Deconstructing Startup India: What Narendra Modi didn't say

The biggest takeaway from the government's shindig with entrepreneurs last weekend is that it is trying to make life a bit easier for startups in the country, though the conservative way it defines a startup tends to take away some of its sheen.

Indeed, a closer look at the fine print reveals that some quantifiable measures announced by Prime Minister Narendra Modi's government on Saturday are also merely relabeling of old wine in the same bottle or out of sync with reality. Much of the industry is still basking in the brighter side of the initiative and not many were keen to come out openly to look at the plan from a critical glass. But here's a quick ringside look.

Are you a startup?

Let's start with the definition of a startup itself, as this would be crucial for entrepreneurs to even use many provisions for their benefit. A startup shall be eligible for tax benefits only after it has obtained certification from an inter-ministerial board created for such purpose. This body would be set up by the Department of Industrial Policy and Promotion, which is part of the commerce ministry, to validate the innovative nature of the business for granting tax benefits.

This means entrepreneurs who are eager to take benefit would have to deal with bureaucracy, besides having to think of their product, UI/UX, monetisation and so on.

The government has also put a lot of weight on incubators that would, in effect, become the first filter for chaffing out ineligible ventures. But these won't be any incubators, either. The incubators that are associated with a post-graduate college in India and are funded or recognised by a government agency would be the first recommendation port-of-call.

Alternatively, such startups would need to be already funded by a SEBI-registered investor. However, the government has said that it would come out with a negative list of funds who won't be eligible under this scheme. It has not specified categorically, but this is likely to exclude hedge funds, who form Category III under SEBI's Alternative Investment Fund norms.

The other way a startup can be recognised as a startup is if it has already been funded by any government-associated innovation promotion scheme or has a patent in certain identified areas.

Then there is a whole gamut of provisions starting with age and not having crossed the Rs 25 crore threshold in any year in the past.

So if you registered your startup more than five years ago but went slow and barely started operations last month, then you may not be considered a startup. You would probably have to shut the company (and the government does make it easier to do so with the faster closure window) and start a new life. The government has specified that such entity should not be formed by splitting up, or reconstruction, of a business already in existence, but then that would have its loopholes.

Tax sops for the privileged few

The provision that received the most applauds was the three-year tax holiday. To begin with, the three-year period itself makes it a non-starter. It takes three to five years for most startups to break even operationally.

While authorities were quick to clarify that this tax holiday would be provided over a five-year window, even then it would benefit a tiny proportion of startups. The issue pertains to income tax and a startup becomes big enough to generate any significant taxable income only over a longer period.

To be fair, this does add to the positive sentiment for entrepreneurship. But one has to be super-lucky to enjoy the fruits.

The three-year period for the tax holiday makes it a non-starter as it takes three to five years for most startups to break even operationally

The headline number looks salivating but one needs to go back one-and-a-half years to judge it better. Finance Minister Arun Jaitley had first talked about the proposed fund-of-funds in July 2014.

It will be managed by a board with private professionals drawn from industry bodies, academia, and successful startups. This may well give it a much needed kick-start as the initiative will not be hijacked by the bureaucracy.

The country's biggest home-grown institutional investor, state-run Life Insurance Corporation (LIC), shall be a co-investor in this fund-of-funds, which would in effect come as a Limited Partner (LP) for other VC funds.

The government has stated that this fund-of-funds shall contribute to a maximum of 50 per cent of the corpus but added that it needs to have already raised the balance half or more of the target size. So if you are a VC fund looking for last-mile funding gap, this could come into play provided it gets off the ground soon. Last but not the least, only SEBI-registered VC funds would be eligible for this funding.

Credit guarantee, capital gains tax and more

One notable part of the initiative is the proposal to give credit guarantee to startups that may pave the way for more bank lending to support entrepreneurs. With a budgetary corpus of Rs 500 crore a year for the next four years, it would provide a pillar for startups to access debt from banks or non-banking finance companies. Many NBFCs already provide collateral-free loans, but this move may bring loans at less onerous rates.

In another procedural move, the government has extended the tax exemption in venture investments from VCs to incubators. This 'startup tax' is payable by firms if they receive investments at a rate higher than fair market value. A controversial tax head when it was launched, it was particularly seen as a tax on angel investment.

Industry bodies have been lobbying to get this removed and while the government has provided some leeway, it did not agree to the industry's wish, which is a dampener. Indeed, angel investment has been one of the fastest-growing modes of funding support to startups and was a key driver for overall private investment deal volume last year.

The good news

Still, there are several bright spots in the action plan. The government is making it easier to start up with easier compliance based on self-certification. A startup hub for knowledge sharing, on-the-go interface with authorities, fast-tracking patent examination process at a subsidised cost, easier norms for winding up, creating new incubators and more support for academic institutions for research are the other positive measures.