Start and Get Up – Startups

When we dream about an idea then it’s a time to start up and living that dream. The Government has launched its flagship program ‘Startup India” in January 2016 an initiative which intends to fulfil millions such dreams of young entrepreneurs. It aimed at promoting entrepreneurship by nurturing, mentoring and facilitating young entrepreneurs. Today people have multiple innovative ideas but same needs to complimented with right infrastructure, business plans and capital. Startup India intends to build a strong ecosystem for nurturing such innovation to drive sustainable economic growth and generate large scale employment opportunities.
To foster the growth of Startups, Government is taking visible steps by keeping it simple and easy to operate business. To accelerate spreading of the startup movement, Government has also made a commitment in its action plan that it will handhold startups and provide funding support, incentives, necessary industry academia partnership and incubation. This is a welcome move and very encouraging for Startups. To a large extend, Startups have been released from compliance burden for instance they are allowed to self-certify compliances under six labour laws, three environmental laws and several state adherences. Mobile apps and portal have also been launched for interacting with government and regulators directly. Not only this but in the event of business failure, swift and simple process has been proposed for exit as well which will encourage startups to experiment with new ideas without having a fear of facing a complex and long drawn exit process.
To qualify as Startup for availing benefits under Startup India Plan one need to meet the definition given by Department of Industrial Policy and Promotion. This definition has been recently enlarged and from now on the age of startup has been raised from 5 years to 7 years. However, in case of Biotechnology sector this period extends to 10 years. This change has been made taking into account a long gestation period by Startups to establish. The turnover criterion remains the same which says annual turnover for any fiscal year shall not exceed INR 25 crore. The most interesting change is increase in the scope of definition. Earlier, the definition included startups working towards innovation, development or improvement of products or processes or services but it now includes scalable business model also with high potential of employment generation or wealth creation.
All this looks good but is it enough. The key to survival lies in funding support and incentives. When we look at a life cycle of startups we find that typically in initial days’ entrepreneurs with new ideas do struggle to evaluate feasibility of their ideas and also have limited source of finance available. Significant number of Startup fails due to lack of funds, collaterals and cash flows. To provide funding support, the Government has set fund of fund with total corpus of INR 10,000 crores. This fund will not directly invest into Startups but shall participate in the capital of SEBI registered funds but is it enough – certainly not. Probably that could be the reason the Government also cannot undermine the need of foreign investment in Startups.
It is interesting to notice that for the first time the Consolidated Foreign Direct Investment (FDI) policy [released on 28 August 2017] lists startups as a separate section. This clearly shows that Startups is a sector that is on the government’s top agenda. The FDI policy allows Startups to raise foreign money from venture capital funds and other investors through instruments such as convertible notes. Startups can issue equity or equity-linked instruments to foreign venture capital investors. This will encourage more venture capital funds to invest in Indian startups. Further, foreign residents (except those in Pakistan and Bangladesh) will be permitted to purchase convertible notes issued by an Indian Startup for INR 25 lakh or more in a single tranche. Non-resident Indians can also acquire convertible notes on a non-repatriation basis but there is a caveat that Startups will have to take requisite government approval in sectors where FDI is not under automatic route to issue convertible notes.
With a view to promote growth of Startups and address working capital requirement, tax concessions have also been given. Initially, when the Startup Plan was launched the tax exemption was given for 3 years out of 5 years but under current regime the timeline for tax exemption has been enhanced to 7 years meaning thereby now profit-linked deductions are available for 3 years out of 7 years. This change has been made because most of the Startups struggle to earn profits in initial years after coming into operation. This will create more space for growth but mind you that exemption is available if there is non-distribution of dividends. Finance Act 2017 has also relaxed provision for carry forward of losses for Startups. As per the tax provisions, the carry forward of losses in business is allowed for 8 years if the company have continuous holding of 51% voting rights. This condition has now been relaxed for Startups and now in order to carry forward losses, only the founders need to hold shares. Thus, with increase in venture capital investments and buy-outs, Startups were experiencing major changes in shareholding and getting denied of benefit of tax losses so this measures is indeed a very welcome change. Having said the same, the Startups are still navigating through tax maze when it comes to issue of investment getting marked down. With startup excitement going down due to increased competition and reducing profitability, valuations of many startups have fallen sharply in recent times. As per the current tax laws the government can levy tax on difference between high valuation and actual valuation on which shares should have been issued.
This provision was introduced to curb unwanted and illegal transaction where black money hoarders used the technique of issuance of shares at a premium in sham companies but there could be an instance where the said provision can hurt genuine case of Indian startups where shares are marked down. To pluck this problem, the government has issued a notification on 14 June 2016 stating that ‘startup’ company receiving monies as consideration for issue of shares in excess of fair market value would not be covered under the said provision and the term ‘startup’ has been defined to mean a closely held company which fulfils condition outlined by Department of Industrial Policy and Promotion. The Government has again taken a welcome step clarifying the issue but this benefit has only been extended to government registered start-ups but fate of other startups is still not known. In my view, fair market value can go up or down over time and hence, the idea of using marked down value as an opportunity to tax in genuine case may hurt the sentiments of Startups and hence should be dealt judiciously.
Undoubtedly, the startup culture in India is booming. Besides, the government extending support and encouraging the idea of entrepreneurship many successful entrepreneurs are becoming role model. Looking at the success stories, the world of Startup looks very glamorized but what young entrepreneurs need to be mindful about that they should be more realistic, innovative and make an endeavour to create a sustainable business.