Off-Topic: RIP, ESOPs. Thank you, Redbus.

No Comments » Written on July 17th, 2014 by
Categories: Startups

Livemint has an inside story on the sale of Redbus.

The development is very sad for the startup ecosystem - because Redbus, at the time of exit, did not let its ESOP owning employees make money. Instead, their ESOPs were converted to ESOPs of the acquirers (Ibibo).

Read this article for more detail.

Why’s this bad? After all, even Whatsapp’s sale to Facebook is largely about giving Facebook shares to ESOP owners? But there lies the twist - obviously, the Facebook shares can be sold and have a price. Ibibo’s shares have no daily price, and no way to sell - effectively the ESOPs (which aren’t even shares of IBIBO.

Effectively what happens? The ESOP owning employees see no money. Maybe they will if they hold the shares, but right now, nothing.

And that is bad only because: the founders saw money. The investors saw money. Someone made a truckload, and the ESOP owners, nothing.

Sure, there’s legal back-up and their agreements were structured like that, and such a deal was legal.

But get this: When you make such agreements that effectively turn a 600 crore acquisition, where money was paid out, to ZERO in the hands of employees, you just turn everyone in the industry off ESOPs. How do startups get smart people to work for them if they can’t offer “market linked salaries”? If someone comes and tells you his fantastic story, and how you can make money off the eventual stake you will own, would you trust him to create a fair agreement?

In this case, it might have been VC-led - or a malicious move by the founders. It was NOT accidental. The spirit of the agreement was for everyone to make money when “Redbus” was acquired; and that spirit was violated.

On the other hand, my story is that I made a reasonable amount of money in ESOPs which accelerated on an acquisition in 2007. It helped me chase my dreams - of algorithmic trading, market analysis and investments - for seven years. I have no complaints, even if perhaps, I had stayed longer, I would have made more. However, I did see some money, and my boss made absolutely sure that I did. It made be realize the value of ESOPs and the value of keeping your word in spirit - because there were a 100 ways he could have told me to sod off, and offered ESOPs of the acquirer instead. He didn’t. And I will forever be grateful.

Redbus has taken us the other way.

I hope there aren’t more like them.

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.


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.

The largest industry is the one that’s the least disrupted: #FinTech hackathon

4 comments Written on February 13th, 2014 by
Categories: GuestPost, Startups

This is a guest post by Mukund Mohan, on an event in Bangalore that involved technology and finance. Mukund is the Director of Microsoft Ventures, which runs a fund, an accelerator and startup engagement programs globally. You can follow his blog on startups at Best Engaging Communities.

Mukund is first from the right


On Sunday I had a chance to judge the #hackafin hackathon at the NASSCOM 10K startup warehouse. While many other industries are going through immense disruption globally, (Books - Kindle, Cabs - Uber, Hospitality – AirBnB) the innovation in Finance is largely at the fringes (Second Market, Angel List and smaller companies).

The Yodlee team provided a set of API’s and training for the 100+ entrepreneurs and hackers that attended the 2 day event. There were 16 teams that participated at the hackaton. My experience has taught me that hackathons that focus on a specific vertical tend to get far fewer attendees (example the travel hackathon tHack organized by Tnooz) but the level of sophistication of the apps themselves is very high.

Overall the conversion of hackathon participation to entrepreneurial ventures is fairly low (2-4%) and in India it is much lower (0.5 -1%). Which means of the total of 60+ hackathons held in India in 2013, only 7 hackathons had startups created after the event. On average a total of 23 teams participated, so about 1400 hacks and ideas were generated. Of these 1400 hacks, only 11 ended up becoming startups, which resulted in a conversion of 0.7%. The positive news is that hackers are participating in droves, with the average attendance reaching 85 developers per hackathon.

There were some very interesting ideas that the hackers presented at #hackafin. Here the top 5 that caught my eye, in no particular order.

  1. El Pancho (FinUp). Imagine you are a startup and an investor is “interested”. The investor wants to get some initial due diligence before they decide to offer you a term sheet. One of the due diligence items is to check your finances. This online service actually automates the generation of your income and expenses based on your bank statement and gives them a pre-release (not pro forma) version of your finances. It should help speed the process of your due diligence with your investor.
  2. Thirukkural: This app provides a simple voice to text interface to your finances. Instead of logging into your credit card website to get your card limit, or log into your bank account to get your bank balance, or log into your DEMAT account to get your asset allocation, you can just ask it simple English questions by speaking to it. For example: say how much did I spend last month and it collects information from all your credit cards and debit cards and gives you one simple answer. Pretty neat. They were a crowd favorite and the winner of the hackathon as well.
  3. iCredit: Getting credit in India is hard. Managing a credit score is limited to a handful of providers. This site helps you build your credit history by looking a more granular level at your transactions (company not individual) and building your credit worthiness as a company. This tool could be used by credit assessors or loan processors to determine credit worthiness or risk.
  4. DI: With this app, you choose the type and issuer of your credit card. You don’t have to enter your credit card information. Based on the location and your cards, it will tell you what the local deals are available for your card. If you select from a list of merchants based location, it will also tell you the card to pay with so it gives you the best points / offers etc.
  5. Bullfinch: This is an offer app. You download this app to your phone. It looks at incoming SMS and other spending data from Yodlee to provide proactive offers for you. E.g. if you have spent INR 700 at Pizza hut in Benson Town one week and the next week you spend INR 800 at Pizza Corner, then you might get a coupon from Dominos for Pizza the following week.

While I think most of these won’t be actual companies, many will end up being just good ideas that are part of a product, the fact that we have so many creative folks thinking of disrupting the existing way of doing business is excellent.

Capital Mind Note: We are kicking ourselves for not attending.

SEBI Finalizes Angel Fund Regulations

Comments Off Written on September 17th, 2013 by
Categories: Startups, StartupTax

SEBI has notified final regulations for angel funds. I have noted many of these in the past, so for background:

In brief, angel funds are now only allowed as an “Alternative Investment Fund” which requires registration.

  • Angel funds must pay Rs. 200,000 to register.
  • Such funds can raise funds of at least 25 lakh (2.5 million) per investor, and a minimum corpus of Rs. 10 crores. (100 million)
  • Can you be an angel investor? As an individual, you need to have a 20 million or 2 crore “tangible” networth apart from your primary residence.
  • Also you need to either have had startup investment experience, have been a founder of more than one startup or have 10 years of experience as a senior management executive.
  • Or if you’re a company, you must have a Rs. 10 crore (100 million) net worth.
  • Angel funds cant invest in companies where control or management is with relatives of ANY angel investor. Relatives means [children, grandchildren , brothers, sisters] (and their spouses), or parents. Oh, and such people can’t be directors of any invested company either (before the investment) and cannot own more than 15% of equity.
  • Funds must be raised within three years.
  • Investments in any company must range from 50 lakh to 5 crores.
  • And money is locked in for three years. This is strange but obviously overridable in case of an acquisition. (Come on, SEBI is not a dolt, they will grant permission in case that happens)
  • You can’t have more than 49 investors in an angel fund.

Basically, the small investor is out of the ambit of these rules. Does that mean the small investor can’t invest? Of course he can!

Just get a convertible debt deal if you’re worried about startup tax. Or if you’re the real risk taking kind, at the small level (sub 50 lakh), don’t even bother about startup tax.

Links: Potash De-Cartels, IIP Shadiness, Redbus-ted Exits

Comments Off Written on September 13th, 2013 by
Categories: IIP, Links, Startups

Pavan Srinath tells us about the breakup of the Russian-Belarusian Potash Cartel:

Two big cartels control the global potash trade: the first being BPC, a joint venture formed by the Russian company Uralkali and Belarusian Belaruskali. The second is Canpotex: an association of three Canadian mining companies. Together they controlled about two-thirds of the supply and ensured reasonably high prices in the global market. This is now under threat after BPC broke apart. Any rapprochement between Uralkali and Belaruskali was ruled out in late August when Belarus detained Uralkali's chief executive officer and charged him with abuse of office. This has since escalated into a diplomatic row and a trade war with Russia, with the latter causing disruptions in oil and milk supplies to Belarus.

On the other side of the world, the Canadian cartel Canpotex is in trouble from another source. BHP Billiton, the world's largest mining company, is looking to enter potash mining in a big way through the acquisition of a $2.6-billion undeveloped mine in Canada called the Jansen mine. BHP Billiton wants to distribute the potash independent of the Canadian cartel and thus poses a direct threat to its continued existence.

This brings prices down from $400 a tonne to $300 a tonne. India is likely to import 35 lakh tonnes (which would mean a $1.2 billion import bill, mostly subsidized). A 25% drop can save us $300 million in imports, but then it seems we have long term contracts that don’t allow this easily.

For the IIP data, Business Standard wonders about the IIP data: (Note: I’d mentioned that the garment production data was very high in July)

For a few months, even as the overall index suggested stagnation, the garments segment seemed to be performing spectacularly. It might be expected to benefit even more in the new currency scenario. While it did not grow as impressively as in months when the rupee was stronger, it was one of the fastest growing segments in July, clocking 44 per cent. However, as in previous months, there appears to be something of a contradiction between this and the performance of the textiles segment, in which production actually declined by 0.3 per cent in July. So, as before, one might wonder where the cloth to produce all those garments is coming from.

The correlation of “textiles” to “garments” was 0.44 in December 2012, and is 0.26 now, so something strange indeed has happened.

In a note about the Redbus acquisition, it becomes apparent that things weren’t all that perfect in acquisition land, as senior members prepare to exit.

A large part of this exodus may be – from what we’re hearing – because of the fact that employees aren’t pleased with the way Employee Stock Options were dealt, as most of the tangible gains from the acquisition have gone to the founding team (+ few very selected ex-employees, not more than 3 in number). That is, the core group and not employees, who must have obviously been sold the dream as well.

An acquisition of 800 cr. (the number’s not confirmed, by the way) could be through a combination of stock and cash. Since the acquirer (Ibibo) is unlisted, the VCs would have demanded a good amount of cash. If things were done fairly, everyone would have the same proportion of cash and stock.

But in many cases, things don’t work like this. Let us assume only Rs. 100 cr. in cash was paid (the rest was stock). Due to complicated agreements and participating-preferred clauses, the main investors would have taken a bulk of this cash. (A participating preferred agreement could say I get at least 3x my investment, and then I participate in the rest. The cash goes to pay for the 3x, they participate in stock)

The remaining small amount of cash goes to whoever’s already got shares (founders). The VCs, option holders and founders get the rest of the compensation in the acquiring company’s stock. Which, most likely, is vested over a longer period. This ticks off the stock option holders because they don’t get anything from the acquisition, while they perceive the founders got something.

If this is the case with the redbus story, it comes to an interesting twist. Whatever the non-founder employee's argument – I don’t agree with it because the founders took greater risks, but still – they have the option to get up and leave. And that’s what they are doing. While this is an ecosystem issue (why will people trust options in startups anymore?), this still means one simple thing: not enough people are making big money off Indian startups.

The Failure Of Financial Web Startups

16 comments Written on July 13th, 2013 by
Categories: Startups

This is going to be a long post.

Investopresto, a finance portal, shut shop a couple of days back. They follow other illustrious startups to create financial web sites and eventually run out of steam, like , moneysights, moneyvidya and many others. This is tragic, and even more to me as I co-founded and shut down Moneyoga three years ago.

Hasn’t Anyone Succeeded?

Some may say the lack of success is the no product-market-profit fit, and others will say it was the lack of funding. These are strong contenders for reasons, but let’s stop right here and look at the successes.

  • Moneycontrol has won the media battle. With decent , video from its group company CNBC-TV18 and an enormous amount of publicity. While I’ve heard that they are independently profitable, the company they are in (Web18) has been unprofitable for most of the last six years. And they can raise money at the drop of a hat.
  • Value Research Online has lasted more than 10 years as a mutual fund information site.
  • Jago Investor has a personal portfolio advisory and coaching service; Manish and his partner have build a great business, even if it’s not one of enormous scale yet.
  • Zerodha is doing well. just raised another Rs. 20 crores, which might not mean they are profitable, but at least they’re not out. Similarly, Policybazaar raised another round recently.

Other current players:.

  • Blufin has an extraordinary board and team.
  • MoneyWorks4Me is strongly pushing their subscriptions.
  • Scripbox has entered as a mutual fund intermediary that makes investing simple.
  • PPFAS – not exactly a startup, but still – has just set up a mutual fund.
  • MProfit is selling a great product (even free) to help manage portfolios.
  • Perfios intends to become your personal financial helper.

So why don’t people succeed?

There is just one reason. That they don’t make money, period. You need money to run a business (and then, profit). You can get that money by “financing” cash flow – where you raise equity or debt to pay the bills. Or you can survive on “operational” cash flow.

Financing wise, life is tough. We are in a different zone with startups today. Some will never make money but are in so much demand they can raise how much ever they want. Like eCommerce a few years ago, like Payment Gateways in 2013 and like dotcoms in 1999. The financial industry is not a hot one. So it will have to make itself worthwhile by making operational money instead.

Operationally, you have to find revenue. It’s not easy, and the barriers to entry are small. Revenue is anathema for most web startups, and their cost structures are so inflated it’s difficult to make revenue that is enough. Staying small and lean helps, but a hard-nosed focus on revenue is just as important.

What’s with revenues?

You can make money in multiple ways with a financial site.

  • Advertising. Print media stalwarts like Dalal Street Journal and Capital Markets, who run a lean shop, have thrived. So have the TV giants. In the online world Moneycontrol and (surprisingly) Yahoo Finance and Eco Times close for company. These are big established media players and to beat them will need more than a fancy looking product. Adsense gives you nothing.
  • Leads: Some financial product players pay for references.  Unfortunately, this model has been tried and wasted as the per-lead rates are low (as low as Rs. 10) and regulation cuts out middlemen. PolicyBazaar has an innovative offering here.
  • Transactions: Brokers like Zerodha and intermediaries like FundsIndia make money off transactions you make on their platforms. The market size here isn’t very big and customer attrition is very high.
  • Technology:  Retail trading software like Amibroker are famous and make great revenue. The big trading software giants in India are Financial Technologies and Omnesys. MProfit is .
  • Data: Reuters and Bloomberg rake it in, selling data. In India, there’s Value Research, selling data and analytics like ratings as do Global Data Feeds. Business plays like CMIE, Dion Global, Tickerplant and CM Online have stayed.
  • Subscriptions: The barrier to entry here is that unless you’re well known, no one will bother.
  • Education: Courses, certifications and placements. Since SEBI requires players to spend a part of their managed asset fees on investor education, there are opportunities here.
  • Money Management: Start a PMS, Become a fund manager, start an AIF Hedge Fund. This avenue may be lucrative if you have the right strategy, though it needs a higher amount of capital to start.

Most players want to be in the media space. The rest are sparsely populated.

But the big play guys who have gotten trampled are supposed to have:

  • Great UI/UX
  • Give you great access to data (bought in raw form from players like Dion/Tickerplant)
  • Rudimentary but great looking screeners.
  • Simple analytics like debt-equity allocation charts.

These are unfortunately, not the pain points India has, that people will pay for, or that advertisers will line up for.

I will live with horrible UX if it solves a real problem. (People using IRCTC, India’s largest ecommerce site, do that regularly) The data from Dion/Tickerplant is often outdated and sadly, wrong. The screeners don’t give you enough to actually make a trade. These don’t solve a serious problem just yet.

The Pain Points

Can anyone solve the KYC and document problem? Every darn financial instrument needs a KYC, mostly with the same documents – ID-proof, PAN Card copy, Address Proof and so on. Some need an “in-person verificiation”. Who’s tried to solve this? CAMS/Karvy have a business solution to digitize docs. Yes bank recently allowed you to upload documents to open an account. In person verification is done by users over a video link. These aren’t holistic but are at least attempts to solve a serious problem.

Cutting through the bullshit. Most financial products are badly designed, or missold. You’re never told what you need to know in simple terms. You’re never told that if you don’t bother to understand this product, you should not invest. You’re never told the negatives of the financial product you’re pitched – and there is no easy way for you to find out.

The lack of an integrated trading software. Traders are a big market – not because of numbers, but because they’re at the market every day. Abroad they get great tools to analyse, visualize and trade all at the same time. Yes, give me data, but allow me to trade as well. Current broker web and application interfaces are rudimentary. This segment can only be handled by a brokerage, because of the stranglehold on third party software by the likes of Omnesys and FT.

Mobile Market Data and Analysis are currently in a different era. If you want the “fundamentals” or any advanced charting you have to jump through hoops.  Fixed income, currency and options markets are almost absent in whatever few mobile interfaces we have. This is a pain point if you consider how much time people spend travelling and that markets now work for longer hours than ever before.  

The pain points are NOT: I want to see great looking UI. Or that I want a faster web site. It’s not the lack of a “financial social network”. These are great ideas but there are bigger problems to solve first. No one I know cares – and while anecdote is not fact, the players who focussed on these elements are getting left behind.

The Problem

Financial application companies in India need to think smaller. Because the market isn’t that big. Probably a million traders, and probably two million investors or so is the total addressable market size.

It’s fashionable nowadays to think only big. Address the 100 billion dollar market. You have a limited runway and most startups fail, so why not try to hit it big? This is sane advice but if you have a niche that you can address and they want a product, it is still worth your while.

What do you want to make out of it really? Change a few lives, make about 20 crores of your own money? You could do that if you build a company worth 50 crores – and an acquisition of this size is quite achievable. If you can think smaller, it might help; plus, all those big thinking players are running out of market size in the financial space.

But this necessarily means standard angel investors or VCs can’t be bothered. So what? Most niche industry investments happen through industry players anyhow. Most angels and VCs I know will happily admit they don’t know a darn thing about the stock market.

You might say people just aren’t interested in personal finance or stocks.

But people aren’t interested because, like Santosh of Moneysights reminded me of what I told him, people are getting 10%+ increments per year and 40%+ when they change jobs. Who cares about saving and investing when you’re getting that kind of income change? Anyhow – that is just an excuse.

India is a tiny investing demographic. It could change tomorrow, it could take 10 years. You just don’t know. No one was buying online in 2002. Suddenly everyone is today. So the financial web site that succeeds will, like ecommerce, have to stick around.

Real estate is both an investment and a consumption good. If it’s your first house, you spend so much on it and take a large loan on, so you don’t have enough left to really invest. Insurance is usually hard sold as a tax free investment, and so people pile on; and that leaves a bad taste so they get wary of everything else.

Regulation could be a problem or a benefit. Strong regulation is needed; too many people are cheated in this business. Mutual fund commissions have been cut because it’s universally accepted that such commissions shouldn’t be built into the product, they should be charged for separately. The insurance industry sees huge misselling, and with their regulated expenses, rules are framed to ensure that investor money doesn’t “leak” out, say by giving big referral commissions to a bank owned by the same group. Brokerages have crippled the system before, so they’re looked at with an eagle eye. Media plays aren’t deeply regulated yet, but they are getting looked at.

The regulator is not the problem, though people like to blame them. The marketplace thrives even when there is deep regulation (the largest growing sector in India has been banks, and they are the most regulated industry in the country). 

The underlying issue is that you have to stick around for a LONG time to make money. Even in the US, Investor's Business Daily (IBD) turned profitable after 19 years.

The Problem isn’t just Indian

Worldwide, financial websites haven’t done all that well. I’ve seen tons of people startup but not make it too big; and the size of even these aren’t much.

One success story was Wallstrip, but it sold at a $5m price tag, which many people think is too small. was one of the first successes in the space, selling for $35 million in 1999 to by James Altucher was sold to TheStreet for $10 million. The most famous of them – – listed at a $1 billion valuation in 1999. Now it’s valued at $60 million, 14 years later.

Thinkorswim (a discount broker with a fabulous trading tool) and Wealth-Lab (a system trading software) were acquired by larger players recently. Motley fool ( is a private company, and supposedly reasonably profitable.

(Of course, sold at a fantastic $180 million valuation to Intuit)

However most others are either in their early stages, or struggling to find a large exit. The market for traders isn’t that big. Investment gestation periods are long. Transactional plays are expensive.

The struggles are worldwide. Human traders are being replaced by computers and large firms are taking over the action from the small trader outfits. That means it’s not a game of number of investors, it’s a game of the amount of money – and that’s not a game a financial website can play that easily.

The Answer.

I wish I knew. (But I wouldn’t tell you)

So Is This The End?

Of this post, nearly. But not of the industry. It will come back again, once we’re off the growth path and people will need to learn to invest their money rather than depend on the massive inflation/GDP growth push in the last decade.

I’m in the financial domain, so my interests are vested, but I’d like to say there is a lot more to come.

The lack of success doesn’t mean no one will succeed. It’s not that this company was too early. Or that the market isn’t great. Or that investors won’t put in money. Some of us failed in our execution, that’s all.

Manish Jain (MProfit) has it right:

A startup’s sole purpose is to figure out the market and create a product for it. The question is whether the need for such a tool exists or is it just a mirage?

Soon, one of us will succeed, and that will change the game. Till then, we’ll just have to struggle and fight.

Disclosure: Investopresto and MoneyWorks4Me have advertised on Capital Mind. I’m an advisory board member of Zerodha. Many of the companies mentioned have good friends working with or founding them.   

Angel Fund Guidelines: Helps the Superangels, Keeps Out Smaller Investors

Comments Off Written on June 26th, 2013 by
Categories: SEBI, Startups, StartupTax

SEBI has introduced new guidelines for Angel Funds. As I’ve said recently, this is an absolutely important requirement in order for startups to avoid the “Startup Tax” (, a tax regulation that classifies investment as “income” if it is at a premium to the “par” value of a share of a company.

(Read the free Startup Tax e-Book)

The tax laws allow angel funds to skirt this rule, but what an angel fund actually means was left to SEBI. And this is what SEBI has said, in simple terms:

Angel funds a sub-category of SEBI AIF Cat-1, Like Venture Capital Funds with Only 25 Lakh Minimums

The SEBI Alternative Investment Fund (AIF) regulation is what allows pools of capital to be used in India to invest in anything. AIFs include Venture Capital Funds (VCFs) as a Category 1 player. An Angel fund will be a sub-category under the definition of VCFs. This sounds complicated, but we’ll get to that.

Other AIF investors, including those in VCFs, need to put in at least Rs. 1 crore (10 million) each.

But for Angel funds, the requirement per investor is only Rs. 25 lakh. (2.5 million) This amount can be amortized over three years, so the investor can spread the money over a period.

My view: AIF Cat-1 regulations are a pain. You can’t get new investors once you’ve launched a fund. (Close-ended) Risk and portfolio reporting requirements are detailed, with items like foreign exchange risk, detailed valuation methodology etc. Investments must be “revalued” every six months. There needs to be an office and detailed record keeping, that SEBI can inspect on demand.

However, there’s no other alternative, so the regulatory cost must be paid.

Angel Investors Must Meet Criteria for the Badge

Want to be an angel investor? You gotta have

  • Early stage investment experience, or
  • Been a serial entrepreneur, or
  • Had 10 years experience as a senior management executive


  • Have Rs. 2 crore (20 million, or $350,000 ) in tangible assets.
  • Companies that want to become Angel investors would need Rs. 10 cr. (100 million) net worth

My View: The entry criteria would have qualified me (I’m a serial entrepreneur) but I don’t have the Rs. 2 crore tangible net worth. That means I can’t be an investor in an angel fund, which makes total sense: The Rs. 25 lakh minimum, with a net worth of less than Rs. 2 crore, is probably a good idea.

If people like me want to invest in a company and can’t meet the above criteria, they should just go in on their own and not create a SEBI regulated AIF entity called a venture fund. Yes, the tax issue can be skirted – if you invest using a convertible debt instrument, it’s just a loan convertible to debt later at a certain valuation.

If you co-invest along with an “Angel Fund” at the same valuation but an amount less than 25 lakhs, you can quite easily prove to income tax authorities why the “premium” was justified – after all, a SEBI registered AIF Category 1 fund did the valuation, and they know best. Income tax problems solved.

Angel Funds Need Minimum Rs. 10 crore

Oh yes. You need Rs. 10 crore (100 million) in “corpus”. At the minimum, you need 40 investors with the 25 lakh commitment each. (Regular AIFs need 20 crore)

My view: This might sound like a big deal, but it’s not. Remember, like I’ve said in the last point, you don’t need to be an investor in an angel fund to actually do angel investments. If you do, and you qualify, it’s not such a bad idea to get a corpus of $2 million (Rs. 10 crore) together.

The Angel Fund “Manager” Must have 2.5% Skin In The Game, or 50 lakh

In the spirit of AIF regulations, all managers need to have their skin in the game, meaning they own a part of the fund. For regular AIFs the limit is Rs. 5 crore (50 million) or 2.5%, whichever is lower.

However, for angel funds, the manager needs to invest Rs. 50 lakh (5 million) or 2.5%, whichever is lower.

My view: It’s very important to have skin in the game. You lose when the fund loses. There’s no greater motivation to succeed. However, for people who don’t have enough money to invest, but can manage a fund, this is a fairly hard barrier.

Restrictions on Angel Investment

To avoid the abuse of angel investment as a vehicle to give bribes or avoid taxes, there are some specific rules that invested companies need to meet:

  • Indian incorporation, and less than 3 years old
  • Have a turnover of less than Rs. 25 crores
  • Are not listed
  • Have no relation to any industrial group whose turnover is 300 cr. or more
  • Has no family in the Angel fund

My View: It’s very unlikely that an early stage company wouldn’t meet this criteria. The industrial group connection and family issue are to prevent abuse.

The family regulation is funny. Venture Capital funds can invest in their own family-own companies!

Each Invested Company Must Get 0.5 to 5 Crore, Locked in for 3 years

Angel funds have to buy in at least Rs. 50 lakh (5 million) and a maximum of Rs. 5 crore (50 million) of any company.

They also have to stay invested for at least 3 years.

My View: Nothing less than Rs. 50 lakh? On principle, I think that’s a good restriction. Companies need more money than that nowadays, and this is an organized fund, honestly, so most investments would meet this criteria anyhow. If someone really wants lesser the deal can be to invest Rs. 50 lakh in multiple “tranches” based on some forward looking milestones that need to be met.

Nothing more than 5 crore? That’s strangely limiting when an investor needs to continue to invest in subsequent rounds to maintain its shareholding percentage. This amount could exceed the 5 crore required

The Three year lock-in is also strange. The waterfall model of investment means an early investor will be bought out by a subsequent investor (a VC fund or such), who might want to deploy more money than the company needs. In which case, it needs to offer existing investors a partial or complete exit.

What About the Fees?

Currently AIFs have heavy fees.

  • Rs. 100,000 to apply
  • Rs. 500,000 to register
  • Rs. 100,000 per individual fund.

There’s no indication of whether these will be relaxed for Angel funds. These fees are difficult to justify at an angel level of investment.

The Judgement: Startup Tax Is Still A Problem

I think the regulations allow a wannabe-VC-fund to now invest in companies. But it’s just a mini-venture-capital-fund, and not really something that serves the purpose for angel investment.

When I complained about the “Startup Tax”, it was about a specific use-case that is probably the most common in early startups. When a company gets early stage investment by angel investors, at a valuation that is a premium because that’s how the market works, it will have to pay tax if it can’t justify the premium.

The tax department said they’d solve it by allowing SEBI to define what an “angel” means, to keep them out of that regulation. (The regulation was created because politically connected companies were being invested into, by corporates, at a massive premium, and there was no taxability involved)

SEBI has now defined Angels as rich investors who pool in capital, but aren’t rich enough to be venture capital investors. Essentially what SEBI is saying is that if you want to invest in an early stage startup, you have to find a fund that has gone through the SEBI hoopla, invest in it, and convince that fund’s manager that the “pool” needs to invest in that company.

This might not fly with many of the angels that currently invest, and they might still go their own way directly investing, even if it means dealing with the Startup Tax issue.

However, nowadays there is more interest in “superangels”. Funds that buy stakes in 500 companies. Funds that have a lot of money and spread it around. Funds that invest in the whole ecosystem, including incubating companies. Funds where money is collected from investors, pooled and invested by managers. For them, this regulation is a brilliant deal, but with a little more money they could register as venture capital AIFs in the first place.

Speculation: SEBI Angel Fund Rules Could Help Ease Startup Tax

Comments Off Written on June 20th, 2013 by
Categories: SEBI, StartupTax

The Finance Minister had in his budget speech mentioned that:

SEBI will prescribe requirements for angel investor pools by which they can be registered as Category 1 AIF venture capital funds.

(Read: Startups in Budget 2013, a Mixed Bag)

CNBC has the news that SEBI might announce the requirements on July 25 (speculation):

In an exclusive to CNBC-TV18, sources say the Sebi board may announce rules for angel funds on June 25. Some of these rules may include angel fund investment to be limited to Rs 50 lakh- Rs 5 crore; angel funds to be invested in a company for at least three years; angel investors to invest in companies not older than three years; investee company to be unlisted and with a maximum turnover of Rs 25 crore; the investee company may not be related to a group with a revenue of greater than Rs 300 crore.

Sources add that the Sebi may also stipulate that the fund must not have any family connection with the investee company and that no angel fund scheme may have more than 49 investors.

Note: Cat 1 AIFs already have three sub-categories:

  • Venture Capital Funds
  • Social Funds
  • SME Funds

The Angel fund will have to be a separate sub-category.

Welcome, Tax-Pass Through

Note that AIF regulations means Category 1 funds, VC Sub-Category get a tax pass through, that is, any income made by fund investors will be their income, not that of the fund, which is beneficial for entities based in mauritius or singapore, who don’t pay any capital gains taxes. Cat-1 AIFs had certain restrictions, like Rs. 1 crore per investor,  which might be relaxed.

While this is a useful thing, it’s no different from the angel investing directly, which is what currently happens. 

An angel fund can help in the sense that it allows people to pool in cash and invest as one entity (for instance, 10 investors in one company can get a single represenation) but with the tax pass through each investor gets the tax benefits that he normally would if he invested on his own.

Fixing the Startup Tax, Somewhat

However some of the rules are designed to help avoid the Startup Tax problem. (Read the free Startup Tax e-Book) Angel investments in companies at a “premium” have been classified as “income” rather than an investment, unless the startup can explain to the tax authorities how such a premium is justified.

This has been brought in because it seems politicians are being bribed by corporates using the investment route. The corporate would invest a large sum of money into a small company owned by a politician, and take a very tiny stake in return. This is effectively a bribe since the money is not expected to be returned (no equity investment is), and the company will pay no tax on the investment (since it’s a capital flow, not income). See the Jagan-Srinivasan enquiry, or the Dasari Rao-Naveen Jindal allegations.

The tax authorities have plugged this loophole. A large investment at a premium will be called income unless the premium is justifiable, and if it’s income, the money will be taxed. In the process they make it very inconvenient for small startups who need capital and much of their value is based on future prospects not easily quantifiable.

In Budget 2012, the above problem was partially addressed; if a SEBI regulated AIF invested in a startup, it wouldn’t get hit with this Startup Tax. But the SEBI AIF rules made it difficult for small angels to start a fund – each fund needs at least 1 crore rupees per investor.

The above rules, I think, are designed to thwart the creation of entities by corporates to, again, bribe politicians. (If rules are lax, a corporate will create an AIF and then pay big money to a startup?) The AIF rules are already stringent – not more than 25% in one entity, minimum lock in, and so on. These rules can further contain the abuse.

The rule that the “group” of the company invested in should not have a turnover of Rs. 300 cr. or more, and there should be no family connection between the fund and the company; this help prevent one layer of abuse. And then, limiting the angel investment to Rs. 5 crore creates less chances of bribes (which would mostly exceed that amount by a multiple of 10).

AIFs currently can have upto 1,000 investors, but the limiting to 49 for angel funds is peculiar. However, the logic may still be related to abuse, to avoid the creation of a pool like Sahara or such.

Still Not Enough

Till the regulations come out, we’re not sure what will happen but many regulations need to be relaxed. For instance, one AIF regulation is that a fund should have a “key person” who has five years of experience in fund management with a professional qualification etc. Angels are typically not this profile, and this requirement must be relaxed.

The current requirement of Rs. 1 crore per investor is sure to be relaxed, but how much? I believe it should be taken down to Rs. 10 lakh, but I doubt that will happen – it is likely to be Rs. 50 lakh or something. Knowing how much angels pool in (5-10 lakhs each, typically) a large minimum would restrict their ability to create an AIF fund together.

June 25 will tell us more. CNBC’s sources haven’t always been accurate so the end-result may be quite different.

Flipkart Won’t Deliver Orders More than 10K to Uttar Pradesh

12 comments Written on June 9th, 2013 by
Categories: Startups

The online retailer Flipkart has, it seems, decided to stop delivering goods to the state of Uttar Pradesh above Rs. 10,000, including the National Capital Regions of Ghaziabad and Noida, says TOI.

While Flipkart said the decision was "purely business oriented", insiders said there were numerous instances of customers ordering expensive goods on the cash on delivery scheme and refusing to accept their orders. There have also been cases of fraud in which lost or stolen credit cards were used to book orders online.

The portal's shipment delivery staff in Lucknow, however, gave insight, saying there were incidents in which customers ordered expensive goods and then refused to accept them. Sources said many people logged on to Flipkart and ordered "just for fun".

"It takes a minimum of 10 days to ship a product to a customer and back to the company if it's not purchased. It causes loss to sellers, selling through Flipkart, as their products get blocked in transit," a senior Flipkart executive told TOI.

You know I’m the skeptical sort, so the questions that plague me are:

Why wouldn’t they just ban cash-on-delivery in UP? Sure, you can make prank calls with a cash-on-delivery order and then refuse to accept the package with nothing lost – but to remove all orders sounds a little harsh. If I’ve already paid – with, say, netbanking, I might not be a risk at all. I don’t buy the “stolen credit card” line either – because you can delay shipping for two-three days on credit card orders (by that time a card will be reported stolen or lost). And if stolen, there is enough information within Flipkart to perhaps nail the perpetrators.

Why are prank calls only a problem with UP? In India nearly everyone must be privy to the concept, and I’m fairly sure their prank call situation occurs all over the country.

One reason could simply be that there is a competitor who’s burning them. This is not unheard of as a strategy. In one story, a large soft drink manufacturer put a competitor out of business by buying out his entire stock of bottled drinks and destroying them – the cost of manufacturing the glass bottles is recouped by recycling them many times, and the newcomer ran out of capital to manufacture more bottles.

Even if that were the case, banning deliveries to the whole state is not a solution. And the competitor can order things worth 9,000 rupees multiple times.

Why Noida and Ghaziabad? Even if I understood why UP is a problem, the cost of delivery or return is not a problem in Noida and Ghaziabad (any more than it is in Gurgaon and Faridabad where there are no restrictions). These cities are literally next to Delhi – the Delhi Metro runs to Noida, for instance.

The only answer that might make some sense is there some sort of political angle to this – that the powers to be in UP have something to do with it. That would answer all my above questions – however, then why would they even delivery up to Rs. 10,000 in the state?

Update: While it may not be political the issue may be specific state regulations. Commenter Anon says:

UP has atrocious sales tax regulation. Each of the goods for sale to UP has to have a Form -38 issued for it by a very corrupt sales department. Each Form – 38 costs money. I guess the physical sellers just bear this cost but to an e-commerce company the margins get hit drastically on each shipment and even more when the goods can’t be delivered.

This observation fills all the gaps – any shipment to an individual needs a Form 39 (and to registered dealers, a Form 38), and this form has to be signed by the commercial tax department. These rules are different from state to state (see Blue Dart Courier’s list!) and it could just be that Flipkart doesn’t get refunded for the VAT it has to pay for unfulfilled orders, and they decided to take that risk upto Rs. 10,000 per order.

Flipkart is in the news recently for having cut many product categories including Flyte (their online music download store) and for having fired many employees. In the light of difficult FDI regulations, the conversion to a marketplace instead of owning inventory, and an increasingly itchy investor set, this news just adds fuel to the “E-Commerce is in trouble” story.

OT: Are Non-Competes Legal in India? Mostly, No.

1 Comment » Written on May 10th, 2013 by
Categories: Startups

Employers routinely hand out pre-drafted agreements that contain clauses like: You will not be employed in a firm that competes with [Company] for a period of two years after the termination of this agreement.” These clauses are supposed to deter employees from joining competition and taking away years of effort in training and what not.

Some startups are trying to get over this by creating non-compete agreements their employees have to sign.

Not Enforceable?

While this may be legal in some parts of the US, such contracts are almost definitely not enforceable in India. There is an “Indian Contract Act” in which there is a Section 27, which states that you can’t deny a person the right to livelihood. Restricting a person from working, even with a competing firm, for a few years, is a restriction on that right, as many judges have ruled.

You can read these two links to see case history on what other people have tried:

Case history shows how the courts have frowned about restrictions after the termination of a contract. Courts understand that employees have little bargaining power at the time of signing a contract and will sign what they are given, or stand to lose a job. In one case in 2009 where the company said they wanted to protect their trade secrets, the court said:

the High Court ruled that in the clash between the attempt of employers to protect themselves from competition and the right of employees to seek employment wherever they choose, the right of livelihood of employees must prevail.

Employees should resist signing non-competes, but in the choice of that or no-job, might as well sign knowing that the contract is illegal and unenforceable. (And you can say it as much over an email to have it on record)

Yet, I’m not a lawyer. So my opinion should be taken as such.

The Fear Factor

One reason for an employer to offer a non-compete is that employees are afraid they’ll get sued, so they won’t go join competition.

After going through a long civil case recently (eviction of a non-rent-paying tenant) I have realized that much about the fear of the law and courts is overrated. The fear that someone will take you to court is a misguided one.

People, and educated folk, are afraid they will have to spend years going to court, even if they are likely to win. And that it will cost so much money. An understanding of the legal process is probably way off-topic for this blog (and I’m not the right person to explain) but it’s not as bad as it sounds. Even if a company does sue, the cost isn’t much. Lawyer costs at lower courts aren’t too high. Your new employer might even bear it for you! (If you’re worth suing, you’re worth defending)

What about the future?

One fear is that the law can be changed, and such contracts suddenly become enforceable. However, laws don’t generally change to disadvantage people that much – after all, the right to livelihood is a solid argument. At the very least I expect that an employer will have to pay your market salary or more, even in the off-chance that they allow non-competes against employees enforced (highly unlikely in my opinion).

What do startups do?

Don’t bother with non-competes, unless some investor kicks up a fuss. Then do non-competes but tell your employees how it is.

Then how do you protect your company? Answer: keep secrets when you must. People will leave. People you trust. You have to let them go if they will, or make them want to stay.

They will demand obscene salaries. Raise the money. This is why you exist, as an entrepreneur. If you think they deserve the pay – if their obscene demands would have been met if only you had the money – then it’s your job to raise it. I know I will face this problem, because people are motivated by money or by the belief that they are contributing to something that will change the world. If you truly are changing the world, you will easily raise money. Either ways, you need that money.

Secondly, put reasonable redundancy and security. Make sure employees take holidays – that way you know what happens if they’re not around. Put up proxy servers and track traffic, even if you aren’t likely to use it (I once found a massive issue with a couple guys through chat transcripts – they were planning to steal our code and such.) You gotta trust people until someone betrays you, and then you need to have that audit trail to figure out everything that person did!

Finally, work on making people want to stay. At a service company, my ex-boss would do this – everyone gets a one-year salary as a bonus if they stuck around for three years. That way, after two years, when the employee was at his productive best, he wouldn’t leave for another year at least – the prospect of getting a large amount for just another 12 months was too attractive. This may not work for you, but you can do other things – remember though that how you motivate people ensures they will stay or leave. (People usually leave their managers, not their companies)

This is off-topic, but it came to mind today. Back to regular programming after this.

The Earth is Shaking for E-Commerce in India

7 comments Written on May 6th, 2013 by
Categories: Startups

Is there something really bad happening with e-commerce companies? Recent developments indicate that the space is now going through a massive correction, and a crisis of confidence.

In Trouble

Arindam Bose, founder of has been arrested along with the company’s CEO, Harish Ahluwalia, for supposedly defrauding customers who paid for orders through their credit cards, but didn’t receive goods. The scale of the fraud isn’t very big – just Rs. 82 lakh from one source. (It has appalling English, but you’ll get the point)

The curtains have begun to close on SeventyMM, the online retailer that started off as a movie rental service and ended up selling pretty much everything they could. It’s raised over $21 million till date, but with the lack of further funds, might shut down soon, reports a site.

One of the oldest players in India, Indiaplaza, seems to be in trouble and needs $5 million to stay alive. I used to buy from it over 10 years back when it was called FabMall; and this is not the first time they’ve seen serious signs of trouble. Yet, the funding environment for such startups is weak, so their future depends on their ability to make someone other than customers pay.


In lesser known cases, merged with so they could secure funding – a case, it seems, of either die separate deaths or live to fight another year.

LetsBuy merged with Flipkart, and because they shared common investors (Tiger Global and Accel) the theory was that the investors made them do it.

Naspers-owned Tradus bought Naspers-funded earlier this year, Myntra bought,  FashionAndYou bought and then shut it down. The list is getting larger.

TechCircle even has a list of potential mergers in 2013 based on common investors.

A larger single player is better in a capital intensive model like online retail, so no matter what you might say of investors calling the shots, the idea of a merger is sound. In a time of crisis, it’s better to concentrate your bets and focus on being the last man standing. In good times, you can spray and pray.

Another big challenge is regulation. With foreign investment in multi-brand retail e-commerce being illegal, companies have created complex mechanisms to skirt the law. Some act purely as marketplaces, not actually selling goods but just handling customer acquisition and payment intermediation. Others put the foreign investment into a wholesale company which then sells to a “retailer” that is only a shell company in the Indian promoters’ name – which then sells the goods to the end-users. All these are quasi-legal, and attempt to stymie regulation.

My Thoughts

The fear of fraud – that is, a company taking your money and then not delivering the goods – is now more real than ever. Trust is essential to e-commerce. E-Bay’s India portal even offers to keep money in escrow until you receive your goods. Retailers fear that customers will order and not-pay – that’s one of the biggest problems with the “cash-on-delivery” model – you incur the cost, but goods get returned. However this two-way-fear is what will hinder even the biggest of companies in the space.

The fear of fraud is greater in India: recovery can take years. And, if court cases drag out that long, it will also mean that founders and other directors will have cases on them for that much time as well – something e-commerce VC funds (who put directors on e-com company boards) will want to consider (Imagine checking a box saying you’re facing a criminal case in India in your visa application).

E-Com players have started to cut discounts, and most think they have brand loyalty because of “convenience” or some such thing. While availability helps because you can’t get goods from local retailers that you can online, that assumptions is largely theoretical because I’ve recently looked for a number of different things from toys to mobile phone to bake-dishes to swimming caps, and in all cases, offline retailers seem to have the variety.

Price beats the crap out of convenience for the masses, in my opinion. There are only two exceptions – where service is exceptionally fast (like your kirana store for buying one or two small items) or where the difference in cost is marginal. E-Commerce shops by definition have a huge service disadvantage compared to offline shops, and in my opinion they haven’t really tried to arm twist manufacturers into letting them discount products much more. Unfortunately, their bloated cost structures and continued mad-growth focus doesn’t allow them to get that much more efficient, which is key to making any profit in this business.

Regulation arbitrage is stupid. All of these players want to be either India’s next or get acquired by it. Yet, once regulation eases up, these companies will set up their own portals since they have way better supply chain capability.

With the Indian government banning FDI in e-Commerce specifically, companies like Flipkart are getting investigated. (which resulted in their selling off the promoter owned front-end retail company to an outsider so they can comply with the rules) Investors are worried because the negative impact of the investigation means they are toast, and the positive is only that they can continue being what they are – the downside is huge, the upside is very small. Given this, the expected action is to tighten the purse strings and say “later”, exactly when the capital intensive business needs continued money to last out a long-drawn battle.

If there is an e-com crash – no, “when” there is one – the impact to jobs will be felt, but remain small. While many have large numbers of technical staff, the biggest numbers of hires is in things like delivery, or elsewhere in the supply chain. However, while this might sound very big to the media, it pales in comparison with losses in, say, the textile export sector a few years back.

While there is a large market in India, I think there have been simply too many e-commerce companies, and this is just the start of the end-game. Eventually the landscape will change, new companies will arrive and the old ones will die. I believe the situation was “bubbly” – I had called the Indian internet a bubble in 2011, when Flipkart was supposedly valued at $1 bn. More thoughts on that meme after being on a TV panel last year. We’re now getting to see the real picture; what are your horror stories in the e-com landscape?

Five Myths of Being A Financially “Lean” Startup

6 comments Written on April 25th, 2013 by
Categories: Startups

I was a mentor at a “Lean Startup Machine” conference recently, where people got together, formed teams and do a first layer of customer validation (“Get Out Of The Building”) for their idea. One of the key concepts of “Lean” seems to be that you don’t spend too much time imagining what can be; instead, you get to the market and if you have to, fail early. Or “Pivot” into new strategies after you hear from your market.

The teams were excellent; one was formed to get doctors for quick advice, another to sell excess stock of IT products that vendors grapple with, and yet another was a local search engine. The businesses weren’t, sometimes, apparently scalable, but they had potential and many of them pivoted even before their own presentation a couple days later.

I presented about being lean – financially. Like a complete dumbass, I didn’t consider time properly and couldn’t finish what I started out to say. So I’m writing about it – the five myths of being Lean, money wise.

What Do I Know?

Everyone should ask this question. Because everyone with a frikking keyboard has an opinion on how startups should be run. Not everyone’s advice is valid, or useful, and more importantly, you have to learn from what people did, not what they think.

I am not a hugely successful startup guy. So if that disqualifies me, stop right here and go your way. I’ve never gotten “funded” by venture capitalists. Another disqualification. I’ve very little idea what happens when your company grows to more than 50 people, because I haven’t built one of that size myself.

I’ve started up thrice – a software services firm, a market information company that became an algo trading firm, and now market education and big-data analysis. I’ve been in startups since 1997 – either one I founded or one I was an early employee in, with the latter just three years in the whole span. I know about the small stuff because I was neck deep in the small stuff, like negotiating with customs officers, getting customers to pay on time, talking to banks about bridge loans and working through hiring and firing. I’ve been lean because you have to when you have no money – all my startups started out poor.

Myth #1: You can start with nothing

I did, in 1998 and 2007. I didn’t have much, so I decided “what the heck” and started up anyhow. This is stupidity. In a lot of ways things have changed dramatically.

Earlier – probably a decade back – the biggest cost of a tech startup was building the darn thing. We built an accounting package. The cost of the hardware needed just to test various scenarious (Windows 98, 2000, “ME” and what not) added up to a  couple lakhs then (which is way more than what a couple of lakhs today would buy you). The rage was Hotmail and early Google and all that. You built a good thing – and it cost you a lot to build it in the first place – and then people would come. You did “viral” marketing. People in India came cheap – at Rs. 15,000 per month you could hire a developer, and it was a small cost compared to hardware and all that.

Things are different today. It doesn’t cost that much to build, or deploy. You get hardware for a very low cost (from Amazon Web Services and the like) and tons of open source software that lets you get started for a very low cost. Laptops are cheap – you can get a developer machine for less than Rs. 40,000 today – I remember paying more than Rs. 100,000 for mine in 2003, and even that was specially imported under a zero-customs-duty license.

And because it’s so easy to build stuff, you have massive competition. People can copy and turn things around relatively fast. A new feature takes a few hours to implement and deploy, no matter how many customers you have. The cost has now moved to the other stuff – marketing, positioning, alliances, branding etc. People are no longer inexpensive in India – the minimum you will pay a good developer to work at a startup could be Rs. 50,000 a month.

Marketing costs have skyrocketed. Your lovely little must-have app has about 400,000 others competing for limited real estate on a mobile screen. Your domain name is nothing. Google ads are expensive. Facebook ads are a black hole. If you build it, they will stand far away on the highway and admire your startup as part of the general landscape but they will not frikking come, because they have a hundred other places to go to. You have to make them, and it’s going to cost you.

Startups today could need serious operational or capital expenditure. Instead of expensive computers, rents have gone up. Embellishments not required earlier – like Air conditioning in Bangalore – are now essential. Travel costs are more nowadays, not because the ticket costs are greater, but because they’re low enough for customers and investors to meet in person constantly.

Regulation adds more compliance costs. You have to pay someone to take care of the formalities of filing Service Tax, VAT, Professional Tax, Income Tax, PF/ESI and other such returns – it’s not that this didn’t happen earlier, it’s that this stuff has gotten more complex now.

When you startup, much of this is not visible. I can build that app if I hack together a couple of PHP pages on top of a WordPress content engine and put in some free databases; the cost of doing this is fairly clear. The cost of getting 1,000 people to your web site to actually transact is just a wild guess in a cell in an excel sheet – it will change by more than 50% once you actually do it.

And what about your costs? I was stunned when at least 30% of the people in the room said they have families; more dependants means that you need money in the bank for yourself while this startup thing works out. A thumb rule is: 18 months of personal expenses are what you need in the bank, apart from what you’ll put in the startup. If you don’t have that – wait to collect it, or be stupid like I was in 1998 and hope for some awesome luck.

How much do you need for your startup? Well, you know the excel drill – put all of your imaginary costs in a spreadsheet. Store this for posterity because it will be a source of much laughter five years later. And then, take the final figure you think you need, and multiply by 2. This is not me being sarcastic; In reality you might find the multiple to be many times greater than 2. You need the buffer.

Myth #2: Revenue or “Traction” is supreme

Focus on revenue, you hear, and everything else will fall in place. You’ll find investors. You’ll be able to reinvest the money in your startup. You can get eyeballs – a metric that was beaten to death in 2000 and which has reemerged now – and thus get a funnel to sustain future growth. You can target marketshare, like “I’m the #1 web site for people looking for left toenail clippers”.

While this is relevant, my belief is that the one thing you should focus on is Cash Flow.

Let’s say you find a customer willing to buy your product, but he’ll only pay you after 90 days. Your costs of delivery for those 90 days are Rs. 500,000, and the customer will pay you, say, Rs. 800,000. If you don’t have the 500K, you’re finished; you can’t even last the 90 days needed to collect your revenue. You might look to get a bridge loan from a friend, saying, give me 500K, I’ll return you 550K in three months – a fabulous return to the friend, but you still make a good profit at the end. You could utilize a bank overdraft – more on this later. You might request an advance from the customer. Whatever you do, the deal here is to focus on cash flow, not just revenue or expenses.

On an accounting perspective, taking an advance for a service given over 12 months means you split the money 12 times and post an entry every month. The unused amount is a “liability” until you finish the 12 month. But from a cash flow perspective the advance is the difference between the full amount (since you can deliver) and zero (if you can’t).

You might need to buffer this in with an equity investor, of course, and this is nowadays the preferred option – but even with them, at a higher level, cash flow is important. You will always want to negotiate good credit periods with suppliers, and ensuring you pay them on time. I hate it when customers don’t pay on time, so I strive to make my suppliers really happy – they will let me delay my payments when I’m in a crunch.  You will want to work with banks to give you a loan “on demand”, so that money is available in a time of need.

In trading, there’s a rule that encapsulates risk and cash flow:

If you don’t bet, you can’t win.

If you lose all your chips, you can’t bet.

Myth #3: Equity Funding is Better

We’re enamoured by equity funding nowadays, with angels, super-angels, Series A VCs, Series B PEs, stock markets and PIPE investors. This is a formidable industry. However, the situation in an early stage startup might be different.

When you sell your equity for a price, you get some money today, but that stake stays sold. It might make a huge difference to your cash flow, but the loss of control and the need for constant reporting might dwarf the gains you make in the longer term.

You could also consider taking a loan instead. From the same investors at phenomenal yield, of say 36%. Or from a bank, or a family friend. The idea here is that once you have generated your profits, you give the money back, and you get to keep all the profits going forward. While this sounds stupid for a mass business like Facebook, remember that when you grow to be a billion dollar company, every 1% that you don’t have is $10 million. And you should divest when you should, but attempt to retain stake where you don’t need to.

When you take debt you don’t easily transfer risk – that is, if you are unable to make the return you want, you still need to pay the loan back. This might lead to “recourse” – that is, if the company shuts down, the bank might take possession of your personal assets (car/house etc.).

And in the end there’s valuation. Should I raise equity today when I will get a low valuation – and therefore give away a huge amount of stake – or take some debt to build up to a certain level, and then raise at a higher valuation?

One way to bridge this might be to use convertible debt. Assume you don’t know current valuations, but you do understand that if you reach milestone X (revenue/traction metrics) then your valuation should be some number that both you and your investor agree. So you take money today as debt – at an interest rate of say 36% payable as a “balloon” payment at the end of the milestone period. Then, at the end of the period, if you have reached that milestone, the investor converts his investment (plus the interest) at the pre-agreed valuation. If you haven’t, then you work out a step down function for a higher stake appropriately (or find a way to return the money).

In India, regulations such as the Startup Tax (Read my free e-book) make convertible debt even more attractive; direct equity investments at pre-revenue valuations might not be palatable to the tax department, but when converted post-traction, the case is stronger.

Myth #4: Banks don’t fund startups

In one way this is true, that they don’t usually buy equity in them. However banks do provide loans in various capacities to startups. You can request an “overdraft” which is a loan that you don’t draw immediately; you can withdraw the money when you need it, and put it back in, and you pay interest only for the time that money is outstanding. A bank might say you need collateral against such a loan – and for that, you can place, say, your car as collateral (they’ll give you only a portion of it’s value but it’s money you can get!)

Banks actually get incentivized for lending to startups – SME (small and medium enterprises) are “priority sector” lending, which needs to be at least 40% of bank lending.

The Indian government also has special interest loans for startups. This could be routed through a bank when the government asks you to pay only 5% and they will pay the rest (an interest “subvention” scheme) or they directly lend to you through a public organization like SIDBI. Don’t think this is silly and unused – SIDBI actually has lent out 48,000 cr. to SMEs.

Public sector banks such as SBI, PNB or Canara Bank are better at SME lending than the private biggies of HDFC Bank, ICICI or Axis. While the private players will give you fully collateralized loans faster, the public sector banks will value a longer term relationship and increase credit limits over time (as you repay) without the need for more collateral. You might start small, but start – over time, the benefits will appear.

If you are an exporter you might be able to get access to export funding – which is even covered partially by the RBI (indirectly). For this there is a cost at both ends, but you will be able to “discount” a large order and get some cash if you’re dealing with a reputed organization. Bill discounting works even for local orders, but this is not quite as easy to get.

Banks do help with cash flow for startups, but it’s not equity. (Though a bank may require that you back your loan with equity – that is, if you don’t pay back, they will own a significant chunk of equity in your company. And they’ll ask you to increase your “authorized capital” appropriately.)

Myth #5: The worst thing that can happen is that you run out of money.

In my experience running out of money is a good thing. What you should be really scared of is:

Running out of growth.

A business is built to make profit, and many startups do reach that goal. However, they might still be a failure and profitable at the same time. For example, you hire at low costs, and keep your personal salary low so that the company can show a profit. Is that real? Any investor who looks at the books will tell you this is unsustainable – eventually, everyone will demand their real share and the company goes back into the red. Only the hope for much bigger things – through rapid growth – allows people the hope that even if they’re underpaid today, they’ll be rewarded with much more in the future.

Hiring and retaining is tough when you’re running out of growth; you might cut expenses to a point of sustenance, and it’s quite likely you can sustain for a long time. Like a company that has sold a lot of licenses in the past could sustain a few years with lacklustre sales only based on, say, maintenance revenue. But eventually if it doesn’t pick itself up, the company is finished.

Zombie companies abound in the marketplace. And too many times, companies are zombies BEFORE they actually die. The worst thing that can happen to the startup is that it stays in the zombie state for way too long. Running out of money is sometimes a good thing, it gives you closure.

These are my thoughts. I don’t intend to paint all startups with the same brush. I don’t expect to get massive applause. This is more of a discussion and I’d love to see it evolve. And remember, that in all of this, you have to chart your own path. Take all that you read with a pinch of salt; if you’re out there to beat the odds, you can’t really care about how other random people like me think.

You can also see my slides here.

Using your Credit Card at Foreign Sites? Get an EMV Chip-based Card

9 comments Written on March 12th, 2013 by
Categories: Banks, Startups

RBI has introduced new regulations on Feb 28, 2013 that mandate changes to all credit and debit cards issued by Indian banks. All these are applicable from Jun 30, 2013.

  • All new credit and debit cards will only be valid in India, except if you specifically ask for international use. This is a no-brainer and I expect everyone to check the option.
  • All international cards can only be “EMV” Chip and Pin enabled – that is, there will be a “chip” in the card, and merchants with appropriate machines will have to “dip” the card in, and let you type in your 4 digit pin before the card is authenticated.
  • Magnetic strip cards (the ones you currently have) will have a limit on international usage, which depends on the bank’s analysis of the customer profile. If you’ve used the card internationally earlier then you might get a higher limit, but if you don’t generally do so you might only get an “omnibus” limit that applies to all such customers. (The example given is $500)
  • All terminals installed at merchants should be certified for security. Two certifications (PCI-DSS and PA-DSS) will be needed.
  • All internet transactions (traffic between payment gateway and acquiring/issuing banks) will need to also be PCI/PA-DSS certified.
  • In addition, if a transaction varies substantially from a regular pattern, the issuer may require what is called a “Call referral”, where a physical card swipe requires the merchant – the shop owner – to call his bank, who will in turn call the customer’s bank, who will in turn call the customer and get approval.

While this can have a big impact, remember that France has had similar legislation since 1992, and Britain since 1994. Even Ireland has had this since 2007. So it’s not unprecedented and is intended to reduce fraud.

Read more on Chip and Pin cards at Wikipedia.

Impact on regular card users

If you’re a card user, you should ask your bank to give you an EMV card, if you ever plan to use it internationally. This includes:

  • Paying for web hosting, or skype points, or any such transaction in non Indian currency
  • Buying anything from Amazon or ecommerce sites abroad
  • Developers: even Amazon AWS payments
  • Travelling abroad and using the card
  • Paying a “subscription” where you provide your information once and are billed regularly.

For online or phone transactions there is no “PIN” that is required. In fact the PIN and Chip have no impact on online transactions. The only way that online transactions are secured is through Verified By Visa or Mastercard Securecode. But, given the above new regulations, you can’t even use a card internationally (above a certain limit) if you don’t have a Chip card, so it’s best to get one.

(Do not write your pin number on your credit card!)

When you use a card at a merchant after June 2013, you should check to see if he has a machine that can take chip cards. If he can, you should type in your pin number with the card dipped into the machine. At restaurants, you may initially have to go to the counter to type your pin, until they all get wireless card machines.

For “Call referral” transactions, a change in usage pattern on the card at a physical merchant (not online) may require a multi way call through your bank to you. Make sure your cell number is updated with the bank, and that the phone is working where you use the card, otherwise the transaction will be declined. This may not possible always, so expect some hitches

RBI has stated that banks should themselves look to implement an additional factor of authentication for cards issued in India and used abroad. We’ll have to see how that pans out.

Impact on Banks

They will need to give customers chip cards. Some are already doing so. I received a new HDFC Bank Credit Card replacement with a chip, for free.

Banks will also need to set up new methods of fraud monitoring, and mechanisms like SMS for blocking, call referral mechanisms, additional authentication for cards used internationally and so on.

RBI has also requested banks to make other mechanisms secure, by considering:

  • Cap on value or mode of NEFT or RTGS transactions, with an additional authentication as required.
  • Alerts for beneficiary addition and a max limit on such additions per day
  • Digital signature requirement for RTGS or large transactions.

The extra cost of these measures might have to be passed on to card users eventually. Also expect that banks are likely to be unable to refuse chargeback on a “stolen” card once these measures are established, because now the system should be secure enough. However a rule to this effect needs to be made by RBI – that it is the bank’s responsibility to demonstrate how a fraudulent transaction took place if there was a customer PIN in place.

Since currently ATM transactions happen through a swipe/pin combination, it is unknown if ATMs will need to change their technology too.

Impact on Payment Gateways

One, they have to be certified under the standards stated. I don’t know how much of a problem that is, but it is a layer of extra cost.

Second, they need to have their connectivity with banks made more secure and they need to work closely with banks to ensure this transition is smooth.

My view: this might be good legislation but only if we know the incidence of frauds, amounts involved and the types (online/offline). Currently I don’t even know where to get that data from, but it would be useful to see how the metrics change post Jun 2013.

Startups In Budget 2013, A Mixed Bag

1 Comment » Written on March 1st, 2013 by
Categories: Budget2013, Startups, StartupTax

What’s in it for startups? Last year, we had a horrible section (Read the full e-book) that still works against angel investors in early stage startups. (Angel investments would be taxed if they couldn’t prove that an investment had a sound valuation backing it – and early stage startups are wet-finger-in-the-air valuations)

The Return of the Rs. 1 Crore Angel, Or Something

In Budget 2013, there are some interesting changes. First, to solve the above problem in last year’s budget, this year the FM said that:

SEBI will prescribe requirements for angel investor pools by which they can be registered as Category 1 AIG venture capital funds.

This can be good or bad. Good because if AIFs are effectively governed like VCs, their investments don’t hit the wall that my last year’s rant was about.

Bad because of multiple factors:

  • Much higher regulation and transparency that is currently required of AIF kinds of funds.
  • The current minimum any investor can put in is Rs. 1 crore. Angels in India don’t really seem to have that kind of money to spare. (other than the big organized ones)
  • Involving SEBI can mean a lot of paperwork (reporting).

Let’s hope that SEBI creates less of a reporting and investing nightmare when it defines what constitutes angel investor pools.

“Pass Through” Status Good For Angel Investors

A company or trust registered as a VC fund or angel fund as above has to pay tax on investments when it generates profits. But the profits are really those of the investors in a fund,and different kinds of investors may have different tax structures. An investor through Mauritius may not have to pay capital gains taxes, but the vehicle – the VC fund – will have to. Another investor may have losses in his books, but he can’t offset them against the gains made by the VC/angel fund because they are in different entities.

In the budget, Category 1 AIF Funds (VC funds) have been given a pass-through status. Meaning, the gains made by the fund are passed through to the investors (in the proportion of their holding). This can help substantially, especially when raising money from foreign shores, where tax structures play an important role.

Maybe Flipkart can Flip The FDI Probe Over

Pratyush brought this up. The only reason Flipkart’s getting grief about FDI in multi-brand retail is that its main investors (Accel and Tiger) are foreign owned. So they have to do a two-company structure, where Accel and Tiger own stakes in a wholesale company, which sells to a retail company that owns the website and handles delivery.

Why are Accel and Tiger foreign companies? Probably because Mauritius has no cap-gains taxes. If they created a VC firm in India, then Indian taxes would apply to any gains, and that’s no good. Now, with the tax-pass-through structure, would it be better for Accel and Tiger to set up an Indian Venture Fund, make it a class 1 AIF with SEBI, and use the tax-pass-through? And then, as an Indian entity, the AIF entity should have no problem owning stake in Flipkart’s retail site.

However, I’m not a lawyer, so I don’t know if the AIF, even if set up as such, would still be a “foreign” investor due to it’s eventual ownership.

SME factoring credit guarantees to SIDBI

SMEs that serve large enterprises might need cash flow before payments flow in (due to long gestation time before payments). Factoring allows banks or institutions to provide cash flow support to an MSME against receivables; and an act has been passed to allow factoring, in 2012 January. SIDBI can act as a credit guarantor for SME factoring, for which the budget has given it Rs. 500 cr.

Additionally, SIDBI’s refinancing facility for SMEs (that is, they take on part of the risk of SME loans made by other financial institutions) is now enhanced to Rs. 10,000 cr. (from last year’s 5,000 cr.). SIDBI even has a website for this.

MSME benefits to continue upto three years after

Micro, Small and Medium Enterprises (MSMEs) may get the MSME ministry to pay for participating in international fairs, or for credit guarantees (mentioned earlier), or for other such schemes that are not tax related.

The budget has proposed that if an MSME should move into a larger bracket and lose the MSME status, it can continue with the above benefits for the next three years.

Incubators for CSR

Funds provided to incubators within colleges and approved by some ministries will now qualify under the Corporate Social Responsibility (CSR) utilization that all companies need to spend on, with at least 2% of their net profits. This is great if you are an incubator inside an institution, but you really need to be going out there, really gung-ho, trying to get funds allocated before the next “insti” starts its round.

SMEs can list without IPO with informed investors

There are now pure SME exchanges with less onerous listing requirements. While they created the tool, they must have squealed in delight. Listing though, has been way too ineffective, with complex listing requirements needed even now. This can be fixed, but the exchange will have to find the traders.

However for new issues , you can list your SME in this exchange, and if you don’t want to do a full open offer, do an offer to “informed investors”.

Unlisted Buy-Backs Get Taxed

Private limited companies might resort to buy-back agreements to offer their investors liquidity. An abuse of this is to use the buyback route to provide money to investors; if the companies buy back at a low enough price, then shareholders can get money in their pockets and pay a very low tax (as capital gains). This has been blocked by the budget, stating that all unlisted company buybacks must pay 20% on the money.

This is scary and throwing the baby out with the bathwater. Buy-backs serve a useful clause as well – to provide liquidity or partial exits to investors, However, there is hope. I can recommend that you set up your company as an LLP where buy-backs of this sort are not at all necessary, since distribution and withdrawal are quite simple (no dividend distribution tax).

Startups and SMEs should learn to accept debt as a part of life and go apply for some of the ventures, even for small ticket loans where the government stands guaranteed. Money can vanish fast so don’t splurge.

What have I missed?

Jagan-Srinivasan Enquiry Explains the Startup Tax

1 Comment » Written on June 9th, 2012 by
Categories: StartupTax

When the CBI investigated BCCI Chief N. Srinivasan’s company, India Cements, they seem to have uncovered why the “Startup Tax” was introduced in the budget. (Read Full Set of Posts) The company invested in companies owned by Jagan Reddy, son of the late YS Rajasekhara Reddy, who was the Chief Minister of Andhra Pradesh, in a way that the CBI says was a disguised bribe. From Firstpost:

According to the FIR, India Cements made following investments in Jagan Reddy’s Companies:

- Rs 5 crore in Carmel Asia Holding Pvt Ltd, one of the 36 companies created by Jagan Mohan Reddy. He paid Rs 252 per share, while the promoters and group companies had paid only Rs 10 per share.

- Rs 15 crore in Raghuram Cements Ltd (now called Bharathi Cements) purchasing 12,50,000 shares at a premium of Rs 110 in 2007.

- Rs 40 crore in Jagathi Publications, which owns Sakshi TV and newspapers.

And in return, according to the FIR, Jagan Reddy’s father YSR Reddy rewarded Srinivasan’s India Cements with the renewal of a land lease in Kadapa district on 11 July 2008. Srinivasan’s cement company was permitted to draw upto 10 lakh gallons of water from Krishna river by a government order on 22 July 2008 and 13 million cubic feet of water from Kagna river through a government order on 12 September 2009.

“It is alleged that the promoters and group companies of Jagan Mohan Reddy had subscribed to the capital at par whereas all other shareholders had subscribed to the shares at a premium of Rs 252 per share in Carmel Asia Holdings as an alleged quid pro quo for the benefits which they got from the Andhra government,’’ the FIR says.

From MoneyLife:

Nimmagadda Prasad alias Matrix Prasad, touted as entrepreneur with a golden touch in the pharma industry, is also alleged to have followed the YSR/Jagan model of investing in their companies in return for getting access to various resources. Prasad has been charged with investingRs100 crore in Jagati Publications that publishes Sakshi Telugu daily, besides putting in another Rs244 crore in Bharati Cements and Rs200 crore in Carmel Asia, all floated allegedly by Jagan.

In return, Jagan's father, late YS Rajasekhara Reddy, allegedly allotted 15,000 acres of land in Prakasam and Guntur districts to Matrix Enport, the company owned by Prasad, for development of the Vadarevu-Nizampatnam Port and Industrial Corridor. Till date the project, initiated in 2007, has not made any progress.

This is important because this is why they decided to have an investor “explain” when he invests at a “premium” into a company. But why didn’t Jagan’s company just bill Mr. India Cements for some random service like “consulting”?

Because a service attracts service tax. Selling a product attracts VAT. And then, the receiving company has to pay income tax on the money it gets. The bribe taker would have to pay, for Rs. 100 received:

a) Rs. 10-12 in service tax

b) 30% of the remaining as income tax (since it’s a bribe they won’t even spend it)

The other method of taking it as investment instead is far more “tax effective”, with India Cements buying a tiny stake for a large sum. It’s not a service, so no service tax. There’s no income to the company – only an investment. So no income tax.

This is why they have created the new tax structure, which as a by-product kills all other legit startups as well.

I recall that I had been told this: even Reliance Infra had purchased shares into Reliance Power at a premium, while the promoter had bought shares at a far lower value a few months earlier.

The current solution – of limiting such investments to Rs. 5 crore - will not help much. The Jagan types will simply float more companies instead. But at least it will be noticed that a large entity is investing exactly 5 cr. in a big number of tiny shell companies, and then justice can happen.

What we need is a law that helps catch the Jagan types but still allow startups the ability to raise money from non-VC investors. But in the light of the massive fraud in the Jagan-Srinivasan case, we might not get an easy way out.

What to do then? Simple: don’t take money as equity. Take money as convertible debt instead. Debt reflects on company books and is likely to be questioned easily in cases like Jagan’s companies, while genuine investments are explained easily. And when the time comes to convert, you can convert it and then be able to explain that time’s valuation better.

(Note: This is not to justify the startup tax, but to state that if we want to repeal it, we need to address abuse cases like the case above.)

OT: Stay Long Term or Think Exit?

Comments Off Written on June 6th, 2012 by
Categories: Startups

Ravi Kiran talks about the Importance of Staying On. (Forbes)

The three most exciting events in the big-city start-up promoter’s life appears to be starting-up, raising funds and exiting. This is what a lot of start-up and VC media write about and a lot of people in the start-up ecosystem talk about. Many start-ups look at the Silicon Valley as a role model and fondly refer to it simply as ‘the valley’. They have been tutored to make ‘elevator pitches’, think of various types of the ‘addressable market’, create a ‘plan B’, learn to time a ‘pivot’ and provide ‘exit options’ for the investors. I am sure these are all important dimensions in business and every entrepreneur must learn about them, but sometimes I feel they are not tutored some other business basics.

One of those basics is developing an ability to ‘stay’ in business, something I find in much better supply in the entrepreneur in Middle India. The fact is starting, raising [funds] and exiting may appear glamorous and worthy of story material, but staying requires a different kind of attitude and skill. It’s a mindset and a ‘heartset’ thing, if you will.

While it is true in general that startups seem more enamoured by a build-and-flip model than by creating a business for the longer term, it’s almost sacrilege to uniformly apply a principle like “staying on for the long term”. My note in the comments section:

I've seen love marriages and I've seen arranged marriages. It seems statistics shows that 20% of love marriages end in divorce, whereas only 10% of arranged marriages do. People in love marriages seem to want to "exit" their marriages much earlier, because they don't try hard enough. People in arranged marriages, though, stay longer because even when it is simply not working out, they have the feeling that failure is not an option, and they will stay together, unhappy, passing on their misery to their children, fighting, not talking, but god forbid they ever use the word "divorce".

You could make that case. It's the same with startups.

There are startups that deserve a longer chance, and there are startups that don't. The service startups that you see today better make sense in a few years, otherwise you end up with something where you're running just to stay in the same place, and that's even worse than dying because it doesn't end. You could give a business 10 years and watch it just about make ends meet, or you could walk out and start another, faster growing company.

It's easy to justify staying on, and there are a lot of hero stories of those that did. What isn't apparent is those that are no longer visible - that guy who tried and tried and got his wife to eat one meal a day until she died. No one remembers him, or her. You have to stay true, but you have to stay practical. If at first you don't succeed, try, try, and try again, and then give it up and try something else. There's a fine line between brave and foolhardy.

The "Quality of Talent" Debate

4 comments Written on May 26th, 2012 by
Categories: Startups

An Open Letter to India's Graduating Classes from a KPMG partner is both eye-opening and outrage-inducing. He talks about how our graduating students are hardly prepared for the real world in terms of skills, problem solving ability, learning new things and being really professional. With very notable exceptions I cannot but agree; in general, there is an overall sense of entitlement, a lot of job-hopping and resume-shopping, a questionable work-ethic or a lack of "professionalism". It is difficult to find the right attitude and aptitude in the same person, and the cost-benefit equation can be exceptionally skewed. Some people price themselves out of the market.

But please note that these large type of companies are also to blame. Those that demand longer hours "when required" tend to be those that demand longer hours all the time, unless you have an emergency that your house is on fire and you can actually smell the smoke on the phone. Those that pretend to a potential customer that they are skilled in a certain technology, and then beg an independent consultant who actually does have that skill to sit in a conference call pretending to be a long-term employee. Then those that double-bill their clients on the number of hours worked because, well because they can. Those financial service companies and banks that tell their managers to lie outright to their customers, even if they are old and widowed and all that. The lala companies where you are expected to be a boss's man-friday. Those that refuse to give you your gratuity or PF benefits when you leave, or create unnecessary delays of months or years. And those that expect loyalty from you while, at the same time, giving a newcomer a salary twice yours as a "market" figure while he contributes far lesser than you. I'm sure you can think of more.

Everyone can rant and rave. Butevery dog has his day. Today, certain people are in demand. Tomorrow, unless they upgrade their skills, they won't be. Today just a large company's name is enough to get people to join it. Tomorrow, even they will have to grin and be proper employers to get the quality people they want. For years, new chartered accountants had no option but to work at salaries like Rs. 5,000 per month as an "apprentice" at large CA firms, working 18 hours a day, 7 days a week. Today they can get 5 times that much at newer firms and IT companies, and the old CA firms crib and crib and crib. Times change. People change, or get left behind.

I have, early in my career, taken Rs. 30 as auto fare as a reimbursement when I actually travelled by bus. I haven't job hopped (how do you do that as an entrepreneur?) but I've hired those who did (which in a way is my fault). I'm definitely inconsistent, being arbitrary when I wanted and demanding fairness otherwise. I hope I've changed, but it sometimes took an exiting employee to help me. I'll probably be both an employee and employer in the future. And I hope people (including me!) will change for the better, that companies will be better places to work.

TV Panel: Is E-Commerce a Bubble?

1 Comment » Written on May 14th, 2012 by
Categories: Startups

I was in a panel discussion on NDTV on Friday: Is E-Commerce a Bubble?

I got a little face time and wasn't able to articulate all the thoughts I had.

Geographical reach: Everyone's talking about Tier 2 and Tier 3 cities. Yes, people there have aspirations, and they have money. But they are also more sparsely populated (at least, the target population that has money). And they might need far more hand holding, and support costs. These smaller cities don't scale as well as cities, and the costs (of transportation, delivery etc.) remain roughly the same. So while you might get coverage, a policy of "free delivery" is totally unsustainable unless you have high margins. And if you have high margins, chances that you'll sell much in the Tier 2s or the Tier 3s is er, very low. Given that most of the e-commerce sites provide free shipping to any town, and still work on wafer thin margins, something has got to change to make this model work.

Losing Money: Yes, it's okay to build infrastructure and lose money, but my question really was - are you making money on an operating basis? Many might say we make money on a per-transaction basis. Per-unit costs can be fudged - for instance, one of things Mahesh Murthy mentioned was an accounting drama in some such startups. A customer would be given a "coupon" which allowed him a discount of, say, 30%. If he used it to buy, the accounting would reflect the per-unit transaction as (FULL Sale Price minus Cost Of Product). The discount, they would say, is a way to try and retain the customer long term, so that cost should be spread across, say, three years.

This is a load of bull, because customers that buy on a discount, for the most part, do not buy in the absence of a discount. That means you can sell to them today with a discount coupon, but they'll just leave if you try to charge full price tomorrow. Data will show this is the case, and from personal experience this is definitely the case. I'm not even loyal to my local vegetable vendor when I can get a bigger discount in a wholesale market, and that applies to most of India. The discount amortization theory is simply garbage.

In that vein, per-unit accounting might show a profit for some startups, but the reality may be different.

Plus, if your infra costs are just going up forever, and you never turn a profit, does it make sense as a business? See airlines. Or some hospitals (Fortis/Wockhardt). Or infrastructure players like GMR. Or most large media channels. There's enough interest, but there's no profit. That wheel turns as long as the lubricant of liquidity is being poured on.

Amazon: Amazon listed in 1997. In early 1998, it had about $147 million of sales, was making losses, and about 600 people handling about 2 million customers. The valuation was around $1.25 billion. Flipkart is valued at close to the same (though they have over 4,000 people and hearsay is about $100 million worth of turnover). This took three more years to go bust; Amazon went on to a market cap of over $40 billion before 2000. Bubbles can last incredibly longer and go much higher than you think.

The downside - Amazon's nominal price (that is adjusted for splits etc.) did not cross it's 1999 high till....2009. Since then the stock is up about 130% or so, but for 10 years it didn't do anything. Even now, Amazon has a P/E of 187 and a forward P/E (assuming estimates work) of over 88, with a mere 3% profit margin ($1.2 bn on a LInkedIn has a 700 trailing P/E and a forward P/E of 90. Much of the forward numbers are guesswork. And if you look at Amazon, it has grown, just that valuations have been way ahead of themselves.

Henry Blodget, who came to fame by calling a $400 price on Amazon in 1998 when it was $200 (and it got there in a month) mentioned a figure of $230 billion for online retail, of which expected 30-40% with Amazon, and with 4% margins and a 40 P/E, you get a valuation of $400 which at that time was a market cap of $150 billion, by 2013. Today, the stock has just 10% of the online market or less, and just $1 billion in profits, and still it commands a market cap of $100 billion (due to the 187 Price to Earnings ratio). Blodget was wrong, but the market hyped up Amazon anyhow.

The deal is - if you want to be Amazon, you have to get those ridiculous P/E ratios. Like LinkedIn. Or Facebook which will come.

Listing: At the 500 cr. turnover level, players should be listing themselves in the Indian stock market. It's entirely silly because we thirst for quality players and detailed numbers. If these players are doing the right things, they should go public now (or should have already gone public). But they aren't doing so - and I hope the reason isn't that their numbers are not in any shape for disclosure. Should they list, I have no doubt they will also get the 90 P/Es etc. I will even buy some of these players if they shoot through the roof - no point missing a great return based on an opinion of profitability. Will exit just as quickly.

Competition: I'd mentioned toys are an unsatisfied niche but it turns out Infibeam and FirstCry have a section. Of course, I would say they need much more - the long tail of toys, if you may - but perhaps I should stop saying that toys are not being addressed.

Bubble or not? Who cares. You and I get great deals at low prices. Some random investor will lose money on a per-unit or company basis. Do you give a damn? I don't. I bought my TV at a mall which offered me a Rs. 200 price lower than Flipkart. You know why? Because it doesn't make any sense to buy from Flipkart when I have a better price for the same darn TV. This has applied to mobiles, to airplane tickets, to books even. Eventually, yes, some players will die and prices may go up - but I can count on the ingenuity of startups to find more investors and lose their money by giving me further discounts. The telecom and airline space are great examples of this.

But bubbles are all about valuation. It doesn't matter if people in Tier 2 or Tier 3 cities are a great market, or if the Indian consumption story is the next big thing. No one's arguing against that. It's just that the valuations given to startups who are trying to attack this place are ridiculous. Consider that Pantaloon Retail and Shoppers Stop are valued at far lesser than $1 billion today, though they have way more customers and Pantaloon is making profits today; online site valuations might just be getting way ahead of themselves. Still, without even a single Indian e-commerce player listing (and therefore, us knowing about the finances) we can't really call it a bubble. It might have some time to go.

There were too many illustrious people on the other side, and my credentials in the e-commerce business are approximately zero, in comparison. So pinch of salt and all that.

Startup Tax: Diluted To Allow "Angels"?

Comments Off Written on May 7th, 2012 by
Categories: Budget2012, StartupTax

The FM, in his remarks while introducing the Finance Bill today, provided some relief to the startup community by potentially allowing angel investments to not attract the Startup tax.

(For More: Read the E-Book, and all posts)

It has been proposed in the Finance Bill that any consideration received by a closely held
company in excess of the fair market value  of its shares would be taxable.  Considering the
concerns raised by "angel" investors who invest in start-up companies, I propose to provide an enabling provision in the Income Tax Act for exemption to a notified class of investors

Let's not rejoice too early. We don't know what the enabling provision is, just  yet. I will post when I find out (and please, do let me know if you do!).

An angel investor isn't a specified class anywhere in any act. The only specific kinds of investor entities are a) Venture Capital Funds or b) Private Equity Funds. Other forms include large institutions like Mutual Funds, Insurers, Pension Funds etc. The concept of an "Angel" is just an individual that invests in a company at the early stage. So I would expect the definition to include equity fund infusions into companies, by individuals, below a threshold limit (say Rs. 10 crore).

Of course, this does create other problems, like what about private equity funds or insurers or other investors investing large sums of money into companies. (Nowadays, e-commerce shops easily raise $15 million) But there are proper venture funds investing here, and these are exempt from the Startup Tax implications.

But this is great news in that the Startup Community has managed to get the FM's ear. Some people have told me I was the first to break this news, and that makes me feel good. What matters, though, is that this has found the ears of the powers that be, and I hope this issue gets resolved soon.

FREE E-Book: The Startup Tax in India

1 Comment » Written on March 27th, 2012 by
Categories: StartupTax

I consolidated material from all the posts on the Startup Tax in India and put it into an easy-to-download E-Book (PDF). I hope you like it!


As things change, I will update the E-Book.

FAQ on the Startup Tax

1 Comment » Written on March 21st, 2012 by
Categories: Budget2012, StartupTax

Lots of questions have come in on the Startup tax post (Angel Investors Beware: Funding Startups Could be Classified as Income) and I’ve tried to address them here. The idea, for those who don’t have the time, is that investments in any company must now be “justified” to a tax officer, unless they are by a VC fund. If the tax officer finds that the money was more than “fair market value” using a set of criteria that are irrelevant to most tech startups today (valuing physical assets etc.), then whatever is extra will be recognised as “income” on the startup’s books, meaning they have to pay tax on it.

It’s Only Active In 2013-14!

The clause applies to “Assessment Year" 2013-14. In that year, you file taxes for 2012-13. It’s one of those strange budget things, but when they say assessment year they mean it applies to the year preceding it.

See the memorandum and search for Section 56, this clause is at the end:

This amendment will take effect from 1st April, 2013 and will, accordingly, apply in relation to the assessment year 2013-14 and subsequent assessment years.

The Clause applies to investment from a “Person”. Angels can create a company and invest.

Under Section 2 of the IT Act (“Definitions”) :

“person” includes—

(i) an individual,

(ii) a Hindu undivided family,

(iii) a company,

(iv) a firm,

(v) an association of persons or a body of individuals, whether incorporated or not,

(vi) a local authority, and

(vii) every artificial juridical person, not falling within any of the preceding sub-clauses.

The last entry could even include an LLP (which is currently not listed specifically). But effectively this blocks any form of angel investment whether directly or through an investment vehicle (other than a VC fund, of course).

Startups Will Spend All That Money, So No Profit To Pay Tax On!

If a startup gets investment it will use most of it up in the year. Even if the tax department classifies the money as income, it will be offset with the expenses thus, no tax will apply.

Two points to note here. First, these “loss” that startups incur in the first few years are offset by profits in subsequent years (losses are “carried forward”). This is a tax element that is legitimate; so if you make a profit in subsequent years, you don’t have to pay the government any tax until you’ve covered up your earlier losses. Effectively, by treating investment as income, the startup tax will eat into future profits. (Loosely speaking, losses carried forward are an “asset”) Either you will pay the tax todaa, or tomorrow; it’s a tax all the same.

Second, note that not all expenses are written off in the first year. Yes, some are, like salaries. But if you buy assets – tables, chairs, a UPS, equipment, machinery and such – these are “depreciated” over time (a different time for each kind of asset).

In a simple scenario where you get Rs. 10 lakhs and use it to invest in equipment with a depreciation rate of 10% a year, the total ‘expense’ in the first year is Rs. 1 lakh. If the investment is treated as income, you have 10 lakhs of income with 1 lakh expense; so your “profit” is Rs. 9 lakhs, on which tax applies. (Remember, at this point you don’t even have money as you used all that 10 lakhs to buy equipment)

But This Will Curb Black Money?

If anyone is aware of the system of black money, it is the tax department. Black money is either money on which you don’t pay tax, or money obtained through corruption. (or both) If an investor legitimately invests in a company, using a cheque from a bank account, is the “black” money the fact that his money is tainted? In which case, use the “Section 68 amendment” to explain the investor’s sources instead; this fair-market-value clause is unnecessary. (Read: Private Cos: Investors Must Reveal Source Of Funds)

The other thing is that this clause does not apply if your investor is a non-resident. Most people know how easy it is to route money abroad and then bring it back as “investment”; if that is all it takes, how can it prevent black money?

Can’t Startups or Angels go Abroad?

Not every investor can, and it’s expensive, through it seems the Singapore route may not be. However, do we really want to be telling our startups that we can’t invest in them unless we go abroad? And what’s to stop the tax department from easily including foreign investment in the clause?

Going abroad has other ramifications. Wealth held abroad is subject to wealth tax. From this budget, you have to report in more detail on your holdings abroad; if they find out you’ve created a company abroad to invest in Indian companies, will they just ignore it? The General Anti Avoidance Rules (GAAR) will likely be used to squeeze the life out of the investor.

Startups going abroad is more painful. You hire here, you work here, you know the market here. How do you service that market from abroad? If you sell locally, you need local presence. While some companies will be able to go abroad, create an entity, and then come back create an Indian subsidiary, this avenue is fraught with risk and expense.

I hate to think of “going abroad” as a solution. In the 90s, I refused because I wanted to start a company. In the 2010’s I should go abroad if I want to start a company? Jeez.


If you have more questions, please comment here. I’ll update this page.

Ramadorai, Ex-TCS-CEO, Will Advise Govt On Startup Tax

Comments Off Written on March 21st, 2012 by
Categories: Budget2012, StartupTax

The Startup Tax situation has elicited serious response. has reported that the Ex-CEO of TCS, S. Ramadorai, has been asked to advise the government on the issue.

Indian government has asked S. Ramadorai, ex-CEO of TCS to advise the government on startup tax bill. S Ramadorai currently serves as an advisor to the Prime Minister of India in the National Council on Skill Development, Government of India. He holds a rank equivalent to an Indian Cabinet Minister.

More from ET: FinMin says New Safeguards For Angel Investors

The finance ministry has said it could bring in more safeguards in the income-tax law to ensure that genuine angel investors are not impacted by a budget proposal to tax exorbitant profits by venture capital funds, but effectively ruled out a rollback.

The use-case that the government is looking to plug is where a large sum of money comes in from an Indian resident into a company, which classifies it as “share premium”. This money has no service tax, and the company pays no income tax on it. The “investor” may get a few shares at a very high rate (say Rs. 1 crore per share). The company gets to use that money for regular expenses, and never pays any tax.

How would the government differentiate that situation from, say, a situation where an angel or seed level investor buys into a startup, and pays a premium because the founders bring in knowledge or experience or connections or passion?

It’s going to be tricky but I imagine what will eventually happen : The tax department will only demand an explanation for investment above, say, Rs. 3 crores per year.

What do you think?

The current workarounds for angel investors are:

a) Go abroad. The tax rule applies only to investments from Indian residents.

b) Use convertible debt, where the investor doesn’t buy equity shares but uses some sort of convertible instrument issued at par, where the convertible ratio may be either deferred (decided later) or pre-decided.

c) Invest in your stake at par, provide the rest of the money as a loan. This has structural issues with new investors coming in, for legit startups.

d) Create the startup as an LLP instead. This has no concept of “shares”.

The tax-evaders can use these routes as well, remember. It’s going to be very difficult to design a system that keeps out only wrong-doers but allows the large majority of valid investments.

Startup Tax: Becoming a Venture Capital Fund

1 Comment » Written on March 19th, 2012 by
Categories: StartupTax
Also Read: Angel Investors Beware: Funding Startups Could be Classified as Income

Many investors have asked, privately, if they can set up a Venture Capital fund, because any company such funds invest in, will no longer get the startup tax.

Such VC funds have regulations from SEBI. You will want to read:

The burning questions, though are:

Who can apply?

Any company, trust or “body corporate” (typically, institutions). No LLPs, currently. No individuals.

Comapnies or trusts need to have their “main objective” as carrying on the activity of a venture capital fund. A company can never request offers from the general public (can only get money as private placements).

The directors or trustees must not have any litigation connected with the securities market, and should not have been convicted of any offense involving mortal turpitude or fraud.

What are the financial restrictions?

There is no “minimum paid-up capital” restriction that usually appears in SEBI regulations. Technically any company that passes muster can apply.

A VC fund can raise money from any investor, Indian or otherwise. But the minimum investment is Rs. 5 lakh per investor .

Additionally, a VC fund will create “schemes” for investment, and each such scheme will have a firm commitment for at least Rs. 5 crores before the VC fund is started.

Note here: the minimum investment may be increased to Rs. 25 lakh soon, given the way things have changed with respect to Portfolio Management Schemes (PMS).

Where can VC Funds Invest?

A VC fund can’t invest more than 25% of its entire corpus in one startup. It has to invest at least 2/3rd of the corpus in equity shares or convertible debt of unlisted companies. The remaining 1/3rd can go into IPOs of startups, pure debt to an investee company, locked-in preferential shares or listed equity shares of a loss-making or sick company.


SEBI charges Rs. 100,000 (one lakh) per application. If the application is okayed, the VC Fund must pay another Rs. 5,00,000 (Five lakhs).

(This is where most angel funds will balk. Effectively, another tax.)


A VC Fund is expected to have a  placement memorandum, with the fees, charges, investment philosophy, tax implications, time period etc. This has to be filed with SEBI, along with a report of all money collected from investors.

SEBI can also ask for any information on demand, and requires proper books to be maintained. It can also investigate through physical checks.

Remember, SEBI is a heavy regulator here. It can even appoint a director level person to take charge of the entire fund and the investments if it feels it needs to do so to protect the interests of investors.


Look at the list of registered funds here. You may be able to piggy-back on them if they can create a pass-through scheme charging low fees, which avoids the new startup tax.

The VC Fund regulations might be time consuming, and they are expensive. And the Five crore “firm commitment” required can stymie many of the angel networks that currently exist (though they may be able to piggyback on an existing VC).

Most early stage investments are less than 50 lakhs; sometimes as less as 5 lakhs. These will be hit by the startup tax. If there is a tacit agreement that tax-authorities won’t try to enforce this law vehemently, things will still go ahead. And I expect they will; the risk-reward equation is so high that it’s worth the change. Plus, remember, as a startup:

a) You’ll be called for scrutiny only if you get really big. (Small investments might not be worth their time)

b) If you get really big, the tax you’ll pay on that angel level investment is going to be tiny, and in all likelihood you can explain away your early “over-valuation” saying: see, we got this big today, the valuation was justified.

But this is small consolation. People like things to be straightforward. It’s not nice to have to look over your shoulder all the time. Our government doesn’t make it easy.

Private Cos: Investors Must Reveal Source Of Funds

Comments Off Written on March 18th, 2012 by
Categories: Budget2012, Startups, StartupTax

Also Read: Angel Investors Beware: Funding Startups Could be Classified as Income

Yet another amendment in the budget will open a can of worms, though this one might seem roughly acceptable, even if it is a big bother. In the Budget, another unnoticed clause requires an unlisted company to know the source of the funds of every single investment of each investor. The only exception is for money received through venture capital funds.

In the Finance Bill, you will see this clause (Search for “section 68” – it is item no. 22, on page 10)

In section 68 of the Income-tax Act, the following provisos shall be inserted with effect from the 1st day of April, 2013, namely:—
“Provided that where the assessee is a company, (not being a company in which the public are substantially interested) and the sum so credited consists of share application money, share capital, share premium or any such amount by whatever name called, any explanation offered by such assessee-company shall be deemed to be not satisfactory, unless—

(a) the person, being a resident in whose name such credit is recorded in the books of such
company also offers an explanation about the nature and source of such sum so credited; and

(b) such explanation in the opinion of the Assessing Officer aforesaid has been found to be

Provided further that nothing contained in the first proviso shall apply if the person, in whose
name the sum referred to therein is recorded, is a venture capital fund or a venture capital company as referred to in clause (23FB) of section 10.”.

Section 68 currently has only this inside: Where any sum is found credited in the books of an assessee maintained for any previous year, and the assessee offers no explanation about the nature and source thereof or the explanation offered by him is not, in the opinion of the Assessing Officer, satisfactory, the sum so credited may be charged to income-tax as the income of the assessee of that previous year.

Let me put this in simple words:

If you have some money that you can’t explain how you got, we’ll assume it is income and tax you.

This is okay. If they find money in your house, or in your bank account, they can ask you where it came from, and you have to get your act together.

The new addition in this budget is:

Oh, if a company gets some money from any Indian resident investors as an equity investment of any sort, that investor needs to tell us how he got that money. If not, we’ll consider it income and tax that company.

This applies:

a) Only if you get investment from resident individuals or companies

b) If the money is in any kind of equity form (including convertible debt, preference shares or whatever). It might not apply to a loan (though I’m not sure about that).

c) Money received from VC funds (as registered with SEBI) will not have this restriction.

Why On Earth Does This Have To Be Done?

It seems too many scams are now happening through random privately owned entities, where the source of funds is unknown. From a DB Realty and the whole Raja scandal, to some smaller issues with Jagan Reddy’s companies, certain private companies have received some money from a resident investor for buying shares, but the source isn’t known.

This law means that the IT department will question the company on the source of such funds – that is, where did the investor get it from? If the investor isn’t able to provide an adequate explanation, the company will be taxed on the investment, assuming it is income.

What Does It Mean To Us?

If you are a startup founder, and you are looking for investment, please make sure you have a statement from each investor about the source of the funds he/she invests. I don’t know how this can be obtained, but the funds could be from accumulated reserves (typically this will need past tax return or a CA statement saying so), or from borrowings (for which there needs to be proof). Such statements should also be taken from the founders themselves.

If you are an angel investor or an LLP/company that buy stakes into other companies, then you need to be ready that if there is a request, you will need to produce proof of the “source” of your income. You may want to give a statement to the investor stating such sources, but more importantly, if there is a scrutiny, you will need to convince an assessing officer about the source of funds that you used to invest.

This can be painful, I agree. And a scrutiny is unlikely to be brought up just for the heck of it, because let’s face it, the IT department has bigger fish to fry. But startups, be ready; once in a while, the assessing officer might just want to abuse his power, and you have to be ready for such demands.

This is a cumbersome law, we have to be able to deal with such demands. Given the ability of our countrymen to create black money, the legitimate folks have to bear a little bit of the cost to control the menace. If we are willing to sign online petitions for Anna Hazare, this is the least we can do – agree to reveal the source of our funds.

The bad part: Obviously this clause can be abused. Say the assessing officer refuses to accept a valid source of funds and charges tax anyway: What then? Answer: You will have to go the legal route – there is a sequence of appeal in the legal system. Remember, the assessing officer loses something – from face to promotions - if a court finds that he was unnecessarily refusing a valid source. So they won’t summarily overrule sources. Too often, people get scared of courts and decide to agree to whatever the officers say, and tax officers use that fear to extract more. But if you are persistent, they’ll listen to you.

(While I know this has been addressed to startups, it applies to any private company that gets investment post March 31, 2012)

Startup Tax: Tax Dept Tells You How To Value Your Startup

Comments Off Written on March 17th, 2012 by
Categories: StartupTax

We know now that the new amendment in the budget will attempt to tax angel investors that want to buy into a company at a “premium” valuation, a concept rife in the startup world.

The "Startup Tax” article has generated some excellent responses. Among them is Rajesh’s reply which I’d like to highlight in a separate post: Rajesh says:

You can always prove the FMV and we will hopefully know it in the fineprints. There is however an existing notification (NOTIFICATION NO 23/2010, Dated: April 8, 2010) for valuing unquoted shares and securities. You may find the details of this notification here –

If you check the last clause(c) for valuing unquoted shares and securities, the FMV of unquoted shares and securities, other than equity shares in a company which are not listed in any recognized stock exchange, can also be estimated to be the price it would fetch if sold in the open market on the valuation date and the assessee may obtain a report from a merchant banker or an accountant in respect of such valuation..

Thus, all that you as a startup might have to do is get the valuation done by an accountant or merchant banker and give a report to the tax man.

And it is reasonable for the tax man to require the startup to get a valuation report from a qualified person.

If I was the valuer, I might do this. Estimate the earnings (E) for the following years, determine the PE of listed companies in the same industry as the startup and apply such PE (avg. or the lower PE) to arrive at the FMV or market price (P) of an equity share in the startup.

I think this is good feedback, about a way to work around the valuation rule.

My reply:

Rajesh, at the seed level, you can’t estimate any earnings accurately. You can only take a wild guess. In fact, most seed level valuations happen with no income in sight for the next one or two years. There is no P/E if there is no earnings (profits). Merchant bankers have found it very difficult to value such companies anyhow, but let’s

Secondly, that’s not what the clause says, I just read it carefully:
…the fair market value of unquoted shares and securities other than equity shares in a company which are not listed in any recognized stock exchange can also be estimated to be the price it would fetch if sold in the open market on the valuation date and the assessee may obtain a report from a merchant banker or an accountant in respect of such valuation..

What I have marked in bold above means that this clause does not apply to unlisted equity shares. You could apply it to unlisted preference shares, stock options (which are securities), RSUs, or other such shares.

The equity share valuation is above in the link you specified.

the fair market value of unquoted equity shares shall be the value, on the valuation date, of such unquoted equity shares as determined in the following manner namely:-

The fair market value of unquoted equity shares = (A-L) * (PV)

Where, A= Book value of the assets in Balance Sheet as reduced by any amount paid as advance tax under the Income-tax Act and any amount shown in the balance sheet including the debit balance of the profit and loss account or the profit and loss appropriation account which does not represent the value of any asset.

L= Book value of liabilities shown in the Balance Sheet but not including the following amounts:-

(i) the paid-up capital in respect of equity shares;

(ii) the amount set apart for payment of dividends on preference shares and equity shares where such dividends have not been declared before the date of transfer at a general body meeting of the company;

(iii) reserves, by whatever name called, other than those set apart towards depreciation;

(iv) credit balance of the profit and loss account;

(v) any amount representing provision for taxation, other than amount paid as advance tax under the Income-tax Act, to the extent of the excess over the tax payable with reference to the book profits in accordance with the law applicable thereto;

(vi) any amount representing provisions made for meeting liabilities, other than ascertained liabilities;

(vii) any amount representing contingent liabilities other than arrears of dividends payable in respect of cumulative preference shares.

PE = Total amount of paid up equity share capital as shown in Balance Sheet.

PV = the paid up value of such equity shares.

This kind of valuation metric is horrendously inadequate for a seed or angel level funding (there won’t be any profit, or reserve, or much paid up capital!)

If you say then that the company shouldn’t be valued so much, then I will tell you that is bunkum. The whole of Silicon Valley has been built on this principle, that you let founders go build companies and give them money, and leave them enough equity to make their effort worthwhile.

Finally, the point is this: It’s stupid to do this law for multiple reasons. First, there are WAY too many startups with investments from friends, family or angels. In comparison with the “black money” funded startups, these regular startups are probably 1000:1 (even going by the number of cases that have been raised for scrutiny) So all this does is cause hardship to more people for the sake of catching a few. Gassing room for mosquito.

Next, The folks that have black money can easily route their money abroad and have a foreign entity invest back into the Indian company – in that case, this stupid valuation metric etc. is NOT EVEN REQUIRED! (it only applies if your investor is an Indian resident).

Plus, the section 68 change [I will elaborate] already requires a company to have a record of where the investor got his money from – that is onerous but more understandable as a law. So effectively, this Section 56 clause (the one that needs valuation) does not prevent ANY money laundering, except by stupid people who can be caught using Section 68 anyhow.

All it does is create enormous power in the hands of an IT Assessing officer to harass legitimate startups. Such discretionary powers are the root of corruption, and we must avoid creating such ambiguous laws completely. What would be best is to remove this law completely, by understanding that valuation is not something IT officers will ever understand, and therefore there is no incidence of tax when a company is invested into. This is the law all over the world, and it exists for a very good reason: common sense.

[Correct me if I’m wrong please…]