What I’d Like To See in the Budget For Startups

3 comments Written on July 4th, 2014 by
Categories: Budget2014, Startups

The Government Budget should not have any real meaning for startups. But startups - and here I mean small and micro enterprises - generate most of the employment in the country. They are also responsible for most of the corpratUnlisted, small companies and entrepreneurs are the backbone of the Indian economy.

We tend to think of startups as the technology startup types. The guys that built Whatsapp. Or Facebook. But these are only one kind of startup; the entrepreneur mindset extends from the local kirana shop to the stockbroker to the fancy we-are-the-next-Flipkart. In general when we talk of startups being important, it is because they build value, and in the process generate employment, increase productivity and solve real problems.

In that context, we should encourage them. But in that context, we should also understand the limitations they work with.

  • They don’t have much cash. Not enough to throw at corporate lawyers, CAs and stuff.
  • They want to spend time building their business, not finding their way through a regulatory maze.
  • Some will raise capital. Others will take debt. They’re not likely to have family property to offer as collateral and all that.
  • They will grow, and they shouldn’t hit a massive wall once they do actually grow.

The stated goal for the government should be to remove obstacles to company creation and operation on a small scale. And you shouldn’t need to be “established” in order to succeed - the new guy on the street should have a level playing field.

In that context, what would I like for startups?

Remove the Startup Tax for Companies Valued Upto Rs. 10 Cr.

Budget 2012 introduced the Startup Tax, which means that if they get investment at a “premium” to face value, they have to justify that valuation to a tax officer by getting the valuation approved by a Tier 1 Merchant Banker (read: Lawyers, Fees).

This makes little sense to the small startup, but it was built to avoid a regulatory loophole where one company could “invest” Rs. 100 cr. in another company of 0.01% of the equity, and there would be no income tax paid by the receiving company as the money is an investment not income.

To ensure that the large fish can’t get away doing this, the Tax will stay. The budget last year tried a stupid stunt last year - of asking SEBI to create guidelines for “angel” funds who were exempt. But this is stupid because any organization of the size of SEBI doesn’t get the concept of angel investing - and prescribes a 1 cr. networth, a minimum 25 lakh investment and obviously fees paid to SEBI for the privilege of investing in your nephew’s company.

While this law helps the tax department tax the one-off company that abuses the old law, the fact is that it restricts real investments into small startups by “friends and family” who are just trying to help (and are best positioned).

This is silly. We should just get rid of this tax for all companies upto Rs. 10 cr. of capital (including “premium”). Above that, I can pay a merchant banker to value my company at whatever I want, because I have the money.

Increase Awareness of Government Schemes, Or Scrap Them

In a quick conversation with Pankaj and Arpit yesterday, we found at least three government schemes for startups. Some are restricted to “manufacturing”, but isn’t a Square a startup that manufactures a device? Some others require documentation to qualify. Yet, the amounts provided by the government are huge - from 1 crore to a SIDBI SME fund that guarantees upto a total of 10,000 cr!

People don’t really know what it takes to get in, and there is no transparent reporting of who got money, how much was paid out, and what checklists you must tick before you can qualify.

The Finance Minister should really help increase awareness of these schemes, and create the transparency required. Also, the process should be to help them get debt as well as equity, but to increase focus on debt - my strong belief is that the government should not own private companies. It has no business being in business.

Remove “Networth” Type of Entry Barriers

Governments often erect barriers to entry for any new business. They want companies to have a certain net worth or operational history. (Example: three years balance sheets. What if a company hasn’t been around that long?)

Having a high net worth is a requirement for anything in the financial business. According to a draft SEBI guideline, a company has to have a Rs. 50 lakh Net Worth before it can send it’s analysts on TV saying they like a certain stock! This is borderline insane.

It is a question embedded in our psyche  - “how do we know they are strong?”. Obviously the answer is that by erecting this barrier you will never know if someone is actually strong, but hasn’t established herself yet. And in the process kill all the innovation.

Creating entry criteria like “needs MBA degree” or “must have 10 years of experience” are arbitrary and useless. And they tend to only destroy the small guy, and foster the big old boys.

If we want to really help startups, these qualifications should be used with extreme care, and by nature allow us to question such qualification requirements in courts.

Reduce Incorporation and Operational Time

Why should it take 20 days to register a business? A DIN takes three days. Then there is a “Company Name Approval” process where you have to justify the name you want. Then you need to get your memorandum and articles approved. Then you need to get service tax registration, VAT, Professional Tax, Shops and Establishment acts, Labour certificates and so on. And your bank account, your PAN, your TAN, all of which need the same proof of existence, signed, and then have notarized affidavits.

Operationally, you need to file random forms of the “Oh I’m still alive” types, every year. Then you need a CA or Company Secretary’s digital certificate to accompany every single form, even if you have your own digital certificate.

Why?

This utter nonsense should be housed in one single clearance window for incorporation. The current data is centralized anyway - so a single Id proof or address proof uploaded should be enough proof for all documentation (PAN, TAN, Bank Account, Service Tax, VAT, etc.) If the bank has got the data from the MCA web site, it is sacrosanct, and enough to qualify as address proof or ID proof. Name approvals should be unrestricted unless there is a trademark conflict (which is not a big deal to cross-verify). If you give in an ID and Address proof you should be able to set up a private limited company in one single day!

Operational challenges continue to deter investment. It’s not easy to import or export things. It’s not simple to transport things across the country. Railway freight charges are too high and designed to subsidise passenger fares. All these come down to one thing - bad taxation or bad rules. We should fix them.

Simplify Taxes

The Service Tax return form has entries like “which Notification’s exemption are you claiming?”, and then you have list the notification number like 3/2013 and a serial number! This is ridiculous.

In your income tax return you are supposed to enter a BSR code, a challan number, and the various TDS items deducted including TAN of the deductor. Why? The Tax Department already has all this information! Why do I need to fill it again? Just say: How much Tax already deducted? X. If it doesn’t match, you raise a flag. 99% of the time, it’ll match.

And then you have changing tax laws. Some industries get Minimum Alternate Tax. Others don’t. Some get zero tax (like agriculture). Some have to pay special taxes (like stock brokers). Other laws suddenly become retrospective. This is confusing and gives the entrepreneur a moving target - and he needs to employ lawyers or professionals just to see if the tax exemptions he got are still valid.

Taxes should be simplified. Keep exemptions low, reduce tax rates, and simplify the process so anyone can file returns easily. It’ll put a lot of CAs out of business, but the small industry will thank you.

Make Debt Easier

This isn’t a budget task because the Companies Act screwed things up. Now, a director’s family can’t give loans to a company easily. Not paying back debt even with best efforts can involve a jail term (!) for the promoter. Debt has to be secured against assets. (So I can’t take a loan and then use the money to buy an asset)

While startups in the tech world flock to equity, the world outside of it survives on debt. The RBI moves to help small companies discount invoices settled by larger companies is a huge game changer. The government can, by itself, buy some of this debt as part of its larger SIDBI or MSME debt initiatives.

Small companies have little or no collateral. Banks are incentivized to lend to them (SMEs are “priority sector”) but don’t because recovery can be very difficult, as even the SARFAESI act only allows them to seize collateral. The government should create a simpler act that allows lenders to quickly take and sell all assets, and RBI should create a centralized system for recording every single borrowing and collateral by a corporate (so existing lenders get notified if a company takes a fresh loan, and all lenders can query to see how indebted a company is) This will make lending easier since banks will not be afraid of not having something to back their loans up.

Introduce a Bankruptcy Law

When you can’t pay back debt, you should get bankruptcy protection. While I support this for both individuals and companies, it makes a lot of sense for startups. If you have bankruptcy protection, a lender can’t go after your personal assets (if you are a promoter). Of course, this has to be along with strong enforcement of anti-fraud laws where if promoters are found siphoning out money they are thrown into jail. But that is not a necessary condition; it is anyhow illegal to siphon out money.

The point of a bankruptcy law is to allow for protection in case the company gets into serious trouble. Then you get the chance of saying, look, I bet and lost, and the best way forward is to just take what the company owns, and forget the rest of the debt. This might actually help revive the company if it has no baggage. And yes I support this of Kingfisher too - banks should just suck it up, and if you’re really angry, please go after the bankers who refused to sell Kingfisher shares long after the company was bust.

Incentivize Indians to Invest in Startups

Currently a lot of investment comes from abroad, for startups. Why? Because it’s bloody easier. If I wanted to create a fund to invest in unlisted companies, I will pay higher taxes in India. As an individual it’s better for me to invest in a public company (no capital gains taxes after one year of holding) than to buy stake in a private company.

Indians get more tax incentives to invest in real estate than in businesses. That’s a crying shame!

Reduce Limiting Rules on Innovation

Uber thrives because the barriers to entry for running cabs is high - you need a licence, tolls are higher etc. Airbnb, same thing - the higher taxes paid by hotels forces them to charge more; your extra room doesn’t have that problem. These businesses succeed because people are sick of the lack of supply.

In India, there are rules that deter innovative business plans. No drones, for instance. No IP Telephony - it reduces the revenues of BSNL. No offering free wifi because heaven forbid a terrorist might send an email through it. No “for-profit” companies that can run schools. These rules don’t help.

What Pankaj Said

I read Pankaj’s excellent post on what the budget might mean for startups. I don’t agree with the creating of an SWF (India as a deficit country should not be investing in equity and should in fact divest), doing an area specific jurisdiction (India’s company law is federal, so the same rules apply all over). But there are good points:

  • Single window clearance - my points above.
  • In case of a shut down, Tax pass through of losses for investors. (I don’t say just VCs, losses should be usable by all investors in proportion of their shareholding)
  • Allow digital signatures to be used instead of physical for agreements.
  • Foreign investors should repatriate gains over the internet. (This has to be forced on the RBI, FIPB and the banks)

It’s Not Only The Budget

Granted that the Finance Minister isn’t going to visit many of these things because they’re not in his jurisdiction. But if he can change the tax incentive system, which favours real estate for investing and agriculture as a favoured sector, to make it more level as a playing field for a manufacturing outfit to raise capital or for a new industry, we are likely to see changes.

But disbanding many of the other laws like labour or bankruptcy acts, fixing the justice system or changing the Companies Act is not the FM’s responsibility. In effect, this is a call for Modi to try and influence these changes.

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About the Author:
http://www.capitalmind.in
The man behind Capital Mind. Deepak is a co-founder at MarketVision, a financial knowledge company. Deepak also provides data research and consulting services, and now lives in Bangalore. Connect with him at deepakshenoy@capitalmind.in.

3 comments “What I’d Like To See in the Budget For Startups”

There is a lot more deserved from the budget. Hope Arun Jaitley heeds to the demands/ wishes of everyone!!

Any case, the article provided valuable insight into what needs to be done for the startups.. Probably not much is being written for them and what ails the new age entrepreneurs.

Would like to see more on the subject.

Many thanks
Varun

Perhaps, Sec 54F for long term capital gains should incentivize investments in VC/Angel funds, directly or indirectly. SIDBI should start a fund of funds to channel money from here.

Great idea!