Has the government been able to turn the tap on startup funding?

Market followers are not strange to the word “Startup” because of the ever increasing buzz around it. An entity (either a registered Company, an LLP or partnership firm) is considered a Startup up to five years from its date of incorporation/ formation and/or till its turnover does not exceed Rs. 25 crore and is working towards innovation.


The Startup Action Plan was unfurled by the Government of India in January this year, which promised a number of special exemptions for startups with a view to breed entrepreneurs and turn India into a job creating nation.

In the nascent stage, a startup requires funding to strengthen their foothold, which primarily consists of having more cash on hand as well as creating flexibility in raising funds. Likewise, Government of India has modified various provisions under the law in order to increase cash liquidity for startups as well as building a suitable ecosystem for startups to grow and flourish.

A provision for three year tax holiday has been made for startups that have the certificate of eligible business from the Inter-Ministerial Board of Certification and are incorporated on or after April 1, 2016 but before April 1, 2019. As most new companies require heavy upfront investment and make no to very less profits in the initial years, this exclusive provision for startups will definitely increase the possibility of budding entrepreneurs taking the plunge of making their own.

Apart from the three year tax holiday, Government, inter alia, amended Section 56(2) (viib) of the Income Tax Act whereby no tax will be levied on capital raised by startups from domestic investors which exceeds the fair market value of the startup’s shares.

Pseudo named as “Angel Tax”, this amendment comes as a breather for startups seeing that the domestic investors that are not registered as venture capital funds will be able to invest without worrying that the excess amount would be taxed, inevitably giving a boost to domestic investments.

Also, on June 29, 2016, the Government released a notification which has the potential to further strengthen the government’s resolve to foster entrepreneurship. The notification amends the Companies (Acceptance of Deposits) Rules, 2014 whereby any advance of more than Rs 25 lakh raised by a startup shall be exempted from being considered a deposit (of course, this comes with caveats!). The definition of deposits under the Companies Act 2013 is an inclusive one with specific exemptions. Apart from the exemptions set out under the meaning of the word deposits, monies raised in any other manner is construed as deposits and consequently companies have to follow stringent deposits rules.

The caveat to this relaxation is that the amount of Rs. 25 lakh or more should be received by the startups:
– by way of a convertible note which is convertible in equity shares or repayable within a period not exceeding five years from date of issue; – and the monies should be received in a single tranche from a person.

“Convertible note” has been defined to mean an instrument that evidences the receipt of money, initially, as a debt, but which is repayable (at the option of the holder) or which is convertible into such number of equity shares of the startup company, upon occurrence of specified events and as per the other terms and conditions agreed to and indicated in the instrument.

Even though a new term ‘convertible note’ has been coined, it is more or less similar to widely known optionally convertible debentures. Debentures are a type of instrument secured against assets through which companies borrow monies whereas it yields a fixed rate of interest for the debenture holder. Debentures may be convertible into equity shares or may be non-convertible. When companies issue convertible debentures, it has to be either (i) a secured debenture with a charge on the assets of the company; (ii) compulsorily convertible debenture to be converted into shares within ten years, or (iii) unsecured listed non-convertible debentures.

In light of this amendment, a startup will be able to raise finances by way of the convertible note which has the option to be converted into shares without any statutory requirement of creating a charge. Also, Companies (Acceptance of Deposit) Rules, 2014 under the Companies Act, 2013 made it difficult for startups to raise funds due to the sheer number of compliances to be made. This is a welcome move as startups often struggle to obtain funds and due to which many of them die down even before their wings start to grow.

These tax and other finances related exemptions are novel and come as a relief to entrepreneurs when it comes to raising finances. Apart from the reliefs related to taxes, there are various sops for startups in relation to administration, compliances, etc. such as – relaxed norms for public procurement (exemption from the criteria of “prior experience/ turnover”, whenever a tender is floated by a government entity or a PSU, without any relaxation in quality standards or technical parameters), self-certify compliances under labour laws, possibility of issuance of sweat equity shares up to 50% of paid up capital up to five years from the date of incorporation/registration, issuance of ESOP to the promoters and to director who directly or indirectly holds more than 10% of the outstanding equity shares of the Company, etc..

There are not only relaxations in laws, but also assistive schemes such as the Startup India Intellectual Property Protection (SIPP) Scheme which provides for fast-tracking of patent applications, set up of panel of facilitators to assist in filing with the government bearing the cost of such facilitation, provision of 80% rebate on filing of patents and filing procedures being simplified with significant reduction in fees for filing Patents. A hub to act as a single point of contact has been created for startups and a mobile application has been made for registrations.

Money does not change anything it just helps one expand horizons. In this case we are referring to budding startups. A little money made available to them might as well facilitate a new Silicon Valley in our country.


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