have to be as all-round as possible. Not surprisingly, we knew everyone before they were hired. Our chief engineer and account manager had both worked for our agent for years. So we just had to find a director, as Alok himself was retiring. At the time, we had a lot of contact with an employee of the Agriculture Council of the Dutch Embassy in Delhi. He knew our company, the industry and had experience with the Dutch culture, so that was a perfect match." 

Expanding the team in India

Meyn would love to expand the team in India now with a junior engineer, but due to the aftermath of the corona crisis, there is a global vacancy freeze. "It was exciting for a while what the virus outbreak was going to mean for our industry because in the first few weeks there was a rumor circulating in India that you would get Covid from eating chicken. But now that it is known that the virus probably came from a Chinese wet market we actually see new growth opportunities emerging in India."

Not only in China are the wet markets popular for selling meat and fish, even in India 90 percent of meat still comes from here. "We now hope that this will start to change. Not only because consumers will think differently about the freshness of meat from such a market, but also because Modi has dared to make bold choices before. He has already spearheaded a major sweep through major cities, so we hope he will come up with a plan to tackle these wet markets . India is the fifth largest producer of broiler chickens in the world and that already offers enormous potential, but if people start buying more chicken in the supermarket it will accelerate the automation of the meat processing industry."

Financing your business in India: these are your options

What is the smartest way to finance your subsidiary or branch in India? This is often a thorny issue for European companies, partly due to Indian regulations. We have listed the various strategic options for you.

Start-up capital

The financing options for your Indian business depend on the legal form of your business in India. The most common legal forms are the Private Limited (Pvt. Ltd) and the Joint Venture (JV), with an Indian company as co-owner. At the time of incorporation, the capital the company will start with is determined by the number of shares issued.

The minimum start-up capital of an enterprise in India is set by law at INR 100,000 (EUR 1,200). Many companies choose to contribute this minimum start-up capital, but bringing in more capital at the outset can solve financing issues in the future. This is because bringing in working capital at a later stage is subject to more rules.

Working capital

Do you need working capital in India? A quick and easy way to raise working capital is to pre-invoice planned exports of products or services to the parent company. The subsidiary may invoice services it supplies or plans to supply in the near future (pre-invoicing) to the European parent company. An advantage of pre-invoicing is that it can quickly generate the necessary cash flow for the Indian company. In case of a joint venture with an Indian partner, financing through (pre)invoicing depends on the agreements between the two JV partners. 

Loan for your Indian entity

Does your Indian subsidiary need capital to make investments in India? There are several options for this, but none of them are easy, quick or cheap. The subsidiary can take out a loan from the parent company in Europe, but this is only possible under a so-called External Commercial Borrowing (ECB) construction. Applying for an ECB is a bureaucratic and time-consuming process, but it has a big advantage: the interest rate on an ECB loan to an Indian party is based on LIBOR + a premium of up to 300 basis points.

Financing through an Indian bank

Indian banks can also provide loans, but the extremely high interest rates rarely make this option attractive or feasible. Interest rates on credit from local Indian banks start at 10-12% and can easily rise above 15%. Only with a cash deposit as guarantee can a lower rate be negotiated in some cases. Apart from the sky-high interest rates, Indian banks routinely ask for collateral if you want to apply for a loan. To organise the paperwork with the bank, you need a local consultant. In addition, you pay the bank an administrative fee of 1% on average. At local banks, you can raise a maximum of EUR 1 to 2 million in this way.

If you need more capital, you can apply to several banks at the same time, which can provide a loan as a consortium. Of course, this only makes obtaining the loan more complex and expensive. In short, borrowing from an Indian bank is really only an option if the Indian branch's cash requirements are extremely high and there will be an almost certain and substantial return on investment by taking out the loan.

International development banks

What other options are there? For projects supported by the Indian government, you can turn to development banks such as IFC (World Bank) and the Asian Development Bank. Chinese banks may also be an option, although these often stipulate that the loan must be spent on products or services of Chinese (state-owned) companies.

Issue additional shares

Finally, it is also possible to raise finance by issuing additional shares in the Indian company. Increasing the share capital is a relatively sustainable, formal and institutionalised way to grow the Indian subsidiary. Moreover, it signals to the outside world that the parent company is serious about developing the services or products of the subsidiary in India.

There are two disadvantages to this route. Issuing new shares is a bureaucratic and time-consuming process and cannot therefore be arranged at short notice. In the event of acute cash flow problems, this does not offer any solace. Another possible disadvantage of increasing the share capital is that it may affect the ownership of the company, especially in JVs with Indian partners.

Want to know more about the best financing options for your business?