This article is written by Rudra Shandilya and Rishi Badraj from DSNLU,Visakhapatnam.
For the purpose of this paper, we have dealt with three major events for start-ups namely, introduction of SISFS, inclusion of start-ups in fast track mergers, and the recent changes to the framework of IGP by SEBI.
On the fifth anniversary of the Startup India program, Indian Prime Minister Shri Narendra Modi announced the ‘Startup India Seed Fund Scheme (SISFS)’ in his grand address at the “Prarambh: Startup India International Summit” on January 15-16, 2021 which witnessed participation from over 25 countries and more than 200 global speakers. Accordingly, the policy and guidelines for the same were released by the government, and are in effect since April 01, 2021.
The SISFS majorly aims to provide start-ups with financial assistance for prototype development, proof of concept, commercialization and market entry. The government has pledged INR 945 crores for providing seed fund to qualifying startups in the next four years, which will be disbursed through approved incubators across India. Around 3600 budding startups are expected to get benefit from this program.
In the ‘Proof of Concept’ and ‘seed’ development stages, the Indian startup environment suffers from a lack of funds. For businesses with profitable corporate ideas, the funding necessary at this point might prove to be a now or never situation. Having easy access to funds is critical for entrepreneurs in the early phases of their business’s development.
Startups can only get funding from angel investors and venture capital firms when they have satisfactorily demonstrated their ideas. Likewise, banks only lend to applicants who have assets to back up their claims. Seed capital is critical for firms with profitable ideas to perform proof of concept trials.
There might be a multiplier effect when Seed funds are provided to such promising businesses, resulting in the validation of many such start-up ideas and the creation of jobs. Hence, it is necessary to propose schemes for seed funds.
SISFS: An overview
The SISFS is only one of many government initiatives aimed at boosting the startup industry. For example, the Small Industries Development Bank of India (“SIDBI”) and Social Alpha in February 2021, announced the creation of the “Swavalamban Divyangjan Assistive Tech Market Access fund”, which will provide financial grants to incubated assistive technology startups. Similarly, the recent union budget extended the deadline for startups to apply for a tax exemption under Section 80-IAC of the Income Tax Act of 1961 until March 31, 2022.
For a startup to be eligible under the SISFS, the below-mentioned points have to be fulfilled:
- It should be recognized by Department for Promotion of Industry and Internal Trade (DPIIT), and at the time of application, it shall not have been in existence for more than two years. Further, a minimum 51% of its shareholding should be held by Indian promoters.
- It should have a business plan to develop a service or product with the chance of scaling, market fit, and viable commercialization.
- The startups utilizing technology in their main service or product, or distribution and business model are also eligible.
- The startups that have not got above INR Ten Lakhs of financial assistance from any other government program/scheme are eligible.
On fulfilling the aforesaid conditions, Seed Fund under the SISFS will be disbursed by the authorized incubator as follows:
- Up to INR Twenty Lakhs as a financial grant for prototype development, or product trials, or Proof of Concept validation. The said grant will be paid in instalments based on milestones. Such milestones can be related to product testing, development of a prototype, and preparing a product for launch in the relevant market, among other things.
- Through convertible debentures, debt-linked instruments, or debt, up to INR Fifty Lakhs as financial grants can be provided to the startup for market entry, commercialization, or scaling up.
One of the most noteworthy points is that the DPIIT is required to establish an Experts Advisory Committee (EAC) for the overall monitoring and execution of the SISFS. EAC which has now already been constituted is required to assess and choose eligible incubators for seed funding. It also has to regularly monitor progress, and take all important steps to ensure that the funds are used efficiently to achieve the SISFS goals.
Following the EAC’s selection of incubators, in accordance with the norms of an Incubator Seed Management Committee, the incubators will be in charge of choosing eligible startups. The startups will be judged on their potential impact, simplicity of use, and novelty of their concepts, as well as their money utilization strategies and team composition. The incubators will receive funds from the EAC in instalments with a maximum limit of INR Fifty Million (USD 675,000).
Problems associated with the SISFS
The Seed Fund through SISFS is more likely to encourage entrepreneurs in industries that have garnered less venture capital than those like education, e-commerce, tourism, and food technology. It is a part of the government’s goal to not just encourage the present and next generations of entrepreneurs, but also to build a strong startup environment that will generate jobs, particularly in smaller and remote areas.
By establishing an online infrastructure, the initiative will boost virtual incubation for startups. This could expand the scheme’s reach, thus, enabling it to deal with the current pandemic problems. Simultaneously, the bureaucratic processes and scheme’s extensive qualifying criteria can make its implementation cumbersome.
The main problem with SISFS is that there are ambiguities over various aspects of the scheme’s implementation. For example, one of the eligibility conditions for startups is that the “Startup must have a business idea to develop a product or a service with market fit, viable commercialization and scope of scaling”.
The SISFS, on the other hand, does not specify the criteria for what constitutes “market fit” or “viable commercialization”. This could possibly lead to a wider issue with the SISFS, which is that the incubators and EAC have been vested with huge discretionary power when it comes to selecting ‘suitable’ startups and incubators respectively.
Likewise, the EAC has the power to set the milestone levels for monitoring progress at its exclusive discretion. Hence, if the milestones are set too above, it will make the fulfilment of the SISFS goals practically impossible. Subsequent distributions of the funds to the incubators, and ultimately the Startups, would then be at a halt.
On a concluding note, presently, the SISFS initiative is being applauded by the startup industry and media, but, its successful implementation will be totally dependent on the functioning and administration of the EAC, the startups and the incubators in synchronization, which remains to be observed yet. Such schemes are not new to the world.
For instance, from a global perspective, the UNICEF Innovation Fund for startups provide early stage (seed) fund to eligible for-profit startups thereby improving the ease of doing business. Further, at the CEO Roundtable in New York with top executives from across twenty sectors and 42 global CEOs, India highlighted the steps taken by it to build a USD 5 trillion economy. The steps include making the startup environment in India attractive. Hence, a scheme particularly for startups in India i.e. SISFS is welcomed by the industry and is also the need of the hour.
Extending the scope of Section 233 to Startups
On 1st February 2021, the Ministry of Corporate Affairs vide its notification through the gazette widened the scope of Section 233 of the Companies Act, 2013 read with Rule 25 of Companies (Compromises, Arrangements and Amalgamations) Rules, 2016 to include a merger between a startup with another startup or a startup with a small company.
Section 233 deals with fast tracker mergers of companies, fast track merger as the name suggest is a quicker process that eliminates a lot of steps in a traditional merger. There is no intervention of courts in this type of merger, i.e. not mandated to seek approval from the NCLT.
With the amendment of the rules, startups are now a recognized corporation under section 233 of the Companies Act, 2013 and Rule 25 Companies (Compromises, Arrangements and Amalgamations) Rules, 2016 for the purpose of merger with the approval of the Central Government.
This type of specific merger could determine the rate of economic recovery after the pandemic, seeing as to how the NLCT would be overburdened with the IBC cases and could specifically be useful with the advantages of ease of doing, the money involved and time invested
Advantages of Fast track merger –
- It is not mandated to seek approval from the National Company Law Tribunal
- Issuance of public advertisement is also not necessary
- The meeting is not court convened
- The administrative burden is lessened
- Same effect as dissolution without the process of winding up of transferor corporation
- Such mergers are cost-effective and time-efficient
There were various roadblocks faced by the small companies and startups which directly relate to their definition, not every company has the resources of a large corporation, especially a startup whose motive is innovation.
The complex procedure was proving to be a hurdle for nascent as well as companies with less revenue/ turnover. The same procedure for each corporation despite the difference in the size was coming to show its ages especially during the pandemic where businesses struggled.
For an entity to be considered as a startup for the purpose of fast track merger, it shall comply with all the necessary requirements to be termed as a startup as notified by the Department for Promotion of Industry and Internal Trade vide its notification dated 19th February 2019
Companies (Compromises, Arrangements and Amalgamations) Amendment Rules, 2016
Companies (Compromises, Arrangements and Amalgamations) Amendment Rules, 2021
Beneficiaries of fast track merger
Before the amendment dated 1st February 2021, a merger (fast track) could be entered between –
After the amendment dated 1st February 2021, a merger (fast track) could now be entered between –
The scheme is introduced to further facilitate the ease of doing business as referred by the finance minister in the budget speech.
SEBI Saving the Start-up Trading Platform
The start-up culture in India is new and booming which is evident from the fact in just 7 months into 2021, the pandemic hit the Indian economy has seen 14 of its start-ups turn to Unicorn, i.e. $1 Billion in valuation.
SEBI to nurture the start-ups had in 2015 launched a Trading Platform for these start-ups known as the Innovators Growth Platform (formerly – Institutional Trading Platform) to list these start-ups, gain visibility and increase the brand presence of these start-ups. The plan of SEBI was to build a trading platform exclusively for start-ups in the shoes of the NASDAQ stock exchange.
While since its inception, the Platform hasn’t seen much success as currently no entity is listed on the IGP, but SEBI hasn’t lost much hope as SEBI sought changes to the IGP as per the board meeting on 25th March 2021 which were notified on 5th May 2021 by way of two separate notifications.
The reason for the active nature of SEBI here is to tap the resources, i.e. the potential investors who are willing to invest in a startup as it is an under-invested field. Only 9% (3436 out of 38,815) of the active start-ups have been able to raise further capital after seed funding rounds.
The goal is not only to fund these start-ups byways of the public market but provide an exit to early-stage investors.
SEBI has reduced the issuer’s requirement of pre-issue capital of 25% from 2 years to 1 year held by eligible investors making it a faster process after changes to the IGP, while the previous regulation stated 10% of the pre-issue shareholding of an investor might be considered of the pre-issue capital, it stands amended to 25%.
While the IGP proposes to be a full-fledged trading platform, the minimum offer size was set at a meagre Rs 10 crores and the trading lots and minimum application size were fixed at Rs 2 Lakhs. The SEBI also tried to make the process seamless by assuring that these start-ups could transfer to the main board of stock exchanges after certain prerequisites are satisfied, namely – 1 year of the minimum listing period on IGP, three years of net worth/ profitability track record or Qualified Institutional Buyers holding 75% of the capital of the startup. These restrictions meant that the IGP could not see any listing so far.
The SEBI, to ease the investment has provided total discretion to transfer 60% of the size of the issue before opening up the issue albeit with a lock-in period of 30 days taking inspiration from the mainboard. SEBI is further aiming to incubate the start-ups and hoping for them to mature under IGP, in the footprint of the mainboard, the company (issuer) with promoters and founders holding Equity shares with Superior Voting Rights can be allowed to list under the Innovator’s Growth Platform.
The concept of Mergers & acquisitions scares startups, due to the costly and time taking nature of the process and a requirement of public offer announcement for a mere 25% of shares ensured less interest, it has now been increased to 49% under the new provisions. Further to protect interests, any change in control, be it direct or indirect will now trigger an open offer.
SEBI has also eased the delisting and the migration procedure to the mainboard. For delisting, a statement of explanation must be sent to the shareholders and they must pass the exit by special resolution, it must also be passed by the Board of Directors in its meeting.
The aim of India to become a hub for tech start-ups was far-fetched a few years back, but the likes of various start-ups becoming unicorns have further boosted the trust in the Indian startup economy. The new regulations are aimed at helping improve the ease of doing business policy of the Government.
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