Editorial. A leg-up for start-ups

If fund-raising became difficult for start-ups in 2022 due to the interest rate hikes of global central banks and steep correction in valuation of technology stocks, conditions have worsened in 2023 due to the ongoing banking crisis in the US. In the first quarter of 2023, money invested into Indian start-up companies by private equity and venture capital investors was down 75 per cent compared with the first quarter of 2022.

Companies in the growth stage, or the older companies, found it more difficult to raise capital due to increased risk aversion. The drought has continued in April 2023, with value of investments down 89 per cent compared with the same month last year. While it is true that valuations in this segment had become overheated due to the excessive liquidity created during the pandemic and needed to moderate, the current conditions can prove to be a serious setback to the Indian start-up ecosystem. The Centre therefore needs to lend some support to help them through this difficult phase.

Many digital start-ups, which had attracted copious funds from global investors in the first two years of the pandemic, are now struggling to deliver on their exaggerated growth promises. Heightened competition due to low entry barriers, change in consumption habits post-Covid and high borrowing cost are impacting profitability, leading to massive lay-offs in this segment. Global PE and VC investors who have suffered large losses in their portfolio are unlikely to provide much funding support. It would not be right to ask banks to provide a credit line to start-up companies since this entails a large degree of risk, as witnessed in the US. Similarly, the Centre also cannot be expected to spend taxpayer’s money on this given the unfavourable risk-reward ratio. The Centre’s Startup India Seed Fund Scheme and the Startup India Fund of Funds are providing minimal funding support to these companies. But there are many high networth investors, investment funds and companies who have displayed a willingness to invest in fledgling companies. These investors need to be encouraged with suitable fiscal and regulatory policies to buttress the segment in periods such as now when global funding dries up.

Recent measures such as bringing non-residents into the angel tax net don’t help. In fact, angel tax — which requires start-ups to pay income tax on capital received at a premium to their fair valuation — should be abolished altogether as it deters fund raising from angel investors. Investment into Alternate Investment Funds which invest in start-ups could be incentivised through a tax concession. Capital gains tax rate paid by resident individual investors on their start-up investment can be lowered to move it closer to the effective rate of 10.92 per cent paid by non-resident investors. Finally, Indian start-ups should be allowed to list on overseas exchanges. This proposal was shelved last year as the Centre felt that these companies should be encouraged to list on domestic bourses. While this may be good for domestic markets, overseas investors are more receptive to the business models of start-ups and give them better valuation.

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