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CHAPTER 4
STARTUPS
1.Define a Startup.
Ans.: Startup as defined vide Notification No. G.S.R. 127(E), dated 19th February 2019 by DPIIT as:
An entity shall be considered as a Startup:
1. Up to a period of 10 years from the date of incorporation/registration, if it is incorporated as a private limited company or registered as a partnership firm or a limited liability partnership in India.
2. Turnover of the entity for any of the financial years since incorporation/ registration has not exceeded ` 100 Crore
3. Entity is working towards innovation, development or improvement of products or processes or services, or if it is a scalable business model with a high potential of employment generation or wealth creation.
However, an entity formed by splitting up or reconstruction of an existing business shall not be considered a ‘Startup’
2.What do you understand by Startup and trace its evolution in India. Or
‘Startup India’ imitative has been started by the government of India for creating conducive environment for startup in India. Explain the pre-conditions for determining an entity as a startup venture. [Dec. 2018 (4 Marks)]
Ans.: Startup: A Startup is an entrepreneurial venture which is typically an emerging, fast growing business that aims to solve an unmet need by developing a viable business model around an innovative product, service, processor a platform.
A Startup is usually designed to effectively develop and validate a scalable business model.
A Startup is started by founders or entrepreneurs to search for repeatable and scalable business model.
Example of Ather Energy: Ather Energy was launched by Tarun Mehta and Swapnil Jain in year 2013 in Bangalore. Ather Energy is a maker of two-wheeler electric vehicles. In 2018, this Startup launched its flagship electric scooter, Ather 450 and e-bike Ather 340 which is set hit Indian roads. The electric scooter launched by this Startup is gaining more and more response from the common people due increasing price of petrol and diesel.
Evolution of Startups in India:
Startup India campaign is based on an action plan aimed at promoting bank financing for Startup ventures to boost entrepreneurship and encourage start ups with jobs creation. The campaign was first announced by Honourable Prime Minister Shree Narendra Modi ji in his address from the Red Fort on 15 August in year 2015.
The Government of India has announced ‘Startup India’ initiative for creating a conducive environment for startups in India. The various Ministries of the Government of India have initiated a number of activities for the purpose.
Eligibility for recognition of Startup: The recognition of the Startups in India is regulated vide notification issued by the Department for Promotion of Industry & Internal Trade (DPIIT).
An entity shall be considered as a ‘Startup’ –
(a) Up to 10 years from the date of its incorporation/registration, if it is incorporated as a private limited company or registered as a partnership firm or LLP.
(b) If its turnover for any of the financial years has not exceeded ` 100 Crore. (c) It is working towards innovation, development, deployment or commercialization of new products, processes or services driven by technology or intellectual property.
Any entity formed by splitting up or reconstruction of a business already in existence shall not be considered a ‘Startup’.
Cessation of Startup Recognition: An entity shall cease to be a Startup on completion of 10 years from the date of its incorporation/registration or if its turnover for any previous year exceeds ` 100 Crore.
A Startup company may cease to be a Startup as it passes various milestones, such as becoming publicly traded on the stock market in an Initial Public Offering (IPO), or ceasing to exist as an independent entity via merger or acquisition.
Type of Organization: The words “entity” means a private limited company as defined in the Companies Act, 2013, or a registered partnership firm registered under section 59 of the Partnership Act, 1932 or LLP under the Limited Liability Partnership Act, 2002.
Thus, Startup is an entity considered to be working towards innovation, development, deployment or commercialization of new products, processes or services driven by technology or intellectual property. Its aim is to develop and commercialize a
new product or service or process or to significantly improve existing product or service or process that will create or add value for customers or workflow.
3. Discuss briefly Benefits/Exemptions to Startups in India under the Companies Act, 2013.
Ans.: Benefits/Exemptions to Startups under the Companies Act, 2013:
(1) Section 2(40) – Definition of financial statement: The financial statement in relation to a private company which is Startup may not include the cash flow statement.
(2) Section 54 – Issue of sweat equity shares: A Startup company may issue sweat equity shares not exceeding 50% of its paid-up capital up to 10 years from the date of its incorporation or registration.
(3) Section 62 – Further issue of share capital: For the purposes of Section 62(1)(b), “Employee” does not include:
(i) An employee who is a promoter or a person belonging to the promoter group.
(ii) A director who either himself or through his relative or through anybody corporate, directly or indirectly, holds more than ten per cent of the outstanding equity shares of the company. The aforementioned conditions shall not apply to a Startup up to 10 years from the date of its incorporation or registration.
(4) Section 73 – Prohibition on acceptance of deposit from public: Deposit does not include an amount ` 25 lakh or more received by a Startup company, by way of a convertible note (convertible into equity shares or repayable within a period not exceeding 10 years from the date of issue) in a single tranche, from a person.
(5) Section 73 – Prohibition on acceptance of deposit from public read with Rule 3 of the Companies (Acceptance of Deposits) Rules, 2014: The maximum limit in respect of deposits to be accepted from members shall not apply to a private company which is a Startup, for 10 years from the date of its incorporation.
(6) Section 73 – Prohibition on acceptance of deposit from public: Clauses (a) to (e) of Section 73(2) shall not apply to a private company which is a Startup, for 5 years from the date of its incorporation.
(7) Section 92 – Annual Return: In relation to a private company, which 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.
(8) Section 173 – Meetings of Board: A private company, which is a Startup, shall be deemed to have compiled with the provisions of Section 173, if at least one meeting of the Board of Directors has been conducted in each half of a calendar year and the gap between the two meeting is not less than 90 days.
(9) Section 446B – Lesser penalties: If penalty is payable for non-compliance of any of the provisions of Companies Act, 2013 by a Startup company or by any of its officer in default, or any other person in respect of such company, then such company, its officer in default or any other person, shall be liable to a penalty which shall not be more than one half of the penalty specified in such provisions subject to a maximum of ` 2 lakh in case of a company and ` 1 lakh in a case of an officer who is in default or any other person.
4. Discuss briefly various tax exemptions available to Startups in India.
Ans.: Following tax exemptions for the Startups had been introduced that was made effective from 2017-18. The proposed incentives and exemptions are:
(1) Tax exemption on profits under Section 80-IAC: The Inter-Ministerial Board of Certification is a Board set up by Department for Promotion of Industry & Internal Trade [DPIIT] which validates Startups for granting tax related benefits.
The Startup incorporated after 1.4.2016 but before the 1.4.2022 is eligible to apply to the Inter-Ministerial Board for a deduction of an amount equal to 100% of the profits and gains derived from an eligible business by an eligible startup for 3 consecutive assessment years out of 10 years beginning from the year in which the eligible Startup is incorporated. However, the annual turnover must not exceed ` 100 Crore in the previous year relevant to the assessment year for which deduction is claimed.
(2) Tax exemption on investments above Fair Market Value: DPIIT Recognized Startups are exempt from tax under Section 56(2)(viib) of the Income-tax Act when such a Startup receives any consideration for issue of shares which exceeds the Fair Market Value of such shares.
The Startup has to file a duly signed declaration in Form 2 to DPIIT to claim above exemption.
(3) Exemption from tax on LTCG: 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 ` 50 lakh.
(4) Exemption from tax on capital gains arising out of sale of residential property: 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:
The condition of minimum holding of 50% of share capital or voting rights in the Startup relaxed to 25%.
The period of extension of capital gains arising from for transfer of residential property for investment in Startups has been extended up to 31st March 2022.
(5) Carry forward of losses: Startups can carry forward their losses on satisfaction of any one of the following two conditions:
Continuity of 51% shareholding/voting power or
Continuity of 100% of original shareholder.
5. Amar is young entrepreneur willing to establish an incubator setup in the space of IT, software development, cloud computing or hardware/ software maintenance. Advice Amar regarding benefits available to entrepreneurs in establishing Startups. [Dec. 2018 (5 Marks)]
Or
“Startups India” initiative is used to promote growth and to help Indian economy by the Government of India. Explain the benefits which are being given to entrepreneurs establishing Startups.
[June 2022 (4 Marks)]
Or
XYZ Solutions Pvt. Ltd. is a newly established technology company based in Bangalore, India. The company specializes in developing Al-powered software solutions for healthcare providers. As part of its growth trajectory, XYZ. Solutions Pvt. Ltd. is exploring the benefits available to startups under the Startup India Program. Advise the company about the benefits given to entrepreneurs establishing startups. [June 2024 (3 Marks)]
Ans.: To promote growth and help Indian economy, following benefits are being given to entrepreneurs establishing startups.
(1) Simple Process: Government of India has launched a mobile app and a website for easy registration for startups. Anyone interested in setting up a startup can fill up a simple form on the website and upload certain documents. The entire process is completely online.
(2) Reduction in cost: The Government also provides lists of facilitators of patents and trademarks. They will provide high quality Intellectual Property Right Services including fast examination of patents at lower fees. The government will bear all facilitator fees and the startup will bear only the statutory fees. They will enjoy 80% reduction in cost of filing patents.
(3) Easy access to Funds: ` 10,000 Crore fund is set-up by Government to provide funds to the startups as venture capital. The Government is also giving guarantee to the lenders to encourage banks and other financial institutions for providing venture capital.
(4) Tax holiday for 3 Years: Startups will be exempted from income tax for 3 years provided they get a certification from Inter-Ministerial Board (IMB).
(5) Apply for tenders: Startups can apply for Government Tenders. They are exempted from the “prior experience/turnover” criteria applicable for normal companies answering to Government Tenders.
(6) R & D facilities: Seven new Research Parks will be set up to provide facilities to startups in the R & D sector.
(7) No time-consuming compliances: Various compliances have been simplified for startups to save time and money. Startups shall be allowed to self-certify compliance (through the Startup mobile app) with 9 labour and 3 environment laws.
(8) Tax saving for investors: People investing their capital gains in the venture funds setup by Government will get exemption from capital gains. This will help startups to attract more investors.
(9) Choose your investor: The Startups will have an option to choose between the VCs, giving them the liberty to choose their investors.
(10) Easy exit: In case of exit, a startup can close its business within 90 days from the date of application of winding-up.
(11) Meet other entrepreneurs: Government has proposed to hold 2 startup fests annually both nationally and internationally to enable the various stakeholders of a startup to meet. This will provide huge networking opportunities.
Therefore, Amar is advised to establish an incubator set up in the space of IT, software development, cloud computing or hardware/software maintenance in order to get the maximum benefits.
6. ABC Private Ltd., a Startup company, received an amount of ` 25 lakh in single tranche from an investor by way of a Note, convertible into equity shares (convertible after 3 years but within 5 years from the date of issue). CFO of the company was of the view that the said amount is not a deposit. In the light of the statutory provisions, explain whether the view of the CFO is correct?
[June 2019 (5 Marks)]
Ans.: The Companies (Acceptance of Deposit) Rules, 2014 have been amended to provide that an amount of ` 25 lakh or more received by a Startup company, by way of a convertible note (convertible into equity shares or repayable within a period not exceeding 5 years from the date of issue) in a single tranche, from a person shall not be treated as a deposit.
Further, as per the exemption notification issued by the MCA, the provisions of clauses (a) to (e) of Section 73(2) of the Companies Act, 2013 shall not apply to a Startup company for 5 years from the date of incorporation.
In view of the said provision, the view of the CFO that the amount of ` 25 lakh received from an investor, by way of Note convertible into equity after 3 years but before 5 years is not a deposit, is correct.
7. Pawan incorporated a Private Ltd. Company in the year 2016 for carrying on the business of supplying freshly chopped vegetables to various food chains in and around New Delhi NCR. He wants his entity to be recognized as a Startup. Advise the process to be followed by him for recognition of his company as a Startup. [Dec. 2019 (4 Marks)]
Ans.: The recognition of the startups in India is regulated vide notification issued by the Department for Promotion of Industry and Internal Trade (DPIIT).
Eligibility for Recognition of Startup: Please refer to answer of Question No. 1.
Procedure of Recognition: Process of recognition of an eligible entity as Startup is given below:
(
a) A Startup shall make an online application over the mobile app or portal set-up by the DPIIT.
(
b) The application shall be accompanied by —
A copy of Certificate of Incorporation or Registration.
A write-up about the nature of business highlighting how it is working towards innovation, development or improvement of products or processes or services, or its scalability in terms of employment generation or wealth creation.
Decision of DPIIT: The DPIIT may, after calling for such documents or information and making such enquires, as it may deem fit –
(
a) Recognize the eligible entity as Startup or
(b) Reject the application by providing reasons.
8. Crowd Funding is a recent phenomena being practiced for getting seed funding usually through the internet. Elucidate. [Dec. 2020 (4 Marks)]
Ans.: Crowd Funding – Meaning: Crowd Funding is recent phenomena being practiced for getting seed funding through small amounts collected from a large number of people (Crowd), usually through the Internet. Now we have companies existing in India which are specializing in “Crowd Funding”.
Process of raising money in crowd funding: The entrepreneur can get money for his venture by showcasing his idea before a large group of people and trying to convince people of its utility and success.
The entrepreneur needs to put up on a portal his profile and presentation, which should include the business idea, its impact, and the rewards and returns for investors. It should be supported by suitable images and videos of the project.
Consultation Paper on Crowd funding: SEBI in 2014, even rolled out a ‘Consul-tation Paper on Crowd funding in India’ proposing a framework in the form of Crowd funding to allow Startups and SMEs to raise early stage capital in relatively small sums from a broad investor base.
The Consultation Paper defined Crowd funding as solicitation of funds (small amount) from multiple investors through a web-based platform or social
networking site for a specific project, business venture or social cause. However, SEBI not issued any further regulations in this regard.
9. J is a B. Tech. in Computer Science from Indian Institute of Technology, Roorkee. J has invented a new procedure for making of battery having long life as compared to lithium battery available in the market. The invention has been patented by J. J has made an online application over the portal setup by the Government of India for initial funding under start-up. In the online application, J observed that there is a column for seed funding. Advise J on the meaning and importance of Seed Capital. [June 2023 (5 Marks)]
Ans.: Meaning and importance of seed funding:
Meaning: Startup business needs the nurturing of finance to explore and grow. The funding done at the nascent stage is called seed funding and the capital is known as a seed capital.
Sources of seed funding: Technically, seed capital is the initial capital used at the time of starting the business. This capital can come from the founders, families or friends. It is required for the market research, product development, and other initial stage operations.
Seed funding helps in business transformation: Seed funding permits exploration of the business idea and converting it into a viable product or service that further attracts venture capitalists. A business founder must be clear on how to utilize seed capital in the most optimum manner to ensure smooth transition to the advanced stage of the business.
Risk in seed funding: Seed funding is a risky investment option, as most funding agencies would like to adopt a wait and watch approach to see whether the idea has a business potential. From the founder’s point of view, the option of obtaining seed funding has to be carefully utilized as obtaining seed funding may result in dilution of ownership of the founder.
Less paperwork and other formalities: The paperwork involved in seed funding is relatively less and straightforward, compared to advanced rounds of funding. Even the legal fees required are also quite less as compared to the seed equity.
The interest rates too are usually lower and there are mostly no restrictions in the manner of business working as it is still in the nascent stage.
Financing options in seed funding: Financing is generally of two types i.e. (a) Equity Financing; or (b) Debt Financing.
10. PQ Pvt. Ltd. is the newly incorporated company engaged in manufacturing of machinery parts proposes to raise the funds through Private Equity and Angel Investors. Explain these equity financing options available to the company. [June 2021 (4 Marks)]
Ans.: Startups are usually equity financed/funded by way of a venture capital/ private equity investors and/or angel investors.
(i) Venture Capitalist/Private Equity: Venture Capital/Private Equity is often the first large investment a Startup can expect to receive.
Convertible instruments are usually the preferred option and most commonly used securities for investment which includes compulsory convertible preference shares and compulsory convertible debentures.
The investor and Startup will normally enter into a non-binding offer based on the preliminary valuation of the Startup usually followed with a financial, legal and technical due diligence on the Startup as required by the investors.
Due diligence will help the investors to finalize the representation and warranties and also to identify conditions precedent to the completion of investments and conditions subsequent in the aforesaid transaction documents.
(
ii) Angel Investors: Angel investors are usually individuals or a group of industry professionals who are willing to fund the venture in return for an equity stake.
Under the SEBI (Alternative Investment Funds) Regulations, 2012, SEBI has made the following restrictions applicable to angel funds investing in an Indian company:
(1) Investment in venture capital undertakings: Angel funds shall invest in venture capital undertakings:
(a) Which complies with the criteria regarding the age of the venture capital undertaking/Startup issued by the Department of Industrial Policy & Promotion under the Ministry of Commerce and Industry, Government of India.
(b) Which have a turnover of less than ` 25 Crore.
(c) Which are not promoted or sponsored by or related to an industrial group whose group turnover exceeds ` 300 Crore.
(d) Which are not companies with family connection with any of the angel investors who are investing in the company.
(2) Investment limits: Investment by an angel fund in any venture capital undertaking shall not be less than ` 25 Lakh and shall not exceed ` 10 Crore
(3) Lock-in period: Investment by an angel fund in the venture capital undertaking shall be locked in for a period of one year.
(4) No investment in associates: Angel funds shall not invest in associates.
(5) Prohibition on investments: Angel funds shall not invest more than 25% of the total investments under all its schemes in one venture capital undertaking.
(6) Overseas Investments: An angel fund may also invest in the securities of companies incorporated outside India subject to such conditions or guidelines that may be stipulated or issued by the RBI and the SEBI from time to time.
11. Explain the unconventional modes of financing options for Startups which are becoming popular in India. [Dec. 2021 (4 Marks)]
Ans.: Following are the unconventional modes of financing options for Startups which are becoming popular in India:
(a) Crowd Funding: Please refer to answer of Question No. 8.
(
b) Incubators: These set-ups precede the seed funding stage and help the entrepreneur develop a business idea or make a prototype by providing resources and services in exchange for an equity stake ranging from 2-10%.
Incubators offer office space, administrative support, legal compliances, management training, mentoring and access to industry experts as well as to funding through angel investors or VCs.
These are usually government-supported institutes like the IIMs or IITs, technical institutes or private business incubators run by industry veterans or companies.
The incubation period can be 2-3 years and admission is rigorous.
Some of the top options in India include IIM-Bangalore NSRCEL, Microsoft Accelerator and IIT, Kanpur, SIIC and the Sri Ram College of Commerce (SRCC).
12. Radha Furnishing Private Ltd., a Start-up Company wants to issue sweat equity shares to its employees. Is there any provision regarding it? Explain. [Dec. 2022 (4 Marks)]
Ans.: Sweat equity shares: Sweat equity shares means equity shares issued by a company to its directors or employees at a discount or for consideration, other than cash for providing know-how or making available rights in the nature of intellectual property rights or value additions, by whatever name called.
Issue of sweat equity shares by Startup Company: As per the Companies (Share Capital & Debentures) Amendment Rules, 2020, a Startup Company, may issue sweat equity shares not exceeding 50% of its paid-up share capital up to 10 years from the date of its incorporation or registration. [Earlier the time period was up to 5 years from the date of incorporation or registration]
Thus, Radha Furnishing Private Ltd., a Start-up Company may issue sweat equity shares to its employees subject to above stated provisions.
