Investing in Start-ups in India

India is one of the fastest growing economies in the world and the booming start-up culture is adding more fuel in driving the country’s economic growth. The Indian businesses have started looking beyond offering traditional services and products, and have moved on to embrace cutting edge technologies to provide innovative solutions to the consumers.

Powered by funding from venture capitalists, angel investors and government programs, the startup culture in India is booming to the point of bursting out. The startups that have mushroomed, aim to cater to several categories of business and consumer needs. Much of the seed funding for these startups comes from Non-Resident Indians (NRIs) either through angel networks or through references.

The innovation is powered by India’s large youth population, the largest in the world, with a focus on resolving local problems in Business-to-Business (B2B) and Business-to-Consumer (B2C) scenarios. The world is watching the booming startup environment in India, to leverage their investments.

Most of the NRIs invest in Indian startups where they know the founders or through angel networks or through equity crowdfunding or in certain cases, through banks. The seed funding is provided to a startup in exchange for an equity stake in it. All direct investments by NRIs in Indian companies are considered as domestic investments and not as Foreign Direct Investment (FDI). Though, the Government of India has flexed the rules for NRI investments in India, there are certain rules still applicable for investments in either startup or in companies listed on stock exchanges.

NRI investments in India are governed by three regulations/government bodies:

  1. Reserve Bank of India (RBI).
  2. Foreign Direct Investment (FDI) policies of the government.
  3. Foreign Exchange Management Act (FEMA).

The consolidated set of rules from all the above entities is as below:

  1. An NRI cannot own more than 5% of the equity shares of any Indian company.
  2. NRIs can partner with any Indian firm without permission from RBI. The partnership can be forged either through direct investment or through acquiring shares from the primary market or acquiring shares from the secondary market.
  3. NRIs cannot invest or partner in any firm engaged in agriculture or plantation
  4. NRIs cannot invest in any company operating chit funds.
  5. NRIs cannot invest in Nidhi companies which are non-banking finance companies whose core business is lending and borrowing between its members.
  6. NRIs are prohibited from investing in companies involved in Print or in Print Media.
  7. NRIs are not allowed to invest in companies that are involved in the business of land and immovable property.
  8. NRIs are allowed to invest in companies which develop and construct real estate properties.

However, all the investments from NRIs are to be mandatorily made from funds earned abroad, remitted to a Non-Resident External (NRE) account. The gains or profit from investment in startups can be repatriated from an NRE account. The taxability of the profits made, is treated in a similar fashion as that of gains in equity trading. However, an NRI providing angel investment or seed capital for a startup firm in India, might have to disclose it as a foreign company stock ownership.

Before jumping into the angel investing bandwagon, it is worthwhile for an NRI to weigh the risks in such investments. To protect the small time NRI investors from the huge risk in startup investments, certain rules have been laid down for funding as an angel investor:

  • Investment from an angel fund is capped to a range of 5,000,000 INR to 50,000,000 INR.
  • Angel investors have to remain invested in a company for three years and can invest only in companies less than three years old.
  • Investee company has to be unlisted and have a maximum turnover of 250,000,000 INR
  • Investee company may not be related to a group with a revenue of greater than 300 Crores.
  • The angel investor should not have any family relations with the investee company promoters.