Home / Companies / Start-ups /  Smart ways to reform the startup ecosystem

Union Budget 2019-20 had some bright spots. The enduring issue of angel tax for startups has been resolved to a large extent, perhaps completely. There are encouraging plans to get India skilled in the realm of artificial intelligence (AI), Internet of Things (IoT) and virtual reality (VR). And the critical gap in research to achieve the well-intentioned goals in the emerging fields of AI and IoT would hopefully be addressed by the setting up of a National Research Foundation, which was another major announcement in the budget speech.

While all of these are of course steps in the right direction, India needs to do more to keep pace with the changing economic demands of the startup sector. A few other issues faced by startups need urgent attention. The government has been trying to address some of them, such as funding, tax on employee stock option plan (Esop), intellectual property rights (IPR), and the official definition of accredited investors, but much more needs to be done.

With regard to funding, the government has established a 10,000 crore Fund of Funds for Startups (FFS) to extend funding support to innovation-driven startups. While it is a great initiative which began in 2016 under the aegis of the Startup India initiative, it is moving at a snail’s pace.

FFS is monitored by the Department for Promotion of Industry and Internal Trade (DPIIT) and operated by the Small Industries Development Bank of India (Sidbi) uses a network of registered Alternative Investment Funds (AIFs) to finally invest in DPIIT-recognized startups. As per the latest numbers released by the government, there are 19,351 such startups and 49 AIFs. Sidbi has committed 3,123.20 crore to these 49 AIFs, but only 483.46 crore has been drawn from FFS, so far, which is a fraction of the proposed 10,000 crore. Also, these AIFs have invested only in 247 startups till date.

The government is looking to sweeten the deal for startups on Esops. The DPIIT has begun discussions with the finance ministry on taxing shares granted by startups under Esop only at the time of sale. At present, Esops are taxed as income when employees exercise their options and convert them to shares. The finance ministry is examining the matter when it looks at proposals for the next budget. The government already has a special carve-out in the tax regime for recognized startups, which could be useful in making specific changes to their stock option framework. This should help in making it easier to attract great talent through grant of Esops by startups.

Albeit a slow start, I commend the government for these resolute moves after the announcement of the Startup India initiative in January 2016. It is a shot in the arm for the Indian startup ecosystem that has grown immensely and is among the top three in the world today. There is no doubt that startups deserve the attention.

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Taxing matters

On the angel tax front, the government’s move to remove it as an impediment to angel investments is a good start, but more needs to be done to make it progressive. Here are some thoughts:

Can angel investors have an option to have some of their investments tax deductible or taxed differently?

As startups in the social impact space address more complex and intricate issues, and can also have large social impact, so, can we provide additional incentives for angel investments in startups operating in the social impact space?

To avail angel tax exemptions, startups need to register with the DPIIT online, submitting certificate of incorporation, providing a write-up about the business, etc. Can we ease this process even further?

Life is a stage

Most of our discussions around innovation focus on startup ecosystem and incentivising startups. This approach is like pushing a string. It will go only so far. We need to take a more holistic approach of building and incentivising innovation ecosystems. To explain it further, let me take the analogy of a theatre. When we look at the basic tenets of an innovation ecosystem, we find it analogous to the basic elements of a theatre. In the innovation ecosystem theatre setting, the startups are the protagonists. To enable them to do their act on stage, there are many folks backstage supporting them, i.e. government, academia and research centres.

Corporations, large and small, and the government are the audience and create the demand for the products and services. The investors provide financing for the theatre. In this way, the entire innovation ecosystem is created, making sure that all parts of the ecosystem are empowered and enabled to play their roles. The startups get to ultimately benefit in this healthy, robust ecosystem.

Undoubtedly, and encouraged by the thinking and doing of the government, we need a more comprehensive approach to creating self-sustaining clusters of innovation economies, rather than just restrict our focus to startup ecosystems. This is a natural corollary to the proposed innovation and smart city zones.

An effective innovation ecosystem is successful when it builds collaboration and desired capacity. Here are some of the measures that can help us achieve that.

Taxation for accredited Investors: Funds received by startups from accredited investors may be exempted from angel tax, subject to complying with certain net worth criteria. This provision is considered by the government as part of an exercise to define “accredited investors" with a view to increase investment flow in startups.

CSR for incubators and innovation ecosystem building: India’s new corporate social responsibility (CSR) law, which mandates that companies spend 2% of their profits on social development, positions Indian companies as innovators in corporate citizenship. We should explore using CSR funds for technology business, not only in the social impact space but also in non-social impact space. It could be used to increase innovation awareness, innovation education, innovation training and innovation hackathons, which help raise the innovation quotient of the society. This is becoming more and more essential in this economy.

Incubator stakeholder training: There has been much effort underway to fund incubators under several programmes. But, in addition, there needs to be concerted efforts to train key stakeholders, such as incubation managers, mentors, angel investors and service providers so that they can serve the startups and the innovation ecosystem better. Further, if these stakeholders are certified and investors accredited, it will help build ecosystems much faster and more efficiently.

Monitoring of incubators: In addition to investment in incubators and incubator stakeholder training, there needs to be clear investments in monitoring them. We need to monitor the level of activity inside and outside of the incubator. We need to measure the impact made by the incubator on the startups in the programme and those that graduated from the programme. This data is important to support and address emerging needs of the innovation ecosystem.

Deployment of FFS effectively: The DPIIT and Sidbi need to ensure that the 10,000 crore FFS is deployed timely and effectively to achieve the required impact on our innovation ecosystem. There have already been delays bringing it into existence from the time it was announced in January 2016.

Corporate Innovation

In the spirit of impacting the entire innovation ecosystem, it is important to help spur the demand for startup products and innovation through demand from corporations. Corporate innovation is perhaps the biggest priority to build an innovation ecosystem. Corporations create demand for the products and services of startups, and without that demand startups cannot reach their full potential. It is happening to some extent, mainly through programmes in multinational companies, but it is at a very small level.

In fact, less than 1% of corporations in India are working with startups and current projections of DPIIT in the “corporate adoption" space also paint a grim picture. This needs to move into a different orbit. Government needs to create an environment and framework that encourages corporations to collaborate with startups. For instance, the government should allow corporations to use their CSR budgets to fund their corporate innovation programmes; have a lower tax rate for revenue generated from corporate innovation programmes to encourage corporations to work more with startups; address tax deductibility for funds spent on corporate innovation programmes for payroll, working spaces, etc.; and make expenses on proof of concept by startups tax deductible.

While the government can create policy frameworks to develop a sustainable innovation economy, we need to unlock the potential for the government to be a consumer of startup products and services.

The government should evolve and implement effective procurement policies for purchasing through startups; grant goods and services incentives to startups; government “challenge grants" to seek innovative solutions from startups or cluster of startups; incentivise startups to use India Stack as an innovation platform.

Another aspect that the government needs to consider is having the right people with the right experience and background with startups in greater numbers. On 16 January 2016, when the Prime Minister Narendra Modi launched the bold initiative of Startup India, several agencies were entrusted with the responsibility to implement various programmes under this initiative.

In addition to evolving the structure and processes, the government needs to bring in the right set of people to help translate the intent of the programmes to progress on the ground.

An important source of such people with startup experience have been entrepreneurs, investors, corporate innovation managers, and thought leaders. A few such people have joined government agencies and provided the required impetus, but we need several more. They can translate the government’s intent to plans and execute them. Several countries around the world have developed great startup programmes and funded them generously. But most of these programmes have yielded mediocre to disappointing results because the right people were not leading and implementing them.

India has a real shot to emerge as a world leader in innovation over the next few decades. Dreams of a “New India" will materialize only when backed by adequate and effective policy measures.

Ravi Narayan is chief executive of T-Hub, Hyderabad

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