India wanted to help angel investors, instead it made things harder

Calling all angels.
Calling all angels.
Image: Reuters/Ilya Naymushin
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On May 24, the Narendra Modi government met a long-standing demand of the Indian startup community, announcing that angel investors will receive full exemption on their investments in startups. But certain conditions apply, effectively meaning that very few young companies gain from the move.

So far, an “angel tax” of over 30% was levied on funds invested by individuals in unlisted firms at a share price higher than the fair market value. Indian angel investors paid this hefty tax, even as venture capital firms and foreign investors were exempt from it.

Now, India’s income tax department has said (pdf) that angel investors will be spared if they fulfill a list of criteria, and the exemption will be retroactively implemented from April 11. These conditions, however, don’t make things easy for investee and investor alike.

For instance, if an angel investor has to get income tax relief, the startup drawing the investment must be approved by an inter-ministerial panel. This would include investors providing their know-your-customer (KYC) documents, among other things, possibly lengthening an already tedious process.

Moreover, a startup must be certified either by a government body or listed with an approved incubator. It must also meet the government’s definition of a startup: incorporated in the last seven years—10 years if in the biotechnology sector—with less than Rs25 crore ($3.7 million) in turnover.

“There are a set of conditions to get certified by a body which says you’re a startup, which itself takes time. It’s not like I apply today, and get a certification by the end of the day,” said Anil Joshi, founder and managing partner at investment firm Unicorn India Ventures. “If that (meeting the government’s startup definition) itself is going to take time and startups cannot raise money until the time they’re certified, it’s only going to delay the process more.”

Between the  lines

The government has also made it mandatory that the valuation of a startup during its funding round must be set by a merchant banker registered (pdf) with the Securities and Exchange Board of India and not just any chartered accountant.

“When you invest in a startup, you’re investing in a pre-revenue, innovative proposition for a disruptive idea. There’s no cash flow so you need to use projected discounted cash flow,” said Padmaja Ruparel, co-founder of the Indian Angel Network. “Only people who understand the sector understand the space, the pain points. A valuation certificate from a merchant banker who’s not likely to understand the sector or potential makes little sense.”

Then there’s the fact that hiring a merchant banker doesn’t come cheap, and spending all that money for an angel round, which is typically only a few million dollars, will increase the cost of funding, said Unicorn India Ventures’s Joshi.

The angel investor, too, must fulfill tough criteria. The individual must report an average income of Rs25 lakh for the last three years, or a net worth of Rs2 crore at the end of the previous financial year.

Such high thresholds can potentially prevent fraudulent investments, but they could also deter several authentic angels.

“There may be someone who understands angel as an attractive class (of investments), they may understand the tech behind a startup and they may be willing to take a risk,” said Zishaan Hayath, co-founder of ed-tech startup Toppr and angel investor for Ola and others.

“Say, someone who graduated from IIT two or three years ago has Rs30-odd lakhs to invest but no Rs2 crore network to show,” he said. “They’re still better suited to make a tech call than somebody with a higher net worth is, but this rule will disqualify the younger and qualify the richer.”