Indian Startup Ecosystem - All you want to know

Today, India is in the midst of a startup revolution. There is an unparalleled upsurge in the number of startups every year, with funding received in the form of angel investments, venture capital and private equity investments, with the rising number of support groups such as incubators, accelerators, event platforms and academic programs, the relaxation of norms and the government initiatives to bolster the ecosystem.  India stands only behind USA and UK in the global startup ecosystem rankings with approximately 4,200 startups operating in the country according to a report by ASSOCHAM. The technology-driven startups have been witnessing tremendous growth due to innovative and creative formats being the norm of these new entities.

Further, a flagship initiative of the Government of India, ‘StartUp India’ is intended to build a strong ecosystem for stimulating and promoting startups in the country. To reach the goals of this initiative, the Government has announced an Action Plan that looks into functioning of startups in India and all related aspects concerning the same. What is heartening to see is that the Government is not only enacting policy, but also giving implementation of these policies great attention in the form of query-resolving helplines, using social media, and creating startup hubs. Keeping in mind the increase in startups along with the vigorous support provided by the Government, India can look forward to advancing ahead with steady and positive growth in this sphere.

Defining a Startup

An entity is considered to be a startup if it fulfils the following parameters:

1. a) Up to five years from the date of its incorporation/registration;
2. b) Its turnover for any of the financial years has not exceeded Rs. 250 million;

c)It is working towards innovation, development, deployment or commercialization of new products, processes or services driven by technology or intellectual property.

For an entity to fulfil the third condition, it should aim to develop and commercialise a new product or service or process, or a significantly improved existing product or service or process, that will create or add value for customers or workflow. However, the mere act of developing products or services without potential for commercialization, or with no incremental value or undifferentiated products or services or processes is not covered under this definition. 

An entity shall include a private limited company, a registered partnership firm or a limited liability partnership. However, an entity formed by splitting up or reconstruction of a business already in existence shall not be considered a startup.

Registration and Recognition

A startup is required to obtain a registration or an incorporation certificate depending on the nature of the entity to be formed before it obtains recognition as a startup. For instance, if a startup is to operate as a private limited company, it must get an incorporation certificate from Registrar of Companies. The process of recognition as a ‘startup’ shall be through the mobile app or through the portal of the Department of Industrial Policy and Promotion (DIPP).

A startup is required to submit a simple application with either of following documents:

1. a)  Recommendation Letter (with regard to innovative nature of business) from any Incubator established in a postgraduate college in India or from an Incubator recognised by the Government of India;
2. b)  Letter of support from any Incubator funded by the Central/State Government;
3. c)   Letter of funding of not less than 20 (twenty) per cent in equity by any Fund or Network registered with Securities and Exchange Board of India (SEBI) that endorses innovative nature of the business;
4. d) Letter of funding by Government of India or any State Government as part of any specified scheme to promote innovation;
5. e)  Patent filed and published in the Journal by the Indian Patent Office.

As the complete application is uploaded a recognition number is issued to the startup.

Fund Raising

Raising funds is one of the crucial aspects for startups. However, funding for Indian startups has also been on the rise in the recent past. According to a Nasscom study, the funding for startups has increased considerably from USD 2.2 billion (2014) to USD 4.9 billion (2015). Also, the overall venture capital, private equity funding and seed capital funding has also increased in the last few years.

The Government of India has approved the establishment of ‘Fund of Funds for Startups’ at Small Industries Development Bank of India (SIDBI). This Fund will not directly invest into the startups, but will extend contributions to various Alternative Investment Funds (AIF), registered with SEBI which shall extend funding support to startups. The Fund will have an initial capital of Rs. 25 billion and a total corpus of Rs. 100 billion over a period of 4 years (i.e. Rs. 25 billion per year). Some of the important features of the Fund of Funds are highlighted below:

        The Fund shall be managed by a Board with private professionals drawn from industry bodies, academia, and successful ss.

•       Life Insurance Corporation (LIC) shall be a co-investor in the Fund
•       The Fund shall contribute to a maximum of 50% of the AIF size.
•       The Fund shall ensure support to a broad mix of sectors such as manufacturing, agriculture, health, education, etc.

Further, the Reserve Bank of India (RBI) has clarified that startup enterprises will be able to receive foreign venture capital investment (FVCI) irrespective of the sector in which they are engaged.

As per the Companies (Share Capital & Debenture) Third Amendment Rules, 2016, a startup may issue sweat equity shares not exceeding 50% of its paid up capital up to five years from the date of its incorporation or registration

Moreover, as per the recent amendment in the Companies (Acceptance of Deposits) Rules, 2014, an advance of minimum Rs.2.5 million to a startup is exempted from being treated as deposit, provided that the person gives money in the form of convertible note (convertible into equity shares or repayable within a period not exceeding five years from the date of issue) and in one tranche.

Tax Benefits

In order to obtain tax benefits a startup shall be required to obtain a certificate of an eligible business from the Inter-Ministerial Board of Certification.

•       The Finance Act, 2016 has made provision for startups to get income tax exemption for 3 years, if they are incorporated between 1st April, 2016 and 31st March, 2019.
•       Under Section 80-IAC of the Income-tax Act, 1961, a startup incorporated after April 1, 2016 is eligible for getting 100% tax rebate on profit for a period of three years. However, the annual turnover must not exceed Rs. 250 million in any financial year up to 31 March, 2021. This exemption shall meet the working capital requirements during the initial years of operations. The exemption is available subject to non-distribution of dividend by the startup.
•       The startups have to pay Minimum Alternate Tax (MAT) at 18.5% along with the applicable surcharge and cess. If, however, the startup fails to make profit, MAT exemptions shall be provided for the first 5 years.
•       In a major incentive, startups can now issue shares to investors at a value higher than fair market value without worrying about tax consequences. This implies that if a startup gets investment from resident angel investors, family offices, or funds not registered as venture capital funds, it will not be taxed even if the investment is made in excess of the fair value.

Self-Certification of Obligations under Certain Laws

Startups have been permitted to self-certify compliance, through the mobile app, with certain labour and environment laws. This self-certification is only required from the second year of setting up of the startup. In case of the following labour legislations, no inspections will be conducted for a period of 3 years. Startups will be inspected only on receipt of credible and verifiable complaint of violation of these laws, filed in writing and approved by an officer senior to the inspecting officer. The laws are as follows:

•       The Industrial Disputes Act, 1947
•       The Trade Unions Act, 1926; 
•       The Building and Other Constructions Workers’ (Regulation of Employment and Conditions of Service) Act, 1996; 
•       The Industrial Employment (Standing Orders) Act, 1946; 
•       The Inter-State Migrant Workmen (Regulation of Employment and Conditions of Service) Act, 1979; 
•       The Payment of Gratuity Act, 1972; 
•       The Contract Labour (Regulation and Abolition) Act, 1970; 
•       The Employees’ Provident Funds and Miscellaneous Provisions Act, 1952; and 
•       The Employees’ State Insurance Act, 1948. 

Further, The Apprentices Act, 1961 has been amended to provide that inspection of startups is dispensed with for a year after the startup is set up provided the entity complies with the self-declaration procedure provided for.

However, punitive action shall, be taken whenever there is a violation of these labour laws. 

In case of environment laws, startups which fall under the ‘white category’ (as defined by the Central Pollution Control Board (CPCB)) would be able to self-certify compliance and only random checks would be carried out in such cases:

•       The Water (Prevention & Control of Pollution) Act, 1974
•       The Water (Prevention & Control of Pollution) Cess (Amendment) Act, 2003
•       The Air (Prevention & Control of Pollution) Act, 1981

Corporate Social Responsibility (CSR)

Schedule VII of the Companies Act, 2013 was amended in 2014 to include ‘contributions or funds provided to technology incubators located within academic institutions which are approved by the Central Government’ as one of the activities that can be undertaken by companies for their Corporate Social Responsibility activities (‘CSR’). A technology business incubator is an organisational setup that promotes technology based and knowledge driven companies by helping them survive during the startup phase in the company’s history, which lasts for the initial two to three years.

Moreover, the DIPP has urged the country’s top 50 companies to fund incubators as part of their CSR expenditure, in order to further strengthen the startup ecosystem. The Government has also gone a step further in this direction by publishing guidelines for providing private sector support to incubators, and also for setting up new incubators as part of the StartUp India initiative.

Companies including SAP, Tata Motors and Bajaj Electricals are investing in startups through government-affiliated incubators as a part of their mandatory CSR spending. Further, other companies have shown interest in spending CSR money in incubators at the IITs and IIMs to nurture student startups that can disrupt traditional business models or even have a social impact.

Incentives for Investors

•       Startups can offer and issue shares under ESOP scheme to its promoters or any person belonging to promoter group up to 5 years from date of registration as startups or date of incorporation.
•       Startups can issue sweat equity up to 50% of its paid-up share capital up to 5 years from date of registration as startups or date of incorporation.
•       An exemption to pay tax will be available to an Individual if the net consideration on transfer of Residential property (Land, Building or both) is invested in an eligible startup. 
•       A further exemption from paying tax will be available if the long term capital gain proceeds are invested by an individual in units of specified funds subject to the condition that the amount remain invested for 3 years.

Intellectual Property Rights (IPR)

In order to protect the inventions and ideas of startups, the Government has launched a scheme called the Startup Intellectual Property Protection (SIPP). This is aimed at facilitating protection of Patents, Trade Marks and Design created by startups and further encouraging innovation and the creative spirit in the startup eco system.

• The Patent Rules were recently amended in order to provide certain benefits to startups:

1. With respect to costs incurred, a startup is entitled to get a reduction in fee equivalent to that of an ‘individual’.
2. Startups are entitled to approximately 80% (eighty per cent) rebate on official fees
3. The entire process of patent applications filing and examination is expedited for startups. The time required at every step of the procedure has been considerably reduced.
4. Startups shall get refund in case of withdrawal of applications.

• For effective implementation of SIPP, a panel of facilitators shall be constituted by the Controller General of Patents, Designs and Trademarks. Facilitators shall provide assistance in filing and disposal of the IP applications related to patents, trademarks and designs under relevant Acts, including appearing in Courts on behalf of startups at hearings and contesting opposition, till final disposal of the IPR application.
• The Government shall bear the facilitation cost i.e., the fees of the facilitators for any number of patents, trademarks or designs that a startup may file.

Other exemptions and benefits

Startups have been given certain other advantages as follows:

Ø In a recent memorandum issued by Ministry of Finance, it is stated that all Central Ministries may relax condition of prior turnover and prior experience in public procurement for all startups whether they fall under the Medium and Small Enterprises category or otherwise, if they meet conditions in Finance Rules of 2005.

Ø A fast track insolvency resolution process is provided for startups in accordance with the Insolvency and Bankruptcy Code, 2016

Conclusion

A good start is equivalent of half done. The entrepreneurial spirit and technology-friendly atmosphere generated in India in recent times are a result of the recognition and significance extended to startups. Further, the fact that startups not only have created valuable business models but also have crept into the daily urban space as service providers goes a long way in stating that startups are here to stay.

The Indian government has taken it upon itself to ensure that Indian startup ecosystem doesn’t go unnoticed globally and that there is steady growth in this sector. However, there are still a few issues that could be tweaked to better facilitate the startup ecosystem. Standards of innovativeness, local functioning and outreach, foreign angel investments and venture capital investments and breaking even are some issues that require a detailed and determined collaborative approach on both ends from the government as well the innovative entrepreneurs. Hope the entire eco-system will gradually and eventually evolve and provide the much needed impetus to the entrepreneurial spirit of India.

May many Silicon Valleys bloom in India !

***************

About the author :

Bhumesh Verma is a Corporate Lawyer with over 2 decades of experience in advising domestic and international clients, with a place in “The A-List – India’s Top 100 Lawyers” by India Business Law Journal. He keeps writing frequently on FDI, M&A and other corporate matters. He can be reached at bhumesh.verma@corpcommlegal.com.

Get the latest legal news and updates at Global Law Experts