Startup Ecosystem in India - Issues, Challenges & Opportunities

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Startups are a vital part of the Indian economy as they promote economic growth, create employment and foster a culture of innovation. The Indian government launched the Startup India Campaign, recognising entrepreneurship as an increasingly important strategy to fuel productivity growth and wealth creation in India. During the Union Budget 2020, the Finance Minister gave high emphasis on measures taken to promote and support startups as they are going to the driver of the Indian economy in the near future. From infrastructure boost to easing tax burdens, the budget has proposed numerous benefits for the startups. The recent economic survey pointed out an increase in startups in India. However, many are opting to register overseas due to complicated compliance norms and loss-inflicting laws. Necessary reforms to ensure ease of doing business for the startups are vital for the success of the startup India initiative.

Contents

What is a startup?

Last year, the Department of Promotion of Industry and Internal Trade (DPIIT) had widened the definition of startups from the earlier definition under the Startup India scheme and Standup India scheme.
As per the new definition, an entity is a startup:

Till up to 10 years from its incorporation/registration date.
If the entity’s turnover for any of the financial year since its incorporation has not exceeded Rs.100 crore.

This entity should be incorporated in India as a:

Private Limited Company as per the Companies Act, 2013, or
Partnership Firm as per section 59 of the Partnership Act, 1932, or
Limited Liabilities Partnership as per the Limited Liabilities Partnership Act, 2008.

Furthermore, the startups should work towards innovation, development or improvement of products or a scalable business model with a high potential of employment or wealth generation.
An entity is not a startup if it is created by splitting or reconstructing an existing unit.
The entity shall cease to exist as a startup if it completes 10 years from the date of incorporation/registration and its turnover for any previous financial years exceeds Rs.100 crore.

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What is the Startup India initiative?

Startup India is the Indian Government’s flagship initiative that aims to build a strong ecosystem to promote innovation and startups in the country.
In doing so, the initiative aims to ensure sustainable economic growth and generate large-scale employment opportunities.
The government, through this initiative, also aims to empower startups so that they grow through innovation and design.

What is the Startup India Action Plan?

To achieve the objectives of the Startup India initiative, the Startup India Action Plan was proposed by the government. Through this Action Plan, the government aims to accelerate the spreading of the startup movement in India:
From digital or technology sector to wide-ranging sectors like agriculture, manufacturing, social sector, healthcare, education, and
From existing tier I cities to tier 2 and 3 cities including semi-urban and rural areas.
The Action Plan is divided across the following areas:
Simplification and handholding
Funding support and incentives
Industry-academia partnership and incubation
The 19-point Action plan includes:

Self-certification compliance
Single point contact through Startup India Hub
Simplifying processes with mobile app and portal (for registration, filing compliance and obtaining information)
Legal support, fast-tracking and 80% reduction in the patent registration fee
Relaxation of norms of public procurement for startups
Easier and faster exit
Funding support through a Fund of Funds with a Corpus of INR 10,000 crore for 4 years. This means that the government will not directly invest in the startups, but will participate in the capital of SEBI registered Venture Funds.
Credit Guarantee mechanism for the startups through National Guarantee Trust Company (NCGTC) or SIDBI.
Tax exemption on capital gains
Three-year tax exemption
Tax exemption on investments above Fair Market Value (FMV)
Annual Startup fest (national and international)
Launch of world-class innovation hubs under Atal Innovation Mission
Setting up of nationwide incubator network
Innovation centres for enhancing incubation and research and development
Research parks to promote innovation
Promote entrepreneurship in biotechnology
Innovation focused programmes for students
Annual incubator grand challenge

What does the Economic Survey 2019-20 say about startups?

According to the Economic Survey 2020, as many as 27,084 startups were recognised across 551 districts as on January 8, 2020.
Tier I cities contributed about 55% of the startups while 45% of the firms operated from Tier II and Tier III cities.
Maharashtra, Karnataka and Delhi are the top three performers in terms of the state-wise distribution of recognised startups in the country.
As for the industry-wise distribution of recognised startups, IT services topped the list with 13.9%, followed by healthcare and life sciences at 8.3% and education at 7%. The renewable energy sector contributed to only 2.8% of the recognised startups.
According to the survey, about 43% of recognised startups have at least one women director.
As per the data sourced from the market research firm Tracxn, in 2019, Internet firms in the country raised a little over $10 billion because of $4.41 billion funding in the October-December quarter.
Fintech startup Paytm notched the largest fundraiser of 2019.
More than 3 lakh users have availed for free Start-up India learning programme to build business plans under the government’s Start-up India Hub initiative.

Why are India’s startups currently opting to register overseas?

To achieve the target of a $5 trillion economy, a simple business-friendly regulatory environment is vital.
Over the past few years, India has made a significant improvement in the World Bank’s Ease of Doing Business rankings. It has risen from 142 in 2014 to 63 in 2019 because of reforms like GST and Insolvency and Bankruptcy Code (IBC).
Despite the progress, further simplification is required in India’s compliance regime.
According to the LocalCircles survey, 11% of Indian startups are considering moving their business to another country due to the heavy compliance burden.
The Economic Survey 2020 compares India with developed economies to show where it needs to improve and how to meet international standards.
Setting up companies: Economic Survey states the steps required to set up a company in India has reduced from 13 to 10 over the past decade. The time taken to incorporate business takes 18 days (down from a month in 2009). However, in New Zealand, a single form is to be submitted in a dedicated agency to start a business. The procedure lasts to only about 6 to 10 hours.
India also lags in the enforcement of contracts and suffers from slow dispute resolution. It ranks 163 out of 190 with countries such as Afghanistan and Mozambique trailing behind it in enforcing contracts. The Economic Survey says that it takes 1,445 days to resolve a dispute in India, whereas, it takes just 216 days in New Zealand. Previous surveys too have pointed out these issues as the cause for an impediment to the ease of doing business in India.
Complicated compliance and legislation requirements for the manufacturing firms have led to a sharp increase in the cost of doing business. According to the survey, manufacturing firms have to comply with 6,796 items and the service sector isn’t any different.
These issues are hindering Indian startups from realising their potential, leading to them pulling out of the country.
To address these issues, the government needs to look at the new laws that are being passed from the “ease of doing business” perspective.
Also, the government must do away with laws that are not facilitating the same for the startups, SMEs, exports, etc.

What did the Finance Minister say about startups during the Union Budget 2020-21?

Seed Fund: During the budget speech, the finance minister proposed to provide early life funding, including a seed fund to aid ideation and development of early-stage startups. At present, there are about 416 venture funds that focus on the early-stage startups in India
Tax exemption for startup employees: Tax relief for employees eligible for Employee Stock Ownership Plan (ESOPs). ESOP is a type of employee benefit plan that intends to encourage employees to acquire stocks or ownership in the company. It is a significant component of compensation for startup employees. Currently, ESOPs are taxable. This leads to a cash-flow problem for the employees who do not sell shares immediately and continue to hold the same for the long-term. To enhance the startup ecosystem, the Finance Minister proposed to ease the burden of taxation on the employees by deferring the tax payments by 5 years or until they leave the company or when they sell their shares, whichever is earliest.
Tax exemption for startups: Previously, an eligible startup having turnover up to Rs.25 crore is allowed a deduction of 100% of its profits for three consecutive assessment years out of seven years if the total number does not exceed Rs.25 crore. To extend this benefit to larger startups, the Finance Minister proposed to increase the turnover limit from the existing Rs.25 crore to Rs.100 crore. Moreover, considering the fact that in initial years, a startup may not have adequate profit to avail of this deduction, the government has decided to extend the period of eligibility for claiming deduction from the existing seven years to 10 years.
Harassment-free tax laws: In July 2019, Café Coffee Day founder V.G.Siddhartha was found dead after supposedly being hounded by regulators and taxman for alleged financial irregularities. There have been several other cases where entrepreneurs in the country harassed by taxmen. During the budget, the finance minister addressed the issue by proposing amendments to the Companies Act and other such laws where such provisions exist so that citizens are free from harassment of any kind.
Investment clearance cell: The budget also proposed setting up an investment clearance cell through a portal that will provide end-to-end facilitation and support, including pre-investment advisory, information related to land banks and facilitation of clearances at the centre and state level. This, in many ways, will assist entrepreneurs in India.

What are the issues and challenges faced by startups?

Cash crunch: Cash availability is vital for startups and it is always a challenge to obtain sufficient amounts. Many finance options are available. However, the fiscal requirement is ever increasing as the business progresses. Scaling of business requires a timely infusion of capital. Proper cash management is critical for the success of startups. A report stated that about 85% of new companies are reportedly underfunded, indicating a potential failure of the Startup India initiative.
Revenue generation: Several startups fail due to poor revenue generation as the business grows. As the operation increase, expense grows with reduced revenue, forcing startups to concentrate on the funding aspect. This leads to dilution of focus on the fundamental business. Therefore, the challenge is not only to generate working capital but also to sustain and expand growth.
Supporting infrastructure: Several support mechanisms play a crucial role in the lifecycle of startups like incubators, science and technology parks, business development centres, etc. Lack of access to such support mechanisms increases the risk of failure.
Lack of awareness about limitations in the market also causes failure of the startups. The environment for a startup is usually more difficult than for an established firm due to the uniqueness of the product launched by the startups.
Regulations: Starting a business requires a number of permissions from the government agencies. Despite the perceptible changes made in recent years, it is still a challenge to register a company. Regulations pertaining to labour laws, intellectual property rights, dispute resolution, etc., are severe in India.
Lack of proper guidance on how to manage innovative startups is also one of the major challenges faced by startups. Little to no industry, business and market experience to get the products into the market has proven to be a major hindrance for the startups. A brilliant idea is successful only if it is executed promptly and efficiently into the market.
Lack of good and effective branding strategy also prevents startups from flourishing. Branding is of paramount importance for startups as it gives an identity and occupies a space in the consumers’ minds.

What are the opportunities for startups in India?

Despite the challenges faced by startups, the Indian market provides numerous opportunities to find solutions. The following are the opportunities that exist in India:

The large population in India is an asset to the Indian economy as it allows for the startups’ progress through trained personnel and increasing demand from the population.
Huge investments in startups from foreign and domestic investors due to the innovative reforms by the government in recent years.
Government and semi-governmental initiatives are currently supporting startups through infrastructure, financial and technical assistance and easier compliance norms.

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What can be the way forward?

Startups are currently an important asset that needs to be supported through fast-paced infrastructure growth.
Additionally, the government must push banks and other financial institutions to give low-interest loans to innovative startups.
These startups must be given free training so that they can survive the competitive market.
India has a huge demographic base. The lack of necessary skills and education are preventing India from realising the human capital’s potential. Reforms in these aspects is a need of the hour.
Red-tapism is still an issue that hinders the ease of doing business in India. Reforms must be made to the current restrictive legislative structure and regulatory norms in a way that allows the startups to flourish.

Conclusion:

During the recent budget, the government has rolled out reforms like a five-year tax holiday for ESOP, tax exemption for startups with turnover less than Rs.100 crores for 10 years and the establishment of seed fund that will spur the startup activities within India. More notably, the budget has also proposed the reforms to make norms more empathetic and supportive to the startups along with the establishment of the investment clearance cell of aiding entrepreneurs in India. However, many other reforms that allow for simplification of compliances must be launched as the bureaucracy, compliance and other complicated laws are still hindering the growth of startups in India.