RBI regulations for startups a boost for entrepreneurs

By Manjula Chawla, Ritika Ganju and Kripi Kathuria, Phoenix Legal
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With the government’s announcement of the Start-up India initiative in January 2016, there have been discussions and endeavours to create an environment which is conducive for nurturing growth of innovations and startups. The latest development has been the relaxations by the Reserve Bank of India (RBI) on external commercial borrowing (ECB) by startups, introduced via Circular No. 13 of 27 October 2016.

Manjula Chawla Partner Phoenix Legal
Manjula Chawla
Partner
Phoenix Legal

As per the notification dated 17 February 2016 by the Ministry of Commerce and Industry, an entity would be considered as a startup (a) up to five years from its date of incorporation, (b) if its turnover for any of the financial years has not exceeded ₹250 million (US$3.7 million), and (c) if it is working towards innovation, development, deployment or commercialization of new products, processes or services driven by technology or intellectual property.

An entity is considered to be working towards innovation, development, deployment or commercialization of new products, processes or services driven by technology or intellectual property if it aims to develop and commercialize (a) a new product, service or process or (b) a significantly improved existing product, service or process, that will create or add value for customers or workflow. Conversely, an entity will be specifically excluded from being a startup if it develops: products, services or processes which do not have the potential for commercialization; undifferentiated products, services or processes; and products, services or processes with no or limited incremental value for customers or workflow.

The RBI has amended the ECB framework from time to time to streamline the process and guidelines for availing of ECB. ECB is currently governed by the RBI’s master direction on external commercial borrowings, trade credit, borrowing and lending in foreign currency by authorized dealers and persons other than authorized dealers, dated 1 January 2016. However, creation of a parallel relaxed ECB framework specifically for startups is a welcome step which will bolster confidence among startups. Many young entrepreneurs see this as an assurance of an avenue to raise finances without seeking help from foreign venture capitalists (which young Indian promoters have often relied on in the past), and without giving up their crucial stake in the start-up venture.

Via Circular No. 13, the RBI, pursuant to its fourth bi-monthly monetary policy statement for the financial year 2016-17, has permitted startups to access loans under the ECB framework up to a limit of US$3 million or equivalent per financial year, either in Indian rupees or any convertible foreign currency or a combination of both. The startup can raise this ECB under the automatic route.

Ritika Ganju Associate Phoenix Legal
Ritika Ganju
Associate
Phoenix Legal

While entities engaged in certain business sectors are eligible to borrow or lend under the ECB master direction, there is no such limited sector-specific eligibility in case of a startup. Only overseas branches and subsidiaries of Indian banks and overseas wholly owned subsidiaries and joint ventures of an Indian company are excluded as eligible lenders.

As a precaution against money laundering, the general principle laid down in the ECB master direction that ECB cannot be extended by individuals from countries which do not adhere to Financial Action Task Force (FATF) guidelines is applicable even in case of startups. Circular No. 13 also provides that ECB can be extended by a resident of either a member of FATF or a member of a FATF-style regional body.

One of the most appreciated reliefs is the lifting of end-use restrictions for startups. Unlike the general ECB guidelines, which restrict an ECB borrower from using the proceeds of an ECB for all business purposes (including as working capital) unless specifically permitted, Circular No. 13 clearly provides the liberty to use the proceeds for any expenditure in connection with the business.

While the ECB master direction prescribes an all-in-cost ceiling through a spread over the Libor interest rate as a benchmark, there is no such all-in-cost ceiling prescribed in respect of an ECB obtained by a startup. The circular provides the liberty to the borrower and lender to mutually agree on all-in-cost.

While the relaxed norms for ECB are intended to encourage young entrepreneurs to explore ECB financing instead of selling stakes to foreign venture capitalists to raise finances, many think that startups will continue to seeking funding abroad, because this has been the practice for other commercial reasons. In any case the returns yielded from startups are a relatively small part of the Indian economy and the returns in next few years will soon help us evaluate the results of this initiative.

Manjula Chawla is a partner, Ritika Ganju is a principal associate and Kripi Kathuria is a senior associate at the Delhi office of Phoenix Legal.

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