Many Nepali entrepreneurs dream of establishing successful businesses. Starting and scaling a business requires capital and accessing the right kind of financing remains a significant challenge for small and medium-sized enterprises (SMEs) in the country. Traditional funding sources such as family, friends, angel investors and banks often fall short of meeting the financial needs of growing businesses. This gap has made private equity and venture capital (PEVC) firms an increasingly vital source of funding for startups and high-growth companies in Nepal. PEVC firms aim to enhance the profitability and operational efficiency of their portfolio companies, with the ultimate goal of exiting through founder buyouts, third-party sales or initial public offerings (IPOs), thereby generating profitable returns.

Before investing, PEVC firms prioritize securing their investments—a standard practice to mitigate risks and protect capital in uncertain market environments. While PEVC firms invest as equity shareholders and share the risks as other sponsors or shareholders, they often secure contractual control rights through arrangements such as shareholders’ agreement with the sponsors of the portfolio company.

PEVC Firms in Nepal

The regulatory framework governing PEVC firms in Nepal has evolved significantly over the years. What began as a patchwork of scattered laws has now been consolidated into a comprehensive framework under the Specialized Investment Fund (SIF) Regulations, 2018, issued by the Securities Board of Nepal (SEBON). Currently, 16 funds are in operation in Nepal, comprising seven local funds, four offshore foreign direct investment (FDI) funds, one onshore FDI fund and other SIF funds established as per the SIF Regulations. Before making an equity investment, PEVC firms typically conduct thorough due diligence—technical, financial, legal, and environmental, social and governance (ESG)—on potential portfolio companies. This process begins after signing a Term Sheet or MoU with the sponsors and portfolio companies. However, there is a significant gap between investor expectations and sponsor performance which can delay investment decisions.

To address these challenges, PEVC firms rely on well-drafted Transaction Documents, such as Share Purchase/Subscription Agreements and Shareholders Agreements. These documents provide critical safeguards for investors, including control rights such as limiting the use of funds, affirmative voting rights on crucial matters, board or observer seat, restrictions on transfer of shares of key sponsors, performance milestones and various exit rights.

Portfolio Monitoring and Investor’s rights

Exit rights, including put options, has long been a topic of discussion among PEVC firms in Nepal. These clauses are commonly used to compel sponsors or the company to repurchase investor shares at a predetermined benchmark price in the event of default circumstances, as specified in the Shareholders’ Agreement. Traditional exit strategies—such as IPO and third-party sale—are considered safer due to clearer legal and contractual frameworks. However, drafting an exit clause without understanding whether it would be enforceable before Nepali courts, in case of any event of disputes, depends on the risk appetite of the investor involved. Ultimately, investors naturally expect sponsors, promoters, other shareholders and portfolio companies to honor these exit clauses without claiming them as onerous provisions deeming them as penalty clauses.

This legal principle carries particular significance in Nepal's jurisdiction, where consistent case law has established that an aggrieved party may only recover actual, provable losses. Even in cases of liquidated damages (predetermined damages), Nepali courts have held that even the predetermined damages should be substantiated by the aggrieved party and in case the predetermined damages exceed the actual damages, it would take the form of penalty (which cannot be claimed by the party contractually). Therefore, there is uncertainty over the enforceability of put option clauses in Nepal. Furthermore, these clauses have not yet been tested before the courts in Nepal to extract sufficient interpretation of these clauses.

Beyond put options, another critical investors’ right which has not been discussed is the use of proceeds. Typically, transaction documents require sponsors and the company to use funds, which are received against subscription of shares by the investors, strictly for purposes outlined in the business plan. Any deviation requires prior written consent from the PEVC firm. Investors often prohibit sponsors from using their investment amount to settle existing debts, instead mandating that funds be directed toward business growth and production of portfolio companies.

Other key investors rights include exercising control over company’s management and accounts. Additionally, investors provide no commitment to further financing, such as additional capital, loans, guarantees or security. If sponsors or the company breach these terms, investors may trigger put options. However, as discussed above, the enforceability of exit clauses from legal perspective and its non-compliance by sponsors/promoters makes this alarming from investors’ end.

Securing PEVC Investments with a Charge on Movable Assets

Given the legal uncertainties surrounding put options and other contractual terms in Nepal, one potential solution is for PEVC firms to secure their investments by creating a charge over the company’s movable assets, such as machinery, intellectual property rights, licenses and transferable approvals. This approach provides an additional layer of protection if contractual exit clauses are deemed unenforceable.

PEVC firms typically seek control over a company to ensure that equity capital is used for its business operations. In practice, the equity capital is deposited into a separate account with a joint signatory from the PEVC firm. A separate contractual obligation can also require the registration of a charge over movable assets purchased by the company at the Secured Transaction Registry Office (STRO) established under the Secured Transaction (AT) Act, 2006. A first charge can also be registered over the company’s accounts at the STRO.

Secured Transactions: A Practical Protection Mechanism for PEVC Firms

A secured transaction involves using property (excluding immovable assets) as collateral for loans. While PEVC transactions are not typically viewed as lending transactions, the Secured Transaction Act allows for securing loans with a charge on movable property. When a PEVC firm invests in a company, it is critical to ensure that funds are used as intended. One way to protect this interest is by having a lien over movable assets purchased using the equity investment. By registering a notice at the STRO, the PEVC firm can secure its rights over these assets. PEVC firms can also exert control by registering a charge over the company’s existing or future movable assets. Although these mechanisms have not been tested in Nepali courts, a prima facie reading of the Secured Transactions Act and Regulations suggest that these mechanisms are not prohibited. Furthermore, as such arrangements can be contractually agreed upon, PEVC firms can secure their investments through these means.

Companies Act Test: Analysis of Restriction on Financial Assistance Section 62 of the Companies Act restricts any company from providing any loan or financial assistance of any kind to any person for purchasing its own shares or the shares of its holding company or subsidiary company or getting entitlement to such shares in any manner. Although this particular provision has not been tested before courts of Nepal, this extends to restriction on any support including guarantees, security provided for the purpose of, or in connection with a purchase or subscription of shares of the company.

Providing security of its own assets by the portfolio company to the investor in connection with the subscription of its shares might be interpreted as financial assistance from the perspective of Companies Act. Any extension of loan, security or guarantee often fall under the financial assistance’s scope.

In order to avoid this risk, investors may consider taking charges over sponsors assets rather than portfolio company assets to enforce put options. Sponsors assets could take the form of movable assets of the sponsors including securitization of their dividend or receivables in case of exercise of put option by the investor.

Conclusion

While untested, preliminary analysis suggests that the ST Act and Companies Act permit securing sponsor assets to enforce put options. Further, the ST Act’s application is not limited to lending transactions, and the legal framework does not prohibit creating a charge on movable property in favor of PEVC firms.

However, negotiating such agreements with sponsors may prove challenging given the risk they have to take as an equity shareholder. Since these arrangements can be contractually agreed upon, PEVC firms can better ensure enforcement of put option clauses in this way. Furthermore, Nepali law permits foreign ownership of movable property, eliminating the need for local security agents to create and enforce security interests over tangible movable assets.

(Singh and Khatry are founding partners of Synergy Law and Chambers.)

(This opinion article was originally published in  April 2025  issue of New Business Age Magazine.)