As the startup funding winter comes to a head, both companies and investors are bracing for some tough times ahead. Apart from uniform taxation across the ecosystem, venture capital (VC) and private equity (PE) players hope the interim budget will bring some clarity to recent circulars issued by regulatory bodies.
Startups have had to deal with challenges in raising equity rounds in recent times. According to a report by market research and data platform Tracxn, 2023 saw the lowest funding raised by startups in the last five years, with a 72% decline year-on-year.
On the other hand, the market regulator Securities and Exchange Board of India (SEBI) has been pushing for regulatory compliance and transparency for Alternative Investment Funds (AIFs), which form the basis of private investment vehicles in India.
Industry body Indian Venture and Alternate Capital Association (IVCA) says that it anticipates potential rule changes and clarification on circulars to address concerns of the industry. “Multiple discussions have taken place, fostering a collaborative effort to address key concerns areas,” IVCA adds in response to queries by YourStory.
Clarity on excuse or exclusion clause
As part of its discussions with the finance ministry, IVCA has sought clarification regarding the circular from SEBI from April 2023 on the excuse or exclusion clause for investors in an AIF. The circular allows AIF to excuse its investors from participating in a particular investment if participation violates existing laws, and other circumstances.
IVCA, in its representation, has sought clarification on the excuse clause that allows insurance companies and pension funds to invest in AIFs, thus encouraging capital inflow.
<figure class="image embed" contenteditable="false" data-id="536472" data-url="https://images.yourstory.com/cs/2/bc14afb0357911eca2270b39b804102d/VCandPEBudget2024Graphic-1706534493396.jpg" data-alt="Key asks of VC and PE sector for Budget 2024" data-caption="
Key asks of VC and PE sector for Budget 2024
” align=”center”> Key asks of VC and PE sector for Budget 2024
“Despite SEBI allowing excuse and exclusion rights, other Indian regulators such as IRDA have not accepted the same. The case in point being, insurance companies are not allowed to invest overseas, directly or indirectly. However, insurance companies investing in AIFs do not give accord to such excuse and exclusion rights and insist that the entire AIF cannot invest overseas, which impacts the overall investment of the AIF,” Divaspati Singh, Partner at law firm Khaitan & Co tells YourStory.
He further said that the insurance and pension regulators will need to accept market standard terms such as excuse and exclusion and allow insurance companies to invest in AIFs which also have the flexibility to invest overseas. This will open up avenues of domestic capital in the ecosystem.
“One of the main objectives this year should be to create larger pools of domestic capital. Regulators should consider creating policies to improve the flow of domestic capital into the startup ecosystem. Startup investment should be considered with the same lens as that of the priority sector. Our focus should be to increase the share of domestic capital in startup investing from 15% to 25% over the next few years,” Vikram Gupta, Founder and Managing Partner of early stage venture capital firm tells YourStory.
“Banks, insurance companies, and pension funds need to be encouraged to invest. Further, the one way to encourage Indian family offices who have been looking at investing in startups as an asset class is through tax relief measures similar to those given in some of the developed countries,” he adds.
Excuse clause for regulated entities investing in AIF
As part of a circular issued in December 2023, the Reserve Bank of India (RBI) prohibited regulated entities such as banks and NBFCs from making investments in AIFs that have downstream investments in a company, which has taken debt from the particular regulated entity.
The circular requires the regulated entities with such an investment in AIFs to liquidate the investment within 30 days from the date of investment or to make 100% provision on such investments.
The circular prevents the evergreening of funds where the debtor company might use the funds raised from the AIF to pay off the loan from the regulated entity, while the regulated entity continues to be exposed to the debt indirectly through its investment in the AIF.
According to the IVCA, regulated entities have nearly 10% to 12% of the $100 billion capital commitments to the AIF sector.
“This move has dried up one major source of funding for startups as very young startups do not have collateral and rely on bank loans for capital needs. In a more enabling system, banks should be able to use the right of exclusion to be able to invest in AIFs and satisfy the regulations set forth by the RBI,” Padmaja Ruparel, Co-founder at and Founding Partner at IAN Fund.
Other issues to be streamlined
Uniform taxation for listed and unlisted securities and taxation of Employee Stock Ownership Plans (ESOPs) at the time of sale of shares continue to be on the wishlist across the ecosystem. Stakeholders also expect procedural clarification around valuation norms concerning the final rules notified by the Central Board of Direct Taxes in September 2023.
Ruparel of IAN further adds that there is a huge opportunity for FDI to flow into India with overseas investors looking at the country as a high growth market, and the government can play a big role in enabling the same.
“It is commendable how the government has opened up critical sectors to private startups such as defence and space technology. Having a ring-fence on PSU procurement from these startups for high-value items will boost value creation and innovation for startups,” she adds.
Anup Jain, an early-stage investor tells YourStory that SEBI should make it mandatory for VC firms to share how key decisions including profit share on income and carry shares are structured in the firm. “This is directly linked to commercials between partners laid out in a detailed LLP agreement which is currently opaque to the Limited Partners in the fund,” says Jain. He added that bringing in this transparency will widen the customer base for AIFs and build trust.
IVCA has also sought relaxation on the due date for filing Form 64D by venture capital firms as part of their tax returns. IVCA has proposed that the government allow unaudited financial statements as per the June 15 deadline, with extension to upload audited statements by September 30.
The industry body has also sought clarification on the Tax Collection at Source provisions under section 206C (1H) on sale of goods, to ensure that the provisions do not apply to AIFs, securities trusts, REITs and Infrastructure Investment Trusts.
Edited by Affirunisa Kankudti
