In its endeavour to promote an effective eco-system for startups in India, the government in January 2016 came up with the Start-up India Action Plan under the aegis of the Start-up India initiative. The action plan highlights several measures that the government intends to undertake for startups. In keeping with the plan, the government in the past year has introduced a slew of regulatory measures to benefit startups.
For instance, the Reserve Bank of India (RBI) has recently allowed startups (being private companies) to issue convertible notes worth ₹2.5 million (US$38,000) or more to non-residents in a single tranche. A convertible note is a hybrid instrument expressed as debt repayable at the option of the holder or convertible into equity shares, within a period not exceeding five years from the date of issue of the note, upon occurrence of specified events as per mutually agreed terms.
This is a significant measure as it may provide startups with an additional funding option, while giving foreign investors a chance to stipulate that the investee company meet pre-defined performance parameters as a condition for conversion of the note into equity shares, failure of which could trigger repayment obligations.
Another key measure by the RBI permits startups to raise external commercial borrowing (ECB) up to US$3 million per financial year either in rupees or any convertible foreign currency, with minimum average maturity of three years. There are no restrictions as to “all-in-cost” ceiling and “end use” of the ECB, unlike in other cases.
This measure is expected to help startups raise funds at cheaper rates as compared to the domestic market. The ECB can also be in the form of non-convertible or optionally convertible preference shares and so it may be possible for a startup to have a structure where it does not have to cough up periodical or yearly coupon payments but instead can redeem such preference shares at a premium.
Additionally, the RBI has allowed foreign venture capital investors (FVCIs), which were entitled to invest only in specified sectors (including biotechnology, information technology, nanotechnology, and research and development of new chemical entities in the pharma sector), to invest in equity or debt instruments issued by a startup irrespective of the sector in which it is engaged. However, given the restrictive definition of “startup”, as laid down by the the Department of Industrial Policy and Promotion (DIPP) in February 2016 – which predominantly covers technology and research-driven entities in which FVCIs are otherwise entitled to invest – the effect of this change on startups largely remains neutral.
In terms of the DIPP notification, a private company, a registered partnership or a limited liability partnership will be considered as a startup up to five years from the date of its incorporation or registration, if its turnover for any of the financial years has not exceeded ₹250 million and if it is working towards innovation, development, deployment or commercialization of new products, processes or services driven by technology or intellectual property. However, any such entity formed by splitting up or reconstruction of a business already in existence will not be considered to be a startup. Also, in order to obtain tax benefits, a startup must obtain a certificate of an eligible business from the Inter-Ministerial Board of Certification.
While it is important to have broad criteria for eligible startups, the DIPP’s restrictive definition may well exclude otherwise deserving entities. For instance, research-oriented entities generally take longer to develop or commercialize products and therefore the cap of five years may not be a good idea. Also, the determination as to whether an entity is engaged in “innovation, development, deployment or commercialization of new products, processes or services driven by technology or intellectual property” is susceptible to subjective assessment by the concerned authority. Besides this, the need to obtain a certificate of an eligible business may cause procedural or bureaucratic delays. Indeed, recent press reports suggest that the DIPP is considering a relook at the existing definition in order to make it broader.
The above-mentioned measures reflect the government’s intent to boost the startup eco-system in the country. However, given the vast potential of startups in the generation of employment and the overall growth of the economy, efforts need to be firmed up with more initiatives based on ground realities and their implementation expedited with swift executive action.
Kanchan Sinha is a partner and Gagan Ahuja is a senior associate at Luthra & Luthra Law Offices. The views expressed here are personal. They are intended for general information purposes and are not a substitute for legal advice.
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