This dramatic increase coincides with the most difficult regulatory environment in India this decade. The Reserve Bank of India has sought to dampen inflationary pressures and a dramatic increase in the value of the Indian rupee -- which is not yet freely convertible on the capital account -- relative to the U.S. dollar and other currencies by restricting inflows of foreign capital into the country. In addition, as Indian political parties prepare for national elections before mid-2009, there has been considerable political posturing at the expense of the international investment community to woo important voting blocks, most notably the export-focused textile industry.

The result of this economic, political and regulatory climate for offshore PE investors has been dramatically increased valuations, particularly in the technology and real estate space, and reduction of flexibility on deal structures. India has long been a destination for minority investments. By contrast, control transactions and buyouts are not as common: Goldman's October 2007 $230 million buyout of Sigma Electric Manufacturing Corp. in October was the largest acquisition of the year. This is likely due to the prevalence of family-controlled businesses with a tradition of "passing on the business to my sons" and government restrictions on foreign ownership. Most business sectors in India now are open to 100% foreign ownership without prior regulatory approval, but cultural impediments to buyouts persist.

Minority investments present structural challenges in the current regulatory environment. They offer limited downside protection because optionally convertible "preference shares" (akin to preferred stock) and most optionally convertible debt structures (including U.S. dollar-denominated offerings) require prior regulatory approval. Accordingly, private equity investors typically make minority investments through equity investments with put-call rights to existing shareholders (usually management, called "promoters" in India) and buybacks by the company over time. Mandatorily convertible preference shares and bonds also are used, though redemption rights are limited. All of these mechanisms are subject to government-imposed pricing guidelines, which restrict arm's-length pricing and curtail downside protection.

Proper tax structuring to efficiently exit the investment is also critical. Taxation in India on capital gains can exceed 40%, and direct investments from many home country jurisdictions, including the U.S., can expose foreign investors to double taxation. Accordingly, investments are structured through tax-favorable jurisdictions (Mauritius, the Netherlands, Luxembourg and Singapore, among others).

As the Indian economy continues its exceptional growth reflecting strong underlying fundamentals, one should see private equity investments in India continue to increase dramatically. With careful attention to legal and tax structuring, investors should continue to see attractive returns on their investments.

Yash Rana is a partner in the New York office of Goodwin Procter LLP.