In fact: Start-up sops are good. Are they essential?

The PM’s Saturday announcement is essentially a reiteration or a repackaging of the 2014-15 Budget proposal.

Written by P Vaidyanathan Iyer | Updated: January 20, 2016 10:47:04 am
Prime Minister Narendra Modi with Finance Minister Arun Jaitley during the launch of "Startup India" action plan at Vigyan Bhawan in New Delhi on Saturday. (PTI Photo by Kamal Kishore) Prime Minister Narendra Modi with Finance Minister Arun Jaitley during the launch of “Startup India” action plan at Vigyan Bhawan in New Delhi on Saturday. (PTI Photo by Kamal Kishore)

An array of initiatives for start-ups announced by Prime Minister Narendra Modi on Saturday are ‘good to have’ for promoting an entrepreneurial ecosystem, but not really ‘necessary to have’. Start-ups can survive and thrive even otherwise. Let’s look at the headlines the PM gave over the weekend.

A Rs 10,000-crore fund of funds: Is it new? Not quite. The first Budget presented by Finance Minister Arun Jaitley on July 10, 2014, proposed to set up a Rs 10,000 crore fund “to act as a catalyst to attract private capital by way of providing equity, quasi equity, soft loans and other risk capital for start-up companies”. More than a year later, on August 19, 2015, Jaitley launched the India Aspiration Fund, essentially a fund of funds to invest in venture capital firms for meeting the equity needs of micro, small and medium (MSM) start-ups.

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The government set aside Rs 2,000 crore for the India Aspiration Fund. SIDBI, which is managing the fund, has given the job of screening proposals from VC firms to an independent six-member committee comprising experts such as Kiran Karnik, T V Mohandas Pai, Saurabh Srivastava and R Vaidyanathan of IIM, Bengaluru. The committee has held 3-4 meetings over the last couple of months and committed about Rs 1,000 crore to various funds. What is commendable about the investment process is that there is no interference by the political class or the bureaucracy. The India Aspiration Fund lends only 20% of the VC fund’s intended corpus, and so the total amount available for investment is five times the government contribution.

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The PM’s Saturday announcement is essentially a reiteration or a repackaging of the 2014-15 Budget proposal. The Rs 10,000-crore will come over four years, with annual tranches of Rs 2,500 crore. The PM, however, introduced a twist in the eligibility criteria of investee companies — funding support will be available for development and growth of innovation-driven entrepreneurs. Unless there are clearly laid down criteria that define innovation, sanction and disbursement carries an element of discretion or subjectivity.

To put the size of the fund of funds in perspective: Rs 2,500 crore ($ 375 million) a year is just about 2-3% of the total VC funding Indian entrepreneurs attract. Even this is welcome, but it’s not an extraordinary allocation. In 2015, total investments by PE and VC firms stood at $ 16.87 billion, according to Venture Intelligence, a firm that tracks the industry.

Who will be eligible? The Department of Industrial Policy and Promotion definition of a start-up runs into a page and a half, or over 500 words. To take advantage of the government schemes, the start-up cannot be more than five years old, and cannot have a turnover of over Rs 25 crore. But it’s not just this. It must aim to develop and commercialise a new product, service or process, or significantly improvise an existing product, service or process. Subjective? There’s more.

It needs a recommendation from an incubator established in a post-graduate college about its innovativeness. It must be supported and funded by an incubator, which in turn is funded by the government. Or by an angel investor, PE fund or incubation fund registered with Sebi. They must also endorse the innovative nature of the start-up’s business. The start-up must also have a patent.

To be eligible for tax benefits, the innovative nature of the business must be validated by an inter-ministerial board set up by the DIPP. With such a long list of musts, will start-ups consider domiciling themselves in India? Ironically, many start-ups, including the likes of Flipkart, Grofers and InMobi, have domiciled themselves outside the country. Besides the Silicon Valley in the US, two other countries that have taken the lead are Israel and Singapore. This has a lot to do with a liberal tax regime, ease of doing business, and a significantly reduced regulatory burden. T V Mohandas Pai and Sharad Sharma of iSpirit have blogged that 54% of all new-age startups in 2014 were domiciled overseas. This is expected to have increased to 75% in 2015.

Not only start-ups, even PE and VC funds structure themselves in a complicated manner to base themselves in Mauritius or other countries, where they do not have to pay tax on capital gains when they exit a start-up. Not surprising then that foreign PE funds invested $ 9.4 billion in 2015, thrice the investment by India-dedicated PEs ($ 3.05 billion).

The PM’s announcement on exempting funds from capital gains is seen as a game changer. But doubts linger. The exemption is available only if the gains are invested in the government’s fund of funds, or invested in new assets including computers and computer software. Contrast this to investments made by individuals in listed firms: if you sell shares after a year, it is considered long term capital gains, and is tax-exempt. VCs pay 20% tax on capital gains.

One-day registration through an app, self compliance, rebate on patent filing and faster exits (90-day closure) are welcome ‘good to haves’. But what do start-ups require the most? Non-glamorous small entrepreneurs (say, a florist or a travel agent) choke due to cash-flow problems. In the services business, once an SME bills its customers, it has to pay a service tax of 14.5% upfront even when payment is still pending from the customer. This hurts their day-to-day operations. To top it, banks insist on collateral for loans. Since there is nothing for an entrepreneur in a service industry to mortgage, she finds the going tough.

SME entrepreneurs desperately need debt venture funds. Or a government-funded insurance scheme that can cover loans being extended by banks, both public and private sector. Hopefully Mudra Bank also fills the gap banks have not been able to.

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