What’s in it for startups? Last year, we had a horrible section (Read the full e-book) that still works against angel investors in early stage startups. (Angel investments would be taxed if they couldn’t prove that an investment had a sound valuation backing it – and early stage startups are wet-finger-in-the-air valuations)
In Budget 2013, there are some interesting changes. First, to solve the above problem in last year’s budget, this year the FM said that:
SEBI will prescribe requirements for angel investor pools by which they can be registered as Category 1 AIG venture capital funds.
This can be good or bad. Good because if AIFs are effectively governed like VCs, their investments don’t hit the wall that my last year’s rant was about.
Bad because of multiple factors:
Let’s hope that SEBI creates less of a reporting and investing nightmare when it defines what constitutes angel investor pools.
A company or trust registered as a VC fund or angel fund as above has to pay tax on investments when it generates profits. But the profits are really those of the investors in a fund,and different kinds of investors may have different tax structures. An investor through Mauritius may not have to pay capital gains taxes, but the vehicle – the VC fund – will have to. Another investor may have losses in his books, but he can’t offset them against the gains made by the VC/angel fund because they are in different entities.
In the budget, Category 1 AIF Funds (VC funds) have been given a pass-through status. Meaning, the gains made by the fund are passed through to the investors (in the proportion of their holding). This can help substantially, especially when raising money from foreign shores, where tax structures play an important role.
Pratyush brought this up. The only reason Flipkart’s getting grief about FDI in multi-brand retail is that its main investors (Accel and Tiger) are foreign owned. So they have to do a two-company structure, where Accel and Tiger own stakes in a wholesale company, which sells to a retail company that owns the website and handles delivery.
Why are Accel and Tiger foreign companies? Probably because Mauritius has no cap-gains taxes. If they created a VC firm in India, then Indian taxes would apply to any gains, and that’s no good. Now, with the tax-pass-through structure, would it be better for Accel and Tiger to set up an Indian Venture Fund, make it a class 1 AIF with SEBI, and use the tax-pass-through? And then, as an Indian entity, the AIF entity should have no problem owning stake in Flipkart’s retail site.
However, I’m not a lawyer, so I don’t know if the AIF, even if set up as such, would still be a “foreign” investor due to it’s eventual ownership.
SMEs that serve large enterprises might need cash flow before payments flow in (due to long gestation time before payments). Factoring allows banks or institutions to provide cash flow support to an MSME against receivables; and an act has been passed to allow factoring, in 2012 January. SIDBI can act as a credit guarantor for SME factoring, for which the budget has given it Rs. 500 cr.
Additionally, SIDBI’s refinancing facility for SMEs (that is, they take on part of the risk of SME loans made by other financial institutions) is now enhanced to Rs. 10,000 cr. (from last year’s 5,000 cr.). SIDBI even has a website for this.
Micro, Small and Medium Enterprises (MSMEs) may get the MSME ministry to pay for participating in international fairs, or for credit guarantees (mentioned earlier), or for other such schemes that are not tax related.
The budget has proposed that if an MSME should move into a larger bracket and lose the MSME status, it can continue with the above benefits for the next three years.
Funds provided to incubators within colleges and approved by some ministries will now qualify under the Corporate Social Responsibility (CSR) utilization that all companies need to spend on, with at least 2% of their net profits. This is great if you are an incubator inside an institution, but you really need to be going out there, really gung-ho, trying to get funds allocated before the next “insti” starts its round.
There are now pure SME exchanges with less onerous listing requirements. While they created the tool, they must have squealed in delight. Listing though, has been way too ineffective, with complex listing requirements needed even now. This can be fixed, but the exchange will have to find the traders.
However for new issues , you can list your SME in this exchange, and if you don’t want to do a full open offer, do an offer to “informed investors”.
Private limited companies might resort to buy-back agreements to offer their investors liquidity. An abuse of this is to use the buyback route to provide money to investors; if the companies buy back at a low enough price, then shareholders can get money in their pockets and pay a very low tax (as capital gains). This has been blocked by the budget, stating that all unlisted company buybacks must pay 20% on the money.
This is scary and throwing the baby out with the bathwater. Buy-backs serve a useful clause as well – to provide liquidity or partial exits to investors, However, there is hope. I can recommend that you set up your company as an LLP where buy-backs of this sort are not at all necessary, since distribution and withdrawal are quite simple (no dividend distribution tax).
Startups and SMEs should learn to accept debt as a part of life and go apply for some of the ventures, even for small ticket loans where the government stands guaranteed. Money can vanish fast so don’t splurge.
What have I missed?