Booster shot for startups: Indian firms can do angel investment

When Uber raised $2 billion to invest in China, Didi went to Tencent & Alibaba for funds. Burning $2 billion in China was a lot for Uber, but it mattered less for Tencent/Alibaba to help win at home.

Not since the launch of ‘Start-up India’ in 2016 has a single notification from the government garnered so much praise from Indian entrepreneurs. The recent notification from DPIIT (formerly DIPP) signalled the death knell for the dreaded ‘Angel Tax’ — section 56(2)(viib) of the Income Tax Act, 1961. The section taxed capital receipts from Indian investors as income in the hands of private companies based on “high” share premium, a taxation approach unique only to India. It also applied only to investments from Indians and not foreigners — an act of discrimination which has seen domestic funding shrink 48% from 2015 and had lead many to dub this the ‘Indian Tax’.

The notification, borne out of roundtables organised by Ramesh Abhishek of DPIIT on February 4, was a refreshing change of pace as it crowdsourced a solution from Indian entrepreneurs as opposed to deciding what was best for them. Some of the measures include: –

A Rs 25 crore blanket exemption for money raised from any Indian source:
Extending the tenure and revenue threshold to 10 years and `100 crore in order to qualify as a start-up
Allowing investments from listed companies to be exempt from the section
But it is the last point around listed companies that is the single biggest game-changer for Indian start-ups.

Every start-up ecosystem in the world thrives when its large listed companies invest heavily into the ecosystem. Silicon Valley owes a lot to listed companies like Google, Facebook, Salesforce, Microsoft, etc., who have invested billions of dollars into start-ups and are amongst the largest acquirers of start-ups there.

China’s Alibaba, Tencent and Baidu are renowned for creating start-up clusters as well. The best example of this comes from the Didu-Uber wars in 2016.

When Uber raised $2 billion to specifically invest in China, Jean Liu, the president of Didi Chuxing, the largest cab-hailing service in China, went straight to Tencent and Baba to get the capital required to take them on. In the words of Yanbo Wang, Chinese academician who studies start-ups, “for Uber, burning through $2 billion in China was a huge amount. But for Didi, and for TenCent and Alibaba, spending $2 billion to win at home? It was nothing”. Which Indian entrepreneur can boast the same of an Indian company giving him or her the capital to take on a global behemoth?

The top 10 listed companies in India are sitting on cash and cash equivalents of over `2.7 lakh crore, which is around $38 billion. Contrast that with the $38.5 billion raised by all Indian start-ups from 2014 to 2018, of which not even 10% comes from Indian sources, and you can see how our listed companies have failed the start-up ecosystem. Companies like TCS, Infosys, Indian Oil, are buying back crores of stock — an indication that the company believes that the money is better returned to investors as opposed to being invested by the company — belies the sheer potential that remains untapped.

But no longer. This ‘Angel Tax’ prevented listed companies from investing in start-ups as their investments would have been liable to being taxed in the hands of the start-up. Due to stringent norms regarding the reporting of the fair value of all investments, this tax amount impaired the value of the start-up and directly hit the bottom-line of the listed company. But after this exemption given to them, their reluctance to immerse themselves into the Indian start-up system should subside.

Make no mistake, India will not become a digital colony unless we have more active participation from domestic pools of capital. Our listed companies are sitting on piles of cash and, yet, their acquisitions of and investments into Indian start-ups are paltry. While the rest of the world is looking at the Indian start-up ecosystem to invest or acquire, why are our largest home-grown heroes still looking abroad? Though our listed behemoths never received venture capital funding and bootstrapped themselves till they listed, the rules of the game have changed. The capital scarcity affecting Indian companies is no longer there — what we are suffering from is domestic participation.

The recent circular will undo close to seven years of harm caused by this faulty policy. The remaining issues around companies who have received notices of not being able to seek relief under the circular, start-ups being unable to create subsidiaries or JVs or acquire another for stock due to self-declaration and the issue around section 68, which claimed two companies, will be redressed shortly by CBDT. Several organisations and people who fought for this, including I, are already working towards this actively and the government has promised us support.

At long last, the restrictions on domestic capital pools have been lifted and the notion of taxing valuations and share premium is being done away with. Indian entrepreneurs have been put on par with their global peers and local laws will no longer hinder their journey. As much as the media and founders are rejoicing, I hope India Inc will start looking at start-ups more seriously and invest into the ecosystem.
To paraphrase Raj Kapoor from Shree 420,

Mera juta hai jaapaani,
ye patlun ingalistaani
poora capital hai amricani
phir bhi dil hai hindustani

Hopefully, our capital can once again become desi.

___________________________________________________________________

This article was first published on February 21, 2019 in the Financial Express. Read the original article here.