Table of Contents
COVID-19 has adversely impacted the overall investment sector. While businesses across all sectors can sense the repercussions of COVID-19, start-ups have particularly been one of the most vulnerable, and in fact, are facing various formidable challenges both, from a business as well as from an operations’ perspective. Most start-ups have witnessed a decline in supply and or demand, except for those start-ups that are engaged in the supply and, or delivery of ‘essential services’, educational technology, gaming or streaming services. Notwithstanding the above, glitches in the supply chain network have either way presented challenges for all start-ups. However, the start-up ecosystem has been continuously striving to adapt to the present situation as flexibly as possible, by focussing on the need to innovate and diversify their business techniques and its operations.
In the past couple of years, the start-up ecosystem in India has emerged as a reckoning force, largely attributable to the efforts of the stakeholders, and the initiatives implemented by the government to facilitate the growth of the start-ups. Investments in start-ups have dramatically surged to $14.5 billion in 2019 from the previously $550 million in 20101.
Notes and guidance issued for Start-ups
A note titled as Coronavirus: The Black Swan of 2020, was issued by the Sequoia Capital addressing its portfolio company founders and CEOs, highlighting the need to be ‘adaptable’ so as to survive the downturn2.The note highlighted the need of questioning every assumption about one’s business pertaining to cash-flows, fund-raising, marketing, sales forecast, capital spending etc.
Likewise, a group consisting of ten leading venture capitalists have issued a guide titled as Best Practices for Founders in the wake of Covid-19‘3 which provides for guidance on various aspects related to start-ups, including among others, fund-raising, restructuring, business continuity plans, re-designing business processes, and so on. The guide further prescribes that the priorities of a company should be in the following order – “first employee safety, second business continuity, and third, liquidity and runway a key.” The guide also stipulates the need to keep abreast of government directions and advises to seek legal assistance when necessary.
COVID-19’s impact on Start-ups
The number of jobs self-reported by DPIIT Recognized startups, as on 6th September 2020, year-wise, for the last three years is as follows. No data on contribution to GDP by Start-ups is maintained by the Department for Promotion of Industry and Internal Trade.
|Calendar Year||Number of Jobs Reported by Recognized Startups|
The Fund of Funds for Startups (FFS) was approved by the Cabinet and established by DPIIT in June 2016 with a corpus of Rs 10,000 crore to provide much-needed boost to the Indian startup ecosystem and enable access to domestic capital. The Fund of Funds does not directly invest in startups, instead provides capital to SEBI-registered Alternate Investment Funds (AIFs), known as daughter funds, who in turn invest money in growing Indian startups through equity and equity-linked instruments. SIDBI has been given the mandate of managing this Fund through selection of suitable daughter funds and overseeing the disbursal of committed capital.
SIDBI has reported that the Private investments in Alternative Investment Funds (AIFs) covered under Fund of Funds for Startups (FFS), have not been put on hold or no decrease has been reported during the COVID-19 pandemic.
The steps taken by Government to incentivise private investment in start-ups post the COVID-19 pandemic are at Annexure-1.
The steps taken by Government to incentivise private investment in start-ups post the COVID-19 pandemic is as follows:
Regulatory measures have been taken by Central government, Reserve Bank of India, Securities & Exchange Board of India (SEBI), Insurance Regulatory and Development Authority (IRDAI) and the sectoral ministries to boost businesses in India. For entrepreneurs, certain measures in terms of tax, regulatory and RBI led monetary relief have been introduced.
- DPIIT had launched the United Against COVID-19- Innovation Challenge to identify innovative solutions to combat COVID-19. Applications were received for solutions to manage the over COVID situation including logistics solutions, testing solutions, Critical care equipment, large area sanitisation and various other critical aspects related to COVID-19.
- SIDBI has launched Covid-19 Startup Assistance Scheme (CSAS) for startups which aims to aid innovative startups that have demonstrated ability to adapt to economic impact from Covid-19 and ensured its employees safety and financial stability. SIDBI recognizes the operational and financial challenges being faced by startups and has been making efforts to provide financial assistance and stability to such startups through schemes like CSAS. Through this scheme, startups can receive a loan of up to Rs 2 crore.
- SIDBI has also announced a concessional interest rate of 5 percent for MSME loans under the SIDBI Assistance to Facilitate Emergency Response against Covid-19 (SAFE Scheme). These loans would be provided within 48 hours, with no collateral and minimum paperwork for MSMEs that are manufacturing products or delivering services related to the Covid-19 fight are eligible for these loans.
- Availability of additional financial window for healthcare sector under scheme called SIDBI Make in India Soft Loan Fund for Micro Small and Medium Enterprises (SMILE) ) for financing the healthcare sector including hospitals, nursing home, clinics, etc. for their requirements related to fighting Corona Virus has also been launched.
Further, 39 such regulatory changes, to enhance ease of doing business, ease raising capital and reduce compliance burden have been undertaken.The list of regulatory reforms is enclosed at Annexure – A. Out of these,three regulatory reforms were brought by Ministry of Corporate Affairs after March 2020.
Annexure – A
Reserve Bank of India
1. Startup enterprises permitted to access loans under External Commercial Borrowing Framework up to USD 3 million.(Oct, 2016)
2. A Securities and Exchange Board of India (SEBI) registered Foreign Venture Capital Investor (FVCI) may contribute up to 100%of the capital of an Indian company engaged in any activity mentioned in Schedule 6 of Notification No. FEMA 20/2000, including startups irrespective of the sector in which it is engaged, under the automatic route. (Aug, 2017)
3. An Indian startup having an overseas subsidiary, may open a foreign currency account with a bank outside India for the purpose of crediting to it foreign exchange earnings out of exports/ sales made by the said entity and/ or the receivables, arising out of exports/ sales, of its overseas subsidiary. (June, 2016)
4. SOFTEX form filed by software exporters moved online. (Feb, 2019)
Securities and Exchange Board of India (SEBI)
5. Lock in period for investments made by an Angel Fund reduced to 1 year from 3 years as amended by the SEBI (Alternative Investment Funds) (Amendment) Regulations,2016, w.e.f. 04-01-2017.
6. Angel Funds are allowed to invest in overseas venture capital undertakings upto 25% of their investible corpus in line with other AIFs as provided by the SEBI (Alternative Investment Funds) (Amendment) Regulations, 2016, w.e.f. 04-01-2017.
7. The upper limit for number of angel investors in a scheme is increased from forty nine to two hundred as amended by SEBI (Alternative Investment Funds) (Amendment) Regulations, 2016,w.e.f. 04-01-2017
8. The requirements of minimum investment amount by an Angel Fund in any venture capital undertaking is reduced from fifty lakhs to twenty five lakhs as amended by SEBI (Alternative Investment Funds) (Amendment) Regulations, 2016,w.e.f. 04-01-2017
9. “Operating Guidelines for Alternative Investment Funds in International Financial Services Centres” issued by SEBI. (Nov, 2018)
Ministry of Corporate Affairs
10. The financial statement, with respect to private company (if such private company is a start-up) may not include the cash flow statement. (June, 2017)
11. A private company, which is considered as a start-up for a period of five years from the date of its incorporation, is also allowed to accept deposits from members without any restriction on the amount. (Sep, 2017)
12. Startup defined for the purpose of Companies Act, 2013: As per the definition, a start-up company means a private company incorporated under the Companies Act, 2013 and recognised as a “start-up” in accordance with the notification issued by the Department for Promotion of Industry and Internal Trade. (June, 2017)
13. Exemption from procedural compliance (e.g. such as issue of an offer circular or creation of a deposit repayment reserve) for raising deposits from shareholders. (June, 2017)
14. In relation to a private company (if such private company is a startup), the annual return shall be signed by the Company Secretary, or where there is no Company Secretary, by the Director of the company. (June, 2017)
15. A private company (if such private company is a startup) is required to conduct at least one meeting of the Board of Directors in each half of a calendar year and the gap between the two meetings is not less than ninety days. (June, 2017)
16. Name Reservation for Company incorporation: Rule 8, Companies (Incorporation) Rules, 2014 substituted with Companies (Incorporation) 5th Amendment Rules, 2019,which provides for new regulations on resemblance with an existing company name, new categories of undesirable names of a company and list of words which can be used only after obtaining approval. (May, 2019)
17. Amendment in Companies (Share Capital and Debentures) Rules, 2014: The Ministry of Corporate Affairs issued a notification on 16th August, 2019 increasing the period in which ESOPs could be granted to promoters and directors (holding more than 10% equity) of Startups, from 5 years to 10 years from the date of incorporation and thereby aligned the provisions of the Companies (Share Capital and Debentures) Rules with the provisions referred to in the DPIIT notification dated 19th Feb, 2019.
The notification also enhanced the limit on shares with Differential Voting Rights in the Company from 26% of the total post-issue paid up equity capital of the Company to 74% of the total voting power. Further, the condition for the company to have consistent track record of distributable profits for the last three years for issue of DVR shares has been removed. (August 2019)
18. Corporate Social Responsibility Funds: In reference to section 135 of the Companies Act 2013, Schedule VII has been amended to include Contribution to incubators funded by Central Government or State Government or any agency or Public Sector Undertaking of Central Government or State Government, and contributions to public funded Universities, Indian Institute of Technology (IITs), National Laboratories and Autonomous Bodies (established under the auspices of Indian Council of Agricultural Research (ICAR), Indian Council of Medical Research (ICMR), Council of Scientific and Industrial Research (CSIR), Department of Atomic Energy (DAE), Defence Research and Development Organisation (DRDO), Department of Science and Technology (DST), Ministry of Electronics and Information Technology) engaged in conducting research in science, technology, engineering and medicine aimed at promoting Sustainable Development Goals (SDGs). (October 2019).
19. As part of Government of India’s Ease of Doing Business (EODB) initiatives, the Ministry of Corporate Affairs has launched a new integrated Web Form christened ‘SPICe+’ replacing the existing SPICe form. SPICe+ would offer 10 services by 3 Central Govt Ministries & Departments (Ministry of Corporate Affairs, Ministry of Labour& Department of Revenue in the Ministry of Finance) and One State Government(Maharashtra), thereby saving as many procedures, time and cost for Starting a Business in India and would be applicable for all new company incorporations w.e.f.23rd February 2020. SPICe+ has two parts: Part A-for Name reservation for new companies and Part B offering a bouquet of services viz. (i) Incorporation (ii) DIN allotment (iii) Mandatory issue of PAN (iv) Mandatory issue of TAN (v) Mandatory issue of EPFO registration (vi) Mandatory issue of ESIC registration (vii) Mandatory issue of Profession Tax registration(Maharashtra) (viii) Mandatory Opening of Bank Account for the Company and (ix) Allotment of GSTIN (if so applied for) (February 2020)
20. Amendment in Companies (Share Capital and Debentures) Rules, 2014: The Ministry of Corporate Affairs issued a notification on 05th June, 2020 increasing the period in which Sweat Equity shares, from 5 years to 10 years from the date of incorporation and thereby aligned the provisions of the Companies (Share Capital and Debentures) Rules with the provisions referred to in the DPIIT notification dated 19th Feb, 2019. (June 2020)
21. Amendment in Companies (Acceptance of Deposits) Rules, 2014: The Ministry of Corporate Affairs issued a notification on 07th September, 2020 increasing the period of issuance of convertible note, from 5 years to 10 years from the date of issue and thereby aligned the provisions of the Companies (Acceptance of Deposits) Rules, 2014 with the provisions referred to in the DPIIT notification dated 19th Feb, 2019. (September 2020)
22. Amendment in Companies (Acceptance of Deposits) Rules, 2014: The Ministry of Corporate Affairs issued a notification on 07th September, 2020 whereby the maximum limit in respect of deposits to be accepted from members by a private company shall not apply to a start-up company for 10 years from the date of its incorporation, instead of 5 years. (September 2020)
Ministry of Finance, Department of Revenue
23. In the case of a domestic company, where its total turnover or the gross receipt in the previous year does not exceed two hundred and fifty crore rupees, income tax shall be charged at the rate of 25 percent of the total income. (Feb, 2018)
24 Definition of eligible business as stated in Section 80-IAC aligned with Startups definition. (April, 2018)
25. Introduction of Section 54EE in the Income Tax Act, 1961: Exemption from tax on long-term capital gain if such long-term capital gain is invested in a fund notified by Central Government. The maximum amount that can be invested is Rs 50 lakh. (May, 2016)
26. Amendment in Section 54GB of Income Tax Act: Exemption from tax on capital gains arising out of sale of residential house or a residential plot of land if the amount of net consideration is invested in prescribed stake of equity shares of eligible Startup for utilizing the same for purchase of specified asset. (Feb, 2016)
27. Minimum Alternate Tax credit allowed to be carried forward up to fifteenth assessment years instead of ten assessment years. (2017)
28. Exemption under section 80-IAC of Income Tax Act: Exemption to eligible Startup for any 3 consecutive assessment years out of 7 years (earlier 5 years) beginning from the year in which such eligible Startup is incorporated.(April, 2018)
29. Exemption from tax under the provisions of section 56(2)(viib) to Startups for issue of shares above fair market value on the basis of a self-declaration to the Central Board of Direct Taxes. The aggregate amount of paid up share capital and share premium of the startup after issue or proposed issue should not exceed Rs. 25 Crore (Feb, 2019)
30. Taxation of convertible notes – Period for which a bond, debenture, debenture-stock or deposit certificate was held prior to conversion shall be considered for determining the period of holding of such shares or debentures acquired upon conversion. (March, 2016)
31. Amendment in Section 54GB of Income Tax Act w.e.f 1st April 2020: (August 2019)
i. The condition of minimum holding of 50% of share capital or voting rights in the start-up relaxed to 25%
ii. Extension of period under which benefit under section 54GB from for sale of residential property can be availed up to 31st March, 2021
iii. Condition restricting transfer of new asset being computer or computer software is to relaxed from 5 years to 3 years w.e.f. 1-4-2020
32. Amendment in Section 79 of Income Tax Act (August 2019): Eligible Startups to carry forward their losses on satisfaction of any one of the two conditions:
i. Continuity of 51% shareholding/voting power or
ii. Continuity of 100% of original shareholders carrying voting power
33. Pass through of losses allowed to Investment Funds i.e. Category I and II AIF similar to pass through of income. These amendments will take effect from the 1st April, 2020 and will, accordingly, apply in relation to the assessment year 2020-21 and subsequent assessment years (August 2019)
34. The investment made by Venture Capital Fund of Category-I AIF in a startup was exempted from the applicability of the provisions of section 56(2)(viib) of the IT Act. This exemption has been extended to all sub-categories of Category-I AIF and Category-II AIF via introduction of “specified funds” in the said section (August 2019)
35. The Finance Act 2020 provides for amendment in section 80-IAC of the Income-tax Act relating to special provision in respect of specified business. The provisions of section 80-IAC, inter alia, provide for a deduction of an amount equal to hundred per cent. of the profits and gains derived from an eligible business by an eligible start-up for three consecutive assessment years out of ten years vis-à-vis the earlier norm of seven years at the option of the assessee and the total turnover of its business does not exceed hundred crore rupees in the previous year relevant to the assessment year for which deduction under this section is claimed. This amendment will take effect from 1st April, 2021 and will, accordingly, apply in relation to the assessment year 2021-2022 and subsequent assessment years. (Feb 2020)
36. The Finance Act 2020 provides for amendment in section 80-IAC of the Income-tax Act relating to special provision in respect of specified business. The provisions of section 80-IAC, inter alia, provide for a deduction of an amount equal to hundred per cent. of the profits and gains derived from an eligible business by an eligible start-up for three consecutive assessment years out of ten years at the option of the assessee and the total turnover of its business does not exceed hundred crore rupees vis-à-vis the earlier norm of twenty-five crore rupees in the previous year relevant to the assessment year for which deduction under this section is claimed. This amendment will take effect from 1st April, 2021 and will, accordingly, apply in relation to the assessment year 2021-2022 and subsequent assessment years. (Feb 2020)
37. The Finance Act 2020 provides for amendment in sections 156, 191 and 192 of the Income Tax Act laying to enable employees receiving specified security or sweat equity share as perquisite under section 17(2)(vi) of an eligible startup referred to in section 80-IAC, to deduct or pay, as the case may be, tax on such income within fourteen days after the expiry of forty-eight months from the end of the relevant assessment year; or from the date of the sale of such specified security or sweat equity share by the assessee; or from the date of the assessee ceasing to be the employee of the person, whichever is earlier, on the basis of rates in force of the financial year in which the said specified security or sweat equity share is allotted or transferred. This amendment will take effect from 1st April, 2020. As per the earlier norms, the said perquisite including ESOPs were taxed in the hands of the employee at the time of exercise of the option.
Ministry of Electronics and Information Technology
38. Removal of clause from Electronic Development Fund (EDF) operating guidelines stating that if a fund draws from Fund of Funds for Startups, then they cannot draw from EDF and vice versa. (Nov, 2018)
Ministry of Commerce and Industry, Department for Promotion of Industry and Internal Trade
39. Amendment in the definition of a Startup: An entity shall be considered as a Startup upto a period of ten years from the date of incorporation/ registration and turnover of the entity for any of the financial years since incorporation/ registration has not exceeded one hundred crore rupees. (Feb, 2019)
This information was given by the Union Minister of Commerce and Industry, Shri Piyush Goyal, in a written reply in the Rajya Sabha today.
It is suggestive that the value of investments in India have fallen to $0.33 billion in March 2020 from $1.73 billion in March 2019, which indicates a fall of nearly 81.1%4.There has been a total fall of 50% in the number of companies funded – presently, 69 firms in March 2020, in contrast to 136 firms in March, 20195. Further sources suggest that sometime between mid-February, 2020 & end of March, 2020, a number of investors have also pulled back from closing current funding rounds6. Thus, one of the major challenges faced by the start-ups has now become sourcing funds, which has resulted in cash flow issues, for many7.
The lock-down has not only impacted the daily business operations, but it has also forced a good-many start-ups into preparing for contingency plans to limit workforce and to cut down employee salaries. Various start-up founders have also taken pay-cuts to limit the losses faced8.
COVID-19 Start-up Assistance Scheme
- After recognising the numerous financial and operational challenges faced by start-ups, the Small Industries Development Bank of India (“SIDBI“), which also operates as an implementing agency for the ‘Fund of Funds’ for start-ups, has promulgated a ‘COVID-19 Start-up Assistance Scheme’ (hereinafter “the Scheme”) which is intended to provide assistance to certain eligible start-ups that have successfully demonstrated the ability to implement innovative measures so as to ensure business continuity amidst the COVID-19 crisis, and has also ensured employee safety as also financial stability.
Eligibility criteria under the Scheme includes the following start-ups that have:
- at least 50 employees;
- a positive net worth;
- received funding through SEBI registered alternate investment funds or VC/PE/Angel funds that invest in start-ups;
- a minimum turnover between INR 20-60 crores ( for the Financial year 2019 and Financial year 2020);
- been incorporated for less than ten years; and meets the requirement of the promoters and, or founders of the start-up having invested their own capital in the businesses.
As per the scheme, the start-ups that were EBITDA positive in December, 2019 or, project a positive EBITDA for the quarter ending June, 2020 would also be included.
Furthermore, under the Scheme, working capital loans of up to INR 2 crores at an interest rate of 10.5% would be provided to eligible start-ups for a period extendable to 36 months.
Responses received from Start-ups:
Various start-ups have requested the SIDBI to review the Scheme by easing the eligibility criteria as initially prescribed, and to provide for further relaxations. Requests have also been made to SIDBI requesting to expedite the transfer of funds from the ‘Funds of Funds’ to support the start-ups in these pressing times.
Additionally, to ensure liquidity, certain demands relating to the facilitation investment by large corporates into start-ups as part of the corporate social responsibility initiatives, have also been made.
- The Ministry of Corporate Affairs (“MCA“) has also provided temporary relaxations to all corporates for compliances under the Companies Act, 2013. These include among others: (i) waiver of additional fees on late filings made with the MCA; (ii) relaxations pertaining to the holding of board meetings with physical presence of directors; (iii) extension of the prescribed interval period between board meetings; and (iv) relaxation of the ‘minimum residency’ requirement of a director. Please read here out detailed coverage on the temporary relaxations introduced by the SEBI and MCA.
Furthermore, vide a notification dated March 24, 2020, the Ministry has also increased the threshold for default for initiating corporate insolvency INR 1 crore (from INR 1 Lakh). The Reserve Bank of India (“RBI”) has also drawn up a ‘COVID-19 regulatory package’ which is intended at reducing the burden of debt-servicing and aims at easing working-capital requirements, pursuant to which lending institutions would be permitted to grant a moratorium of three-months (i.e. from March to May) on payments of instalments on loans, that are outstanding as of March 1, 2020. Further, various timelines including the ones for filing of certain income tax and GST returns have been extended.
The various relaxations that have been introduced by the regulatory bodies are aimed at easing the financial burden of corporate houses, including the start-ups and to facilitate the day-to-day business operations.
Responses received from Start-ups:
The stakeholders of the start-up community in a letter dated March 30, 2020, addressing the Finance Ministry, have requested the government to provide for further benefits to start-ups including, among others:
- reimbursement of (at least) 50% of the salary bills and contract wages paid by start-ups from the month of April to September 2020;
- establishing unique credit models, that can provide loans with a low interest rate against the GST/IT refunds;
- deferral of interest payments along with access to quick short-term loan plans and schemes; and
- provisions of expedited refunds for the IT/GST returns that have been filed.
The future of Start-ups: what to expect?
Given the global scale pandemic and the uncertain economic situations spurred by it, there is a strong likelihood that fundraising for start-ups would become a significant challenge in the future, since various investors may choose to focus their future fund deployments only on the existing portfolio companies, in order to ensure that they are able to tide over the present global crisis.
Furthermore, the various restrictions that have been imposed by the Department for Promotion of Industry and Internal Trade (“DPIIT“) on April 17, 2020, vide a Press Note (being 3 of 2020, hereinafter the “Press Note“), would also delay or rather, dis-incentivise a large number of strategic and financial investments from China, some of them such as from the Alibaba Group, the Tencent Holdings, Fosun etc. from investing in the Indian start-ups, even though there has existed a long-standing professional relationship between these investors and the Indian start-ups9. Pursuant to the release of the Press Note, fresh funding from new investors, and additional funding from the existing investors would be requiring prior approval from the Government of India.
Traditionally, India has been heavily reliant on foreign direct investment (“FDI“) to fund and sustain growth opportunities. An assessment of the impact of the Press Note would be particularly crucial, especially in the post-pandemic era, where open and free markets would be significant towards ensuring a steady investment flow and job creation. While it is stated that the Press Note has been formulated so as to prevent opportunistic takeovers/acquisitions, it would be interesting and critical to examine the notifications issued thereunder, in order to assess the extent of scrutiny now involved for Chinese companies investing in India, and also whether any carve outs would be applicable in the scenario.
Start-ups are likely to witness heavy negotiations on deal valuations since the new investors may now demand bargains or discounts in the value, which may result in potential delays in the deal execution and closing. Investors may also adopt a more cautious approach towards funding and would also insist on thorough diligence (both commercial as well as legal) of the subject start-ups’ business prospects, including any/all contingency plans implemented during the COVID-19, so as to ascertain sustainability of the start-up in the longer-run.
Consideration and Comments
While the regulatory measures (as mentioned in the preceding paragraphs) have been introduced, they may temporarily assist the start-ups to deal with ‘business continuity plans and issues’ and limit expenses arising on account of certain statutory breaches, stakeholders within the industry have strongly demanded ‘fiscal’ support, in the sense, access to cash-flows and capital. The Scheme does alleviate various and concerns amongst start-ups and the stringent eligibility criteria might result in exclusion of a large segment of start-ups from the market.
Certain countries such as the United Kingdom and France have announced a relief package for start-ups, which includes various measures such as establishing funds to invest in start-ups as well as providing loans/financial assistance to the start-ups10. India is also contemplating to implement a comprehensive and a more formal relief scheme that would provide access to capital, while also establishing an effective monitoring system to assess the utilisation of the funds. Start-ups play an important role since they not only encourage innovation among the home-grown entrepreneurs but also generate employment opportunities. Given the vast potential, established by the start-ups, a swift and running action by the concerned regulatory authorities would be crucial in shaping the future of our Country’s start-up bionetwork.
This update is intended to provide an overview of the relevant-applicable legal framework, however, since the subject matter pertains to an evolving issue, the author strongly recommends to seek specific legal advice relevant to your business scenario before implementing any of the definitive measures mentioned herein above.
Thank you, Stay safe and healthy!