Tag Archives: funding

Startup India – announcements of many initiatives

Action Plan on Startup India: A Brief Overview

Startup India Action Plan (“Action Plan”), launched by Prime Minister Narendra Modi on 16 January 2016, is part of a flagship initiative of the Government of India for boosting the startup ecosystem in India that will drive sustainable economic growth, generate large scale employment opportunities. It aims to accelerate spreading the startup movement in existing tier 1 cities to tier 2 / tier 3 cities, semi urban and rural areas, in a wide range of sectors, varying from digital/technology sector to agriculture, manufacturing, social sector, healthcare, education, etc. In the recent years, India has witnessed a dynamic trend of people with no or little business background emerging to be the new age entrepreneurs.  The upsurge has had a massive outreach and the impact has been the launch of the “Startup India: Stand up India” campaign, followed by the detailed 19 point Action Plan that interestingly is an unprecedented move even in comparison to other strong startup ecosystems of the world and as pointed out by Masayoshi Son, Chairman and CEO of Softbank, “this is the beginning of a Big Bang for India”.

The word ‘startup’ has been around for quite some time now and it comes as a relief that the Action Plan, for the first time, defines ‘startup’, albeit for the purpose of government schemes only. The definition reads as follows:-

“Startup means an entity, incorporated or registered in India not prior to five years, with annual turnover not exceeding INR 25 crore in any preceding financial year, working towards innovation, development, deployment or commercialization of new products, processes or services driven by technology or intellectual property.

Provided that such entity is not formed by splitting up, or reconstruction, of a business already in existence.

Provided also that an entity shall cease to be a Startup if its turnover for the previous financial years has exceeded INR 25crore or it has completed 5 years from the date of incorporation/registration.

Provided further that a Startup shall be eligible for tax benefits only after it has obtained certification from the Inter-Ministerial Board, setup for such purposes.” (Emphasis supplied)

The definition is important in order to understand the eligibility criteria for the various benefits that the Action Plan talks about. However, what remains to be seen is how the definition gets formalized by way of a statute or notification and how the concerned authorities, for example the Inter-Ministerial Board, interprets “working towards innovation, development, deployment or commercialization of new products, processes or services driven by technology or intellectual property” for the purposes of certification. Usage of words such as “new” may open up dialogues on what may be considered as new and what should be the criteria for determining “new”.

Broadly, the Action Plan talks about schemes and initiatives to be undertaken in four major categories:-

(a) Ease of doing business: For easing operational aspects of the workings of a newly incorporated company

  • compliance regime based on self-certification with labour laws and environment laws;
  • no suo motu inspection with respect to labour law compliances for the first 3 years
  • only random checks in ‘white category’ startups with respect to environmental law compliances;
  • mobile app to provide on-going accessibility for registering startups, tracking the status of the registration application, filing for compliances and obtaining information, etc.;
  • legal support and fast tracking patent examinations; 80% waiver of patent filing fees;
  • relaxed norms for public procurement;
  • faster exits,
  • income tax exemption for a period of 3 years,
  • extension of capital gains tax exemption to ‘computer or computer software’)

(b) Funding: For enhancing funding support through a Fund of Funds with an initial corpus of INR 2,500 crore and a total corpus of INR 10,000 crore and through credit guarantee fund via National Credit Guarantee Trust Company/SIDBI with a budgetary corpus of INR 500 crore per year for the next four years; extension of exemption from Section 56(2)(viib) of the Income Tax Act 1961 to investments made by incubators above fair market value; seed funding to potentially successful and high growth startups;

(c)  For promoting visibility through national and international fests and encouraging innovation through national and state level awards; and

(d) Programs and Centres: For structuring and enhancing the startup ecosystem through various programs such as Atal Innovation Mission (AIM), Self-Employment and Talent Utilization (SETU), Innovation core program in schools and establishment of Startup India Hub, 500 tinkering labs, incubators, innovation centers and Research Parks.

In the inaugural speech, the Prime Minister has also made special mention of the lack of patent experts/lawyers as the patent protection remains one of the biggest concern of newly incorporated companies working in the fields of innovation and technology. As such, the Action Plan talks about fast tracking mechanisms to exclusively cater to startup patent applications in order to protect the intellectual property rights of startups at an early stage. Another key highlight of the Action Plan is the panel of facilitators and lawyers to assist startups in filing and disposal of patent applications. Government shall bear the entire fees of the facilitators for any number of patents, trademarks or designs that a startup may file.

Overall, the Action Plan goes a long way in identifying the various problems persistent in the startup ecosystem today and aims to bring thousands of entrepreneurs from across India into this discourse and force the growth of a transformed, diversified and inclusive economy.

Introduction of the Insolvency and Bankruptcy Bill, 2015 (Read more at https://novojuris.com/2015/12/28/bankruptcy-bill-2015/) and recent announcements by the Reserve Bank of India of incentives to ease business norms and drive growth in the ecosystems, which inter alia include:

  • creation of a dedicated mailbox to provide assistance and guidance to the startup sector,
  • permitting receipt of deal value on a deferred basis in case of a transfer of ownership of a startup,
  • accessing rupee loans under the External Commercial Borrowing framework with relaxations, etc., indicate the Government’s existing and ongoing commitment to actualizing the Action Plan.

However, it leaves one wanting for more answers with respect to how the various actions points will be formalized and implemented by the concerned authorities and the timelines that we are looking at, amongst other things. The nuances that may be associated with ‘simple’ form for registering startups and the practical aspects of uploading documents for registration through a Mobile App; executing faster exits in 90 days; allocating funds for the announced rebates; effective management of the Fund of Funds and strategizing rollover of its profits are some of the questions that loom large. However, ambitious times call for ambitious ventures and the Action Plan certainly has opened up a whole new horizon.

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Liquidation Preference. Does it really work?

 Liquidation Preference, simply put, is a term used in venture capital contracts to specify that the investors get paid in preference to other parties.  The shareholders agreement (SHA) describes how much they get paid and in preference to whom.

SHA, typically also captures a definition of Liquidation Event.  In most cases, it is defined pretty wide to include winding up, consolidation, merger, sale of more than 50% (this percentage varies) of shares, change in control and the like.

Some of the variants of the liquidation preference clause that you generally see in early stage funding are single dip or double dip.  Here’s an example.   Let us assume an investor invests $ 2 million into a company for 25% of the company and there is an exit at $ 10 million.  Single dip would mean that of the $ 10 million, the investor gets his 25% and the rest goes to other shareholders i.e. the money gets distributed according to the pro-rata shareholding.  Double dip would mean that investor gets his $2million first (further variant could be 1x, 1.5x, 2x) and then the remaining $8 million gets distributed according to the pro-rata shareholding.

Most VC deals use preference shares as an instrument of investment.  The Companies Act describes preference share capital as that part of share capital which carries a preferential right to receive dividend and capital, including a right to share in surplus assets in the event of a winding up.

The Companies Act, also has another section which details over-riding preferential payments should there be a winding up. At a high level, when the company is solvent, workmen dues and debts due to secured creditors shall be paid in priority to all other debts.

For obvious reasons, the investors would like to retain the preferential rights as long as they can and delay conversion to equity shares in order to protect their investment.

Further, in order to ensure that the SHA is enforceable in the Court of law, the SHA ingredients are restated in the Articles of Association.

Last year, under Foreign Direct Investment guidelines, Reserve Bank of India, revised the pricing guidelines.

I.        Issuance Price:  the price of shares issued to persons resident outside of India shall not be less than:

  • As per SEBI guidelines if the company’s shares are listed on recognized stock exchange in India.
  • If the shares are unlisted, then, fair valuation of shares done by a SEBI registered category I Merchant Banker or CA as per discounted free cash flow method.

 II.        However, the changes in the pricing guidelines for transfer of shares, preference shares and compulsorily convertible debentures, seem to be hurting.

Here’s a comparative of previous provision to the revised provisions. Please read the RBI guidelines for complete text. Here’s a copy.  http://goo.gl/Y4ZM4

–       Transfer of shares by Resident to Non-resident

Status Earlier Provisions Revised Provisions
a. Listed on stock exchange Transfer of shares by way of sale, by resident to non-resident shall be at a price not less than the ruling market price. The price of shares shall not be less than the price at which a preferential allotment of shares can be made under SEBI guidelines.
b. Unlisted shares The price shall be as per fair valuation done by a chartered accountant based on guidelines issued by erstwhile Controller of Capital Issues. The price shall not be less than the fair value as determined by a chartered accountant or SEBI registered Category I merchant banker as per discounted free cash flow method.

–       Transfer of shares by Non-resident to Resident

Status Earlier Provisions Revised Provisions
c. Listed on stock exchange -Prevailing market price if effected through SEBI registered merchant banker/ stock broker.-In other cases, the price arrived at by taking the average of daily high and low for one week preceding the date of transfer with a variation of 5%.- if the shares are transferred by foreign collaborator / promoter to the existing promoters in India with the goal of passing management control, then a premium of 25% to the above price is permitted. The price of shares shall not be more than the price as described in (a) above.
d. Unlisted shares -The price shall as mutually agreed between the parties, if the consideration is less than Rs. 2 million per seller per company.-If the consideration is above Rs. 2 million, then price based on EPS linked to P/E multiple, or a NAV linked to book value multiple, whichever is higher; or- at a price which is lower of the two independent valuation of shares, one by statutory auditors and the other by a chartered accountant / SEBI registered Category I merchant banker. The transfer price shall not be more than the fair value as determined by a chartered accountant or SEBI registered Category I merchant banker as per discounted free cash flow method.

While thankfully, there are no definitions of the applicable discount rate, growth rates, number of years of cash flow etc., the pricing guidelines is causing quite a stir in the VC community which might get affected during exits.

We are curious to know the outcome of the dialogue between IVCA (India Venture Capital Association) and RBI, if at all that happened.

Thanks to the blog post of Mr. Mohanjit Jolly, Executive Director of Draper Fisher Jurvetson India, http://www.vccircle.com/columns/what-in-the-world-liquidation-preference, which had a few VC firms ask us for our thoughts.

Disclaimer: This is not a legal opinion and should not be construed as one. Please speak with your attorney for any advice.