By Ritesh Banglani, Stellaris Venture Partners
Folks are quite fond of saying, ‘Data is the new oil’ — data is the fuel that powers the new economy. However, data and technology are also the new oil in another sense — they are the most strategic national assets of the 21st century. Yet, India is, unknowingly but systemically, handing over ownership and control of technology companies to foreigners.
Take autonomous vehicles, a.k.a. driverless cars. At some point in our lifetimes, they will constitute a majority of vehicles on Indian roads. This technology should be domestically owned and controlled. However, an Indian company that develops such technology has a near-zero likelihood of raising money domestically and, in all probability, will be majority foreign-owned even before the product is launched.
Let’s start with tax policy, which actively discourages domestic investment into technology startups. An Indian angel investor is taxed at 29% for gains made on a startup investment. A foreign investor pays 10%. A stock market investment by the same Indian investor is taxed at 11%. On top of that, she must report to the taxman her shareholding in each startup company and its current value on an annual basis, only for that value to be questioned by tax authorities. Why should she even bother with such a risky asset class?
The world over, large financial institutions are the primary investors in startups, either directly or through venture capital funds. India took a massive step by setting up the Fund of Fund for Startups (FFS) in 2016, with its Rs 10,000 crore corpus managed by the Small Industries Development Bank of India (Sidbi). This enabled many new funds to start investing in this asset class.
However, FFS has remained a flash in the pan. Other large Indian financial investors are discouraged from investing. Pension funds can’t invest at all; insurance companies can only invest with stringent riders that are hard to satisfy.
In 2012, Sebi set up a regulatory framework for domestic Indian funds that invest in startups, the Alternative Investment Funds (AIF) regulations. It was a regulation that finally provided the guardrails for funds to raise domestic capital. But the rules changed midstream. Sebi has come up with new guidelines that make it harder to run an AIF.
Just Paper Over This
For example, the new rules significantly increase the paperwork from the already insane amount generated compared to other economies. All this certifies is that you are following the terms of your existing paperwork, even when nobody claims otherwise. Venture funds (VFs) have extremely lean teams, with one or two people managing all fund administration. The new paperwork will only create employment for a range of consultants, outsourcing partners and auditors, increasing the expense burden on investors.
The new regulations also violate another fundamental tenet of the industry: that private equity is private. Sebi has now limited the terms that can be negotiated between investor and fund manager. Even the documents between the two need to be written in a specific format, even if both parties prefer something different. The funds will also have to disclose their performance to a third party, and the benchmarking will be made publicly available for all AIFs. Bye-bye nuance, hello mis-selling.
Absurdly, Indian VFs must pay GST on their cost of running the fund, because GoI defines ‘fund management’ as a service. It’s like saying a CEO is providing ‘management services’ to the company for which it must pay GST. The result, again, is a higher cost to the investor — about 3.5% of capital. Indian investors have to produce more paperwork, pay higher taxes, incur higher costs and operate within tighter constraints than their foreign counterparts. So, what can be done?
First, GoI needs to recognise the strategic importance of this industry. The top five most valuable companies in the world (and 7 of the top 10) are tech companies. Within 20 years, this should be the case for Indian companies too. These companies will control technology vital to areas like defence, governance, healthcare, transportation and industry. This realisation will hopefully spur policy action in the right direction.
Second, India needs a unified technology policy. This will require coordination between various government ministries and regulators to ensure everyone is rowing in the same direction. Hopefully, the policy formulation will involve representation from the industry — both startups and venture capital firms — so that its impact can be assessed in advance rather than post facto.
As important as the content of the policy will be its consistency and predictability. Startup investments are long-term and illiquid. So, investors will need an assurance that the rules won’t change midway.
Partners in Grime
Third, the mindset of the authorities must shift from one of suspicion to one of promotion. Far from being crooks, startup investors are the drivers of the brave new world and need to be seen as such. Domestic startup investors must be treated on par with foreign ones, and startup and AIF investments should be made at least as attractive to investors as public equity investments.
If AIFs are subject to the same rules as foreign investors, foreign capital is likely to be allocated too. This will retain control, if not ownership, within India. Not for a moment is anyone advocating for protectionism. But a level playing field with foreign investors is the least this industry needs.
(The writer is founder, Stellaris Venture Partners. Views expressed above are his own)