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Why an LLP Act is Important for Building an Investor Friendly Environment

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Sri Lanka begins 2019 amidst a low growth environment and on the back of a weak currency. Investment and foreign earnings have never been more vital to bring back stability. The Private Equity and Venture Capital industry can play a key role in mitigating  these challenges as it not only facilitates a climate for entrepreneurship and economic growth, but also catalyses foreign capital flows into the country. The Private Equity and Venture Capital industry in turn demands the proper legal framework to thrive – a Limited Liability Partnership Act (LLP). Industry experts Ayomi Aluwihare, Precedent Partner at F.J. & G. de Saram; and Nissanka Weerasekara, Former Managing Director of the Abraaj Group for Sri Lanka and Bangladesh, and members of the National Agenda Committee on Finance and Capital, discussed their views on why they believe a case for an LLP Act in Sri Lanka has already been established.

Their interview with Shenali de Silva and Gayara Pathirannehe of the Economic Intelligence Unit of the Ceylon Chamber of Commerce, lays the groundwork for both the need for an LLP act as well as the shortcomings within the current system in place.

What is an LLP?

  • A Limited Liability Partnership combines the elements of both a Limited Liability Company (LLC) and a Partnership. An LLP incorporates the limited liability of shareholders in an LLC and the flexibility of management of internal affairs enjoyed by partners in a Partnership. It stands as a legal entity, separate from its owners with perpetual succession ensuring longevity. A weakness seen in venture capital firms of the past as noted by Nissanka was that the investors were shareholders and not partners.

Why do we need an LLP Act?

  • An objective view of the Sri Lankan economy reveals, sluggish growth and a weak export sector. Despite this gloomy outlook, experts state that there lies great potential for growth facilitated by start-ups.

 

Nissanka: ‘Demand for capital to start new businesses is higher than in the past but venture capital funding has dried up.’ 

 

LLPs help bring in this funding and are used globally to set up Private Equity (PE) and Venture Capital funds. Nissanka stated that in funding local businesses, local investors are likely to have higher risk appetite due to their familiarity with the people and the business environment. In the past single investors with high levels of personal capital have pooled resources to fund these start-ups. However, the establishment of LLPs will enhance the efficiency of this process, by allowing money to be drawn from a larger pool of investors and managed by experienced fund managers.

 

  • Neighbouring countries, such as India, Malaysia and Singapore already have an LLP act in place. The Qatar International finance centre is evidence of global demand for the LLP structure as seen by the need of investors to see all investment vehicles offered globally within the legal framework of the centre, a noteworthy point for the Colombo International Financial Centre. This hole in Sri Lanka’s legal framework is further evidenced by Ayomi’s experience with entities looking to set up PE funds within the country, having experience and investment from outside of the country by parties very familiar with the LLP structure.

Ayomi: ‘In some companies the investment structure behind the local company in Sri Lanka is an LLP structure, positioned overseas, allowing investors to follow a familiar structure outside and for funds to come into a local company in Sri Lanka. Investors are aware that LLCs are a fall back.’

 

 

 

What are the benefits of an LLP?

  • Both Nissanka and Ayomi emphasize the weakness within the current LLC structure in place, where gains on investments are recognised as regular trading profits thus are subject to income tax, resulting in double taxation of gains at both a personal and fund level. An LLP needs to be subject to partnership taxation as of today, where only the personal income of partners is taxed as per the Inland Revenue Act.

 

  • Nissanka identified one of the key factors for investors in venture capital firms as ease of investment, both in terms of investing funds in the start-ups as well as obtaining future returns. In Sri Lanka both these processes present a challenge. Regarding the former, shares in LLCs are usually fully paid at the beginning due to difficulty making multiple rounds of capital calls. Therefore, funds lie idle during the investment period, negatively affecting the internal rate of return. The winding down of VC firms are a time-consuming process, taking years for funds to be returned to investors.

 

Nissanka: ‘We have venture capital firms incorporated in 1991 that are still being liquidated.’

 

  • An LLP would allow capital calls to be made from investors as and when needed as well as facilitate a faster liquidation of funds at the end of the lifecycle of venture capital firms.

 

What are the roadblocks for introducing an LLP Act?

  • Nissanka and Ayomi believe the only possible roadblock faced in the successful enactment of an LLP act is simply the policy priority for implementation by the government.

 

Ayomi: ‘It is unlikely to be contentious as there is no negative consequence….entails only agreeing to framework facilitating legislation.’

 

 

  • However, it is assumed that this too will not propose a challenge given that the framework for an LLP Act was proposed by the Hon Minister of Finance in his 2018 budget speech. The introduction of the LLP is timely in the face of the recently introduced ‘Innovation and Entrepreneurship Strategy ‘, aimed at increasing the innovation and resilience of the economy by encouraging an entrepreneurial society.

 

 

  • Conclusively, Ayomi and Nissanka have indicated the unsuitability of LLCs to be used for private equity and venture capital funds. An LLP Act rather than being simply an incentive for investment is a necessity to facilitate both foreign and domestic investment. A more accommodating environment will result in higher gains for investors, finally translating into higher tax revenue for the government.

 

Ayomi: ‘The LLP act is a necessity…. It’s not so much about bringing foreign investment but being ready with appropriate investment vehicles and having the legal structure in place once the foreign investment does come in.’

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