As an active player in the entrepreneurial ecosystem, we believe in advocacy. We make representations to the government and industry, with suggestions and requests, to ease the journey of an entrepreneur.
We believe in advocating, on behalf of, and at times to, all the stakeholders in this ecosystem. In recent past, we have approached the authorities multiple times. The aim of these representations has been –simplify the process of doing business in India.
Being a part of the start-up ecosystem, where looking at the bright side is often the only ray of hope, let’s ask – what can our Government do for start-ups?
On a basic level, it translates into- what would I do if I were the Finance Minister? Since finance people like numbers, we begin with the fact that a start-up friendly policy environment can create over 10 million direct jobs for the Indian youth in 10 years.
Then we identify the bottlenecks in the growth of start-ups – starting, conducting and closing a business – and the lack of easily available risk capital for them.
The ground reality is that it is tough for a start-up to meet all the regulatory criteria to set-up, conduct and close a business because. How can the start-ups compete globally and efficiently, if the regulations suck their energy and enthusiasm? For ease of understanding let’s limit the discussion to Small & Medium Company (SMC as defined in Dec’06 by the Ministry of Corporate Affairs.)
Given the number of compliances and the steps needed to operate, it is not surprising that India ranks 173rd globally on the index measuring ease of doing business in a country. The irony is that India is extremely friendly on the e-governance front, as many processes are online and thus easier. However, the number of steps, amount of time, and costs to navigate is a dampener. As a VC, it is shocking to see, that a start-up sometimes considers an incorporation certificate of their company a bigger feather in their cap than winning a customer order.
Years ago, an M&A expert told me, walk into partnerships only if you know the exit mechanism. The procedures for winding-up a SMC must be simplified with stringent timelines, given the high risk of failure for a start-up. Thus having simple processes with defined time-lines to close a company will encourage setting-up a company the moment an idea germinates. Moreover, start-ups must consider a formal corporate structure rather than the current way, of sole proprietorship or partnership firm,as the former is more transparent and accountable.
Not only exit, the formation of a company should be made easy too,with a single application taking care of multiple requirements – Name Search, Director Identification Number, Digital signatures, Incorporation certificate, and Permanent Account Number. When the start-up decides the place of operation allocate Tax Account Number, register it under Shop & Establishment Act and the MSME Act again in a single application. Only when the start-up reaches the minimum number of employees, a common application should be made for Professional Tax, EPFO, ESI and Gratuity.
An appeal on behalf of the entire start-up ecosystem would be – don’t make our start-ups defaulters from the first day of operation. It is really difficult for a VC to find a SMC that is fully compliant in their initial days. Let me share an experience.A start-up normally makes payments to Google, Facebook, or Amazon via credit card, within a few days of starting operations. Unknowingly they become defaulters on Withholding Tax, Tax Deduction at Source (TDS), Foreign Exchange Regulation and even the Reverse Charge Mechanism to gross-up for deposit of service tax.
Can we provide some breathing time and concessions for a start-up so that they can standup and start walking before being dragged into such a complex compliance regime? Similarly, what is the need to mandate an internal audit or appoint an independent valuer for ESOP valuation for SMC’s accounting? Instead of valuation, the last issue price per share should be good enough. We need to permit self-regulation and self-compliance for SMCs with stringent penalties for prevention of potential misuse. Steps in these directions can save valuable a start-up valuable time, better utilized for building their product that may go global.
Let us move to the issue of finding that critical risk capital. We as a nation have consistently failed to channelize the savings of our rich for creation of productive jobs for millions of poor. All our savings go into government securities, gold, fixed income securities and real estate. Productivity of a nation enhances only when savings are channelized into risk capital. I once asked a real estate developer – what is more valuable Rs.1 of sales or Rs.1 of equity contribution in your company. His instant response was equity infusion and the wonders it can achieve. Every day multiple full-page newspaper advertisement lures our rich to invest in property. In contrast, if, our regulator, SEBI, educates the rich to invest in Listed Equity, Equity Mutual Fund, Private Equity or Venture Capital, it may increase national productivity.
We have been encouraging our rich to invest in residential properties. The capital gains from one can be re-invested in another residential property and tax can be saved under Section 54 of the Income Tax Act. We need a similar provision for VCs so that capital gains are re-invested in venture capital funds. The risk takers have to be encouraged and rewarded.
The crux is that India has a supply side problem. We want investment-led growth for our economy. We should no longer be a pure domestic consumption story. That is more than 2 decades old. It is time to fund and invest in our future.
Our budding entrepreneurs are filled with ideas. Most of them are the first generation entrepreneurs. They have a dream. Equity or venture debt can take them on the path that realizes their dreams. Let us tap multiple sources of finance for our SMCs- global pension funds, provident funds, insurance, endowment funds, charitable and religious institutions, foundations, and the developmental institutions – that want to invest in Indian Venture Capital. Strangely, our own Indian institutions, except insurance and SIDBI, are not allowed to invest in Venture Funds.
At present all the savings largely go to Government securities. Nation building requires this capital for our private sector. Let me share a controversial example – I would like a factory labourer to be proud of being able to create a job for his or her own child. One who earns Rs.10,000 per month and saves Rs.500 in Pension can be made to allocate 3% – 5%, say Rs.25 per month, for venture capital or say start-up capital. Imagine the pride when he sees his savings leading to job creation. Let us all take some bold steps… invest in our savings in start-ups. We can not continue to lose out to start-up nations like Israel, Chile, Singapore, UK, US.
Before concluding, let me state another pain-point. It takes months to convince a NRI/PIO to invest in Indian Venture Capital Funds. Now our FDI policy, as per clause 3.2.3, requires DIPP & FIPB approvals for the NRI/PIO to invest via their NRO bank accounts in India in a Domestic Venture Capital Fund (DVCFs) or say local fund managers who invest in our start-ups. Despite months and years of struggle, approvals have not been granted to many such DVCF. The advice handed to these disgruntled fund managers is set-up a fund in Mauritius and channelize it to India. This is just not viable for a fund that plans to support start-ups. Second, these local managers help the Indian Government to earn the genuine 10% capital gains tax if a non-resident reaps capital gains from Indian ventures. Since, we are not able to discourage gold import nor hold back successful & large businesses from investing overseas… how and where do we go and find cash for our budding entrepreneurs!
Maybe some of these suggestions reach the ears of the powers that be and our start-ups have a chance to be a part of the growth story and create jobs that in turn give birth to more start-ups.
The department can help the entire ecosystem by intervening in the start-up process.
This requires permitting self-regulation and self-compliance for businesses with turnover of less than Rs. 25 crore, and stringent penalties for prevention of potential misuse.
The risk taking can be encouraged for a young entrepreneur only if the entry and exit process are simple and easy to comply with.
By presenting a 5-point action plan to the finance ministry we hoped to trigger a process where in start-ups would contribute towards sustainable economic growth. A growth led by investments rather than consumption.
YourNest Angel Fund, is responsible for generating direct employment, since our launch in March ’12, to over 100 people. Through our investments, in three companies so far, we build global companies amongst the first generation Indian entrepreneurs.
To provide an impetus to start-ups, we suggest the following actions points, in order of priority.
Decision Point – Encourage Indian fund manager to float and manage Venture Capital Funds (VCFs) or Alternative Investment Funds (AIFs) from within India by allowing automatic route for NRI/PIO investment in these funds from the NRE/NRO account in the SEBI approved VCF/AIF on repatriation basis.
Supporting Points – The proceeds from NRE / NRO account could be used to invest in mutual funds, whereas investments into VCF/AIFs are not explicitly permitted. Similarly if a VCF is set-up as a company the automatic route is allowed, whereas if VCF is set-up as a Trust NRI/PIO investment is subject to FIPB approval.
Additional Recommendation – To enable greater access to offshore capital, all non-resident investors meeting specified Know Your Client (KYC) requirements ought to be permitted to invest from the overseas bank account (Non NRE/NRO) into early stage venture capital funds set up as trusts and registered with the Securities and Exchange Board of India (SEBI) under the automatic route. Also, all repatriations by such funds to offshore investors especially in respect of capital must be permitted without prior approval from the Reserve Bank of India. Approvals at entry and exit create a regulatory risk for investors and therefore liberalisation on the above lines will greatly incentivise offshore investors to invest into domestic funds.
Amendment Required – In the Clause 3.2.3 under “3.2 ENTITIES INTO WHICH FDI CAN BE MADE” of the CONSOLIDATED FDI POLICY (EFFECTIVE FROM APRIL 10, 2012), Department of Industrial Policy and Promotion, Ministry of Commerce and Industry.
Current Clause – “3.2.3 FDI in Venture Capital Fund (VCF): FVCIs are allowed to invest in Indian Venture Capital Undertakings (IVCUs) /Venture Capital Funds (VCFs) /other companies, as stated in paragraph 3.1.6 of this Circular. If a domestic VCF is set up as a trust, a person resident outside India (non-resident entity/individual including an NRI) can invest in such domestic VCF subject to approval of the FIPB. However, if a domestic VCF is set-up as an incorporated company under the Companies Act, 1956, then a person resident outside India (non-resident entity/individual including an NRI) can invest in such domestic VCF under the automatic route of FDI Scheme, subject to the pricing guidelines, reporting requirements, mode of payment, minimum capitalization norms, etc.”
Desired Clause – “3.2.3 FDI in Venture Capital Fund (VCF) or Alternative Investment Fund (AIF): FVCIs are allowed to invest in Indian Venture Capital Undertakings (IVCUs) /Venture Capital Funds (VCFs) /other companies, as stated in paragraph 3.1.6 of this Circular. If a domestic VCF or AIF either is set up as a trust or as an incorporated company under the Companies Act, 1956 a NRI or PIO person resident outside India (non-resident entity/individual including an NRI) can invest in such domestic VCF or AIF, on repatriation basis, subject to approval of the FIPB. However, if a domestic VCF is set-up as an incorporated company under the Companies Act, 1956, then a person resident outside India (non-resident entity/individual including an NRI) can invest in such domestic VCF under the automatic route of FDI Scheme, subject to the pricing guidelines, reporting requirements, and mode of payment, minimum capitalization norms, etc.
However, a person resident outside India (non-resident entity/individual excluding an NRI or PIO) can invest in such domestic VCF or AIF can invest in such domestic VCF under the automatic route of FDI Scheme, subject to the pricing guidelines, reporting requirements, mode of payment, minimum capitalization norms, etc.
For computation of sectorial cap in areas where FDI is restricted the proportionate shareholding of only the persons resident outside India be considered to be FDI in the VCU. For example, if a domestic VCF/AIF has 40% contribution coming from person resident outside India and it holds 30% stake in a VCU the FDI should be counted as 12% (40% of 30%).”
Positive Action that must Continue – We appreciate the business incubation support being extended by Department of Science and Technology (DST) along with Technology Development Board (TDB). DST program of business incubation has reward and supported 2400 Indian start-ups resulted in employment generation of nearly 20,000 employees, generating revenues of nearly Rs.7000 crore with minimal financial support. A continued and much higher support by MoF can enable them to incubate businesses at a much faster pace.
Decision Point – Encourage Insurance companies (both private & public), Provident Funds, Pension Funds, charitable or religious foundations, Banks to invest their long-term funds in building and supporting Indian Start-ups and small businesses. They can start funding the Venture Capital Funds (VCFs) or Alternative Investment Funds (AIFs) from the savings available within India. It can be limited to Category 1 AIFs that is Venture Capital Funds, SME Funds, Social Venture Funds, and Infrastructure Funds.
Supporting Points – Indian start-up need capital from within India. Until now the international pension fund and endowment funds are being rewarded for their proactive investments in Indian SMEs and Start-ups. The early stage business offers attractive return whereas the India’s own long-term funds are not participating in this asset class. These institutions have been encouraged to invest in listed equity market in recent times. It is time as the Indian start-ups and small businesses are also supported through SEBI registered Venture Fund for accessing long-term capital from these institutions. Some useful facts are –
Additional Recommendation – A beginning can be made in FY’13, with Provident Funds and Pension Funds allocating only 5% of the fresh investments going towards building a portfolio of equity assets. This will yield Rs.3000 crores towards the risk capital. Gradually, it can be increased to 5% of the total corpus of this funds that will bring additional assets of Rs.25000 crores into equity assets.
Amendment Required in “Asset Class E” to include “within the cap of 50%, a sub-limit of 10% may be invested in SEBI approved Category 1 AIF such as Venture Capital Funds, SME Funds, Social Venture Funds, and Infrastructure Funds”.
Decision Point – Encourage Indian High Net-worth Individuals, family offices, Corporate, Firms, Institutions, Public Sector undertakings with investible surplus to invest in Category 1 AIF by extending fiscal incentives.
Supporting Points – The desired risk capital for India can come from within India. Today, Indian HNI deploy most of the investible surplus in Real Estate followed by debt and gold. It is time to get this surplus diverted to Category 1 AIF Funds. The economic multiplier impact of investment in equity is many-fold compared to investments currently flowing in the real estate or debt instruments.
Indian HNIs are risk averse to invest in Indian start-up or Venture Funds for the following reasons –
Recommendation – The provisions of Section 54 can be replicated to encourage the HNIs / other entities to invest in the Domestic Early Stage Venture Fund (Category 1 Funds as per SEBI (AIF) Regulation’2012) to seek a deduction upon investment against capital gains made on any asset category.
Additionally, to attract capital a general deduction in respect of investment into such funds could also be granted under Chapter VIA on the lines of section of section 80C, section 80CCB.
To really incentivize capital flow into early stage ventures, it may be provided that any capital gains arising from sale of investment in venture capital undertaking, a securities transaction tax on the lines of transactions in listed companies and equity-oriented mutual funds could be introduced.
Amendments Required (Point 1 & 2 or Point 3 only)
Decision Point – MoF could also allow companies registered in India to make an initial public offer on exchanges outside India without or before listing in India, as was the case earlier.
Supporting Points – Indian start-ups require significant funding to scale themselves to serve global customers. Opening-up the doors of equity fund raising from across the globe will widen their scope. We do not want Indian Start-ups to have Head Quarters outside India to keep the option of raising funds globally with them.
Entrepreneurship in India, over the next decade, has the potential to create 2500 successful high growth ventures, with combined revenue of over Rs. 10 lakh crore (USD 180 billion), and to generate 10 million direct & 20-30 million indirect jobs. Consequently, powering India’s economic progress with –
This cycle has been set in motion over past few years with emergence of first generation entrepreneurs, increasing availability of capital, and strengthening of the ecosystem.
The Committee’s recommendations include –