Dwarfed by luxury apartments and posh bungalows in Bengaluru’s upmarket Koramangala is a nondescript building that houses the office of Tonbo Imaging - a start-up that develops cutting edge technology products for the defence industry.
Tonbo is a little-known company, but its advanced night vision systems are made for Indian and international customers including Darpa, a branch of the U.S. Department of Defense, responsible for the development of emerging technologies for use by the military. Tonbo’s products are used on observation platforms, reconnaissance drones, and artillery and naval weapon systems.
Tonbo is the only indigenous manufacturer and exporter of thermal imaging-based devices. But from being a purely Indian company, Tonbo has moved to become a global products business based out of Singapore. Its international expansion was largely fuelled to leverage the benefits offered to international suppliers on buy-global Indian programmes.
“Indian suppliers are levied customs duties at the component level and taxes at the product level,” said Tonbo founder Arvind Lakshmikumar, an alumnus of BITS Pilani and Carnegie Mellon University. “Foreign bidders don’t face this problem. This creates a clear 30-40 per cent difference in just government levies.”
Tonbo is among a growing list of Indian start-ups that have moved base to overseas markets such as Singapore, the U.S. and the U.K., which have business-friendly tax regimes and regulations. >Excessive red tape in processes such as early-stage investing and mergers and acquisitions is also forcing these young, promising ventures in India to shift overseas.
A similar story is that of Jalandhar-based customer support software maker Kayako, which, after finding it difficult to work in the Indian regulatory environment, moved to the U.K. this year. Kayako has over 30,000 clients including U.S. space agency NASA, European carmaker Peugeot, and Japanese gaming firm Sega.
London made sense for Kayako because of the U.K.’s regulatory environment: research and development credits, capital gains tax credits for entrepreneurs, and a friendly and pro-active tax regime. Not only did the directors of U.K. Trade and Investment along with other high-level officials visit Kayako’s offices, they also arranged for a tier one entrepreneur visa within a record time of 20 days. “I had officials from London & Partners and U.K. Trade and Investment visiting me even after the move, offering help with basic personal stuff like housing or settling in London,” said Kayako’s 30-year-old founder Varun Shoor. “There is freedom of movement and labour; I can get access to talent from the whole of Europe.”
Mr. Shoor said Kayako had a lot of remote workers in countries such as Ukraine, Belgium and Canada. Paying them month-on-month was a mess because of the paperwork the company was required to file in India — it had to prepare six different forms and get certified by chartered accountants and banks. He said there is also a lot of ambiguity on export of services and service tax in India. Added to this, companies get conflicting notifications issued every month by various departments.
Last year, 54 per cent of the funded young tech ventures domiciled in Singapore, the U.S and the U.K. because of better regulatory environment in these countries. The figure shot up to 75 per cent this year, according to software product think tank iSpirt.
Nine of the top 30 business-to-business software product companies by market capitalisation have already relocated to the U.S., Singapore and the U.K. These 30 companies are worth $10 billion (Rs 65,589 crore), employing 21,000 people, according to iSpirt’s software product index, which tracks the growth of the industry.
Bridge to Silicon Valley
The government and investors in these countries are hungry for intellectual property and are welcoming young Indian ventures with a red carpet. “The enormous value that is being created in the tech industry is leaving our shores,” said Sharad Sharma, co-founder of iSpirt. “This exodus is like the 18th century East India Company invasion.”
But the exodus can be stopped, he said. All we need is a “few smart actions by the government”.
That’s where Silicon Valley, the world’s innovation hub that >Prime Minister Narendra Modi visited last week , could play a part.
“I think Mr. Modi’s visit to Silicon Valley changed the equation when he spread a red carpet for start-ups,” said Naren Gupta, managing director of Nexus Venture Partners, a venture capital firm that was one of the first investors in online retailer Snapdeal and has backed affordable eye care hospital chain EyeQ. “The previous government was more about ‘if you are coming to India, we will give you special break’. People are not looking for special breaks but ease of business,” Mr. Gupta said. He was part of a meeting between start-ups and Mr. Modi and his team in Silicon Valley.
For India’s nascent start-up ecosystem, the >Silicon Valley experience offers several valuable lessons . It has earned its reputation as the global tech Mecca with 14,000-19,000 start-ups and 1.7-2.2 million high-tech workers, according to the Global Startup Ecosystem Ranking by the U.S.-based research firm Compass. It is home to success stories such as Apple, Google, Facebook, and countless others. Just these three companies combined have a market cap of $1.5 trillion and employ more than 1,65,000 people worldwide, according to Compass.
“What Silicon Valley shows is that you need to encourage risk taking and you don’t have to punish failure,” said Infosys co-founder and billionaire Nandan Nilekani, who spearheaded India’s massive unique identification project. “You can fail and come back. It rewards diversity, merit and an open society.”
India is already deeply connected to Silicon Valley through its diaspora. Indians account for 6 per cent of the population, but for 15 per cent of the start-ups. Successful companies such as Facebook, Dropbox and LinkedIn, which are equally popular in India as in the U.S., also contribute to the link. “We are seeing Silicon Valley start-ups launch in the U.S. first and then in India as a second market,” said B.V.R. Mohan Reddy, chairman of IT trade body Nasscom and founder of tech company Cyient, who was also part of a delegation that represented the young Indian ventures when Mr. Modi visited Silicon Valley.
Manu Rekhi, director of Inventus Capital Partners, again part of the Silicon Valley team that met Mr. Modi, says what exists now is “a wooden innovation bridge” between Silicon Valley and India and “what the government can do is to convert this wooden bridge into a six-lane steel bridge.”
The government is now trying to make this happen in collaboration with top legal minds, investors, entrepreneurs and organisations like Nasscom, entrepreneur network TiE, and iSpirt, to consolidate key policy recommendations.
Last Sunday, Mr. Rekhi attended a breakfast meeting with the senior government advisors who are leading the ‘Startup India’ initiative. He said the meeting was extremely collaborative and the advisors solicited detailed feedback on how to make the initiative a reality. “It was encouraging to see bureaucrats with a sense of purpose, as they laid out their objectives to make it easy for companies to get created, grow quickly and execute an orderly shutdown, as needed,” said Mr. Rekhi.
The process of streamlining exits in terms of mergers and acquisitions and initial public offering was also discussed in some detail. Mr. Rekhi said there is now a direct line of communication between policymakers in the government and TiE in Silicon Valley.
During the same period, a significant event, the >India-U.S. Startup Konnect Programme , was hosted by IT trade body Nasscom. The objective was to inspire thousands of small companies and create connections.
Forty Indian start-ups were also showcased at the exhibition for the Silicon Valley ecosystem to understand and appreciate the momentum for quality companies in India.
“These start-ups came from different segments of industry like agriculture, healthcare and energy, which have a significant impact on the poorest of poor in India,” said Mr. Reddy of Nasscom. “They got an opportunity to look for funding and also partner with the valley professionals.”
One such firm was Bengaluru-based NextGen founded by BITS Pilani and IIM-Bangalore alumni Abhishek Humbad and Richa Bajpai, both 27. Nextgen provides technology to large customers such as Bharat Petroleum, HDFC Bank and Vodafone Foundation to implement their corporate social responsibility projects effectively.
“When Mr. Modi visited our stall, it gave us credibility and visibility which was not possible if we were on our own,” said Mr. Humbad, who not only got access to a large market like the U.S., but also got a chance to meet several investors and mentors. “I am about to close a funding round in the next one month,” he said.
Mr. Rekhi of Inventus feels that for ‘Startup India’ to succeed, the government must rework the system to make it a more efficient and pro-business meritocracy. For example, small firms are responsible for two-thirds of jobs in the U.S. The same can be true of India with the implementation of streamlined policies addressing the entire lifecycle of a start-up: creation, growth and shutdown. “If unleashed, young Indian firms will employ a majority of the ten lakh new youth that join the workforce every month,” he said.
Challenges ahead
Though Mr. Modi’s team is trying to convince Indian start-ups that their long-standing demands over ease of doing business will be met, the entrepreneurs want to see action on the ground.
For instance, the key idea that Silicon Valley represents is that challengers are more important than incumbents. >Experts say the government hasn’t yet understood this key policy principle.
“So, they ignore Indian challengers to Google like mobile advertising firm InMobi, and kowtow to Google and Facebook,” said an industry executive who did not wish to be quoted. “Google, Facebook and Microsoft are incumbents; their commercial interests are not the national interest of India,” he added.
New capital will not come from Google, Facebook and Microsoft, but from individual angel investors and venture capitalists, the executive said. This is different from the old economy where incumbents were vehicles for new capital flows (for example, American multinational General Electric investing in India).
The major issue Indian start-ups face is capital gains taxes on venture capital and private equity. “These ‘nuisance taxes’ are inhibiting investment and development of Indian start-ups, reducing foreign and domestic technology, capital inflows, job creation, and hurting overall economic and government revenue growth,” said Dr. Rajan Govil, former economist at the International Monetary Fund and now cofounder at Marketnomix, an independent economics and markets research firm. Capital gains tax is a type of tax levied on capital gains incurred by individuals and corporations. Capital gains are the profits that an investor realises when he or she sells the capital asset for a price that is higher than the purchase price.
About $10 billion (Rs. 65, 589 crore) in venture capital and private equity funds has been invested in India’s technology product industry from 2010 to March 2015, according to iSpirt. Most of this investment has been routed through Mauritius and Singapore because of their favourable capital gains tax exemptions for investors.
Last year, angel investments totalled $24.1 billion (Rs. 1.58 lakh crore) in the U.S., according to Centre for Venture Research. A significant number of these angel investors or individuals are of Indian origin. “Many have made their money in Silicon Valley and would like to invest in India, but individually find it expensive and complicated to invest via Mauritius or Singapore,” said Mr. Govil. He said these Indian professionals and entrepreneurs could bring in a large new pool of capital of at least $12 billion (Rs. 78,671 crore) over the next five years, if tax codes are simplified and capital gains tax is reduced.
“Knowledge sharing and learning from these experts would help link ecosystems in India with Silicon Valley,” he said. “These expert investors would serve as an innovation bridge bringing best corporate practices to the country.”
Merger and acquisition hurdles
The other major issue that start-ups face in the country is lack of exits due to bureaucratic and regulatory hurdles in the merger and acquisition processes. About 95 per cent of start-up exits happen through mergers and acquisitions, and only 5 per cent happen by going public.
“But it is easier to acquire a large company abroad than to buy a small firm in India,” said Sanjay Khan, an associate at law firm Khaitan & Co.
There is also a need to make convertible notes possible, similar to the U.S., where over 3,00,000 angel investors invest in this manner. Convertible notes are debt instruments, a signed document from a company to an angel investor, intended to convert to stock once a start-up raises a larger round of financing from a venture capital firm.
Mr. Khan said one of the key advantages of issuing convertible notes is that the valuation issue is avoided until the first round of financing — when there are a lot more data points. “It’s much easier to value a start-up at that stage,” he said. Another significant advantage of issuing convertible notes is to avoid giving the investors any control, as convertible note holders are rarely granted control rights and have no minority shareholder rights, he added.
Despite all these challenges, entrepreneurship in the country is booming. Out of 138 global unicorns or start-ups with a market cap of over $1 billion (Rs. 6,558 crore), India now has seven, which is a market share of 5 per cent. More interestingly, most of these have been created in the past two years.
“There is momentum and the government is engaging with start-ups. This is good, but we need action on the ground,” said Mr. Sharma of iSpirt. “There is a cautious optimism that this will happen in the near future.”
peerzada.abrar@thehindu.co.in
