Navigating Startup Funding Regulations in India: The Impact of Government Initiatives on Startup Growth and Investment

India has a thriving startup scene that is full of aspiration, creativity, and a strong sense of entrepreneurial spirit. India has emerged as the third largest startup ecosystem globally, fostering the growth and realisation of audacious ideas and aspirations.

India’s startup scene is booming because of government financing, expanding digital infrastructure, business-friendly policies, and an entrepreneurial mindset. There were 1,23,900 DPIIT-recognised startups as of March 14, 2024, with at least one firm recognised in each state.

By December 31, 2023, more than 12 lakh people had direct jobs thanks to the acknowledged startups. With such astounding figures, India is well on its way to leading the world in innovative and cutting-edge technology.

Innovative startups have been at the forefront of offering innovative products, services, and technologies that have the potential to transform the world. while generating jobs, establishing valuable enterprises & nurturing innovation. The Government of India has been leading the transformation of the startup ecosystem with strategic initiatives that facilitate innovation and enable entrepreneurs to generate growth.

Obtaining investment is not only a big step in the Indian startup ecosystem’s constant evolution, but it also involves a difficult legal process. The objective of this article is to furnish entrepreneurs with a comprehensive comprehension of the legal aspects linked to diverse funding categories, funding cycles, investment contracts, and regulatory obligations in India.

Laying the Groundwork

A key part of the government’s approach to supporting startups has been streamlining and digitizing the process of establishing a business.

The Tax Deduction & Collection Account Number (TAN), the Permanent Account Number (PAN), and the Director Identification Number (DIN) are now merged into a single form, SPICe+. This platform allows startups to easily register their business online, with no incorporation fee for startups with capital up to INR 15 Lakh.

The “Project Insight” initiative aims to improve collaboration among different tax authorities, promoting transparency through digitization. Additionally, the Income Tax Transaction Analysis Centre (INTRAC) uses data analytics to enhance tax reporting, while the Compliance Management Centralized Processing Centre (CMCPC) utilizes these insights to reduce the compliance burden for startups.

Regulatory Reforms

Since 2016, 53 regulatory changes have been made to boost the startup environment in India. The latest change extends the startup recognition period to 10 years from incorporation, with a turnover cap of less than INR 100 Cr. Startups that incorporate before March 31, 2024, and have a turnover under INR 100 Cr, can also benefit from tax rebates for 3 of the 10 years.

To reduce compliance hurdles, startups can self-certify compliance under nine labor laws and three environmental laws for the first 3-5 years. They can also get an 80% discount on patent filing fees and a 50% discount on trademark filings. Further, educational institutions now get an 80% rebate on patent filing.

Closing a business is now easier too, with startups designated as “fast track firms,” allowing them to wind up operations in 90 days, compared to the usual 180 days for other companies.

These reforms aim to create an environment that promotes innovation, eases business operations, and nurtures successful companies.

Funding Innovation

The government has initiated multiple schemes to support startups, including financial, technical, and infrastructural assistance. The Startup India Initiative, led by the Ministry of Commerce & Industry and the Department of Science & Technology, offers various support programs.

The Startup India Seed Fund Scheme provides financial aid to startups through approved incubators, covering expenses from proof of concept to commercialization. As of December 31, 2023, 217 incubators were part of this scheme, with an approved budget of about INR 841.8 Cr.

The National Initiative for Developing and Harnessing Innovations (NIDHI), from The National Science and Technology Entrepreneurship Development Board (NSTEDB), has set up over 170 Technology Business Incubators (TBIs) since 2016, each receiving INR 220 Lakh to support 10 innovators every year.

For startups focused on advanced technologies like AI, IoT, and robotics, the TIDE 2.0 initiative, launched by the Ministry of Electronics & Information Technology, funds 2000 startups through 51 incubators across India.

The government has also taken steps to encourage foreign partnerships and global exposure, with a relaxation of FDI policies and various other incentives.

Capital Support

The government has relaxed Foreign Direct Investment (FDI) policies to encourage global trade and investment. Now, there’s a 100% FDI allowance for satellite system procurement and manufacturing. Additionally, DPIIT-recognized startups are exempt from the “angel tax” under Section 56 of the Income Tax Act.

To promote exports, the Remission of Duties and Taxes on Exported Products (RoDTEP) scheme provides tax and duty rebates on exports. For the current financial year, this scheme has an INR 15,070 Cr budget, with an expected increase of 10% for the 2024-25 period.

SIDBI’s Fund of Funds, operating under Startup India, has provided venture capital worth approximately INR 10,284 Cr to 131 AIFs, while the Credit Guarantee Scheme for Startups offers credit guarantees up to INR 10 Cr for loans to eligible startups.

The Startup India Investor Connect, an AI-based platform, connects startups with investors, facilitating new investment opportunities.

Startup India & Atal Innovation Mission

The Startup India Initiative and Atal Innovation Mission (AIM) are leading programs fostering innovation and entrepreneurship in India. AIM, launched in 2016, supports over 3,500 startups through 72 Atal Incubation Centres (AICs), focusing on various sectors like health tech, fintech, and edtech.

The Startup India Initiative has various programs to support entrepreneurs and strengthen the startup ecosystem. Its platform, with over 6 Lakh users, is a one-stop resource for startups, offering information on schemes, certifications, and more.

Annual programs such as States’ Startup Ranking, National Startup Awards, and Innovation Week aim to further develop India’s startup ecosystem, fostering growth and innovation.

Funding Stages and Types of Funding

Seed Funding: This is the initial capital that startups require to begin their journey. It often comes from angel investors, family, friends, or incubators and is used for product development and early-stage operations.

Venture Capital (VC) Funding: As startups grow, they might seek venture capital. This involves getting significant financial investments in exchange for equity, with venture capitalists often engaging in subsequent funding rounds.

Series Funding Rounds:As startups advance, they go through different funding stages—Series A, B, C, and beyond. Each round represents a new growth phase, with larger investments and higher company valuations.

Debt Financing: Some startups choose debt financing, obtaining loans or issuing convertible notes, which differ from equity-based funding in terms of repayment and ownership stakes.

Investment Agreements

Term Sheets: These documents serve as preliminary agreements, outlining key terms and conditions before entering into detailed negotiations. Term sheets are used to set the basic framework for the investment.

Convertible Notes and SAFE Agreements: These are common in early-stage funding, allowing startups to receive investment with the flexibility of determining equity structure at a later stage.

Share Purchase Agreements (SPAs): These agreements are crucial for equity-based funding. They detail the terms of share purchases, including the responsibilities and guarantees from the founders.

Compliance Requirements

SEBI Regulations: Startups need to comply with rules set by the Securities and Exchange Board of India (SEBI), particularly regarding private placements, disclosures, and investor protection.

Foreign Direct Investment (FDI): Startups seeking foreign investment must follow the Reserve Bank of India’s (RBI) FDI guidelines. This includes adhering to sector-specific caps and meeting certain reporting requirements.

Tax Implications: The tax framework can significantly impact startups. Entrepreneurs should be aware of the tax consequences of different funding structures and plan accordingly to achieve tax efficiency.

Due Diligence

Legal Due Diligence: Before investing, investors conduct a thorough legal review. Ensuring that all legal documents, contracts, and intellectual property rights are in order can expedite this process.

Financial Due Diligence: This involves a detailed review of the startup’s financial health. Startups must provide accurate financial records and transparently address any issues that might raise concerns.

Conclusion

India’s startup ecosystem has witnessed remarkable growth, with a record 114 unicorns valued at $350 billion as of March 2024. The surge in unicorns, with 45 emerging in 2021 and 22 in 2022, signifies the country’s robust entrepreneurial spirit.

India is paving the way for its startups to reach new heights, indicating a promising trajectory. As Indian startups continue to expand, navigating the complexities of funding and investment becomes crucial. Entrepreneurs must carefully choose the right funding options, draft detailed investment agreements, and comply with regulatory frameworks to ensure sustained growth.

By staying well-informed and utilizing key resources, startups can attract a variety of funding sources and lay a strong legal groundwork for future success. In India’s evolving startup ecosystem, the opportunities are limitless, and the journey is upward and onward.