What the Budget 2020 could have in store for PE, VCs and start-ups

Published on February 2, 2020

The recent Indian government policies, especially the ones related to start-ups and venture capital (VC) industry have been more favorable than ever, however, there are always some unmet expectations that every participant of the industry hopes would be delivered in the next budget. It is not a surprise that startups and VC firms are looking forward to the Union Budget 2020 with a lot of excitement and hopes. And why not so. India is the third-largest startup ecosystem in the world and a few decisions can stir the industry in the right direction and fetch a lot of gains.

Recap of Previous Budgets:

Previous budgets have given us policies and schemes like Startup India (Gave provisions for research parks, incubators and startup centers among others and created funds of funds helping startups gain access to funds), Atal Innovation Mission (promoting the culture of innovation and entrepreneurship), Make in India (initiative that replaced the outdated and obsolete frameworks with latest and user-friendly methods), etc. The Union Budget 2019 relaxed the rules under the infamous Angel Tax giving much respite to venture capitalists and private equity investors. Another highlight was the committee set under Central Board for Direct Taxes (CBDT) to deal with the challenges faced by start-ups. However, there were a few areas that were overlooked by the government and we are hoping that this budget will cover certain measures to boost the ease of doing business, considering the crisis around working capital.

Tax Parity:

Tax parity for Indian investors is the need of the hour for reasons more than one. The current long-term capital gain taxation levied on foreign investors is 10% whereas the Indian VC and PE investments are taxed at 20% for LTCG and an enhanced surcharge up to 37% in both cases. On the other hand, despite the volatility, the public market investments are taxed at the rate of 10% proportionally less than the 20% tax levied on unlisted shares. This tax imparity between listed and unlisted shares, and between foreign and domestic investors has been a reason for heartburn amongst the investors and hopes are high for it to be covered in this budget. Moreover, introduced in Finance Act,1997; Dividend Distribution Tax (DDT) which is a flat rate tax paid by companies in addition to the corporate tax, for distributing dividends to its shareholders, has taken a lot of toll on investments. Accordingly, replacing DDT with a rationalized system of taxation in the coming budget can infuse positive sentiments for foreign direct investments in the country.

Budgetary Aid for Domestic VCs:

India is known for being the third-largest base of startups in the world and for funding Indian PE/VC majorly relies on foreign LPs. PE & VC flows have become the largest component of FDI investment into India and even larger than all other sources of FDI put together. PE & VC investment in India reached US$ 37.5 billion in 2018 and touched US$ 36.96 billion in 2019. While earlier the funds flowed largely from the west, the focus is now inclining towards east owing to investors from Japan and China, but these funds overpower the funds raised within the country. Capital allocations to support PE, VCs and alternate lending platforms are required to further catalyze growth in the ecosystem and encourage entrepreneurship.

Inspiration from other ecosystems:

USA is hailed as the best country for startups. Its Startup America Initiative’s core goal is to increase the number and scale of new high-growth firms that are creating economic growth, innovation, and quality jobs. To facilitate this, it has committed $2billion investment in High Growth Companies and provides 100% tax for capital gains realized on the sale of certain small business capped at $10 million or 10x the basis in the stock of the taxpayer. Right after Silicon Valley, Israel is the second-largest startup ecosystem in the world. This country houses Israel Innovation Authority, an independent publicly funded agency, consisting of six primary innovation divisions. Each division offers exceptional “toolbox” of incentive programs including 85% of the approved budget, up to NIS 3 million for a period of up to two years, supplementary financing of 15% of the approved budget is invested by the incubator, financial incentives for R&D activities, etc.

The UK government too provides several grants and subsidies to support startups. It offers loans of up to £25,000 at a fixed interest rate of six percent per annum for new business ideas along with guidance on writing a business plan and up to 12 months of free mentoring. On the other hand, China’s Mass Entrepreneurship and Innovation initiative is highly acclaimed, including 89 measures for key areas affecting entrepreneurship and employment, especially 78 new preferential tax measures covering the whole life cycle of enterprises since 2013.

Such measures would encourage people to start new businesses. We hope to see a positive change in the ecosystem enabling more startups to flourish, raise funds and realize exits. However, a key point to remember here is that a lot of these activities would not have been possible if the government would have not made and implemented the policies it did in the recent past.