Angel tax changes to cheer investors, aid late-stage funding say experts

• The changes proposed to angel tax are ‘inclusive’ and will facilitate ongoing investments in the country, says Karthik Reddy, chairperson of IVCA.
  
• The CBDT has been listening to the industry, said Sunil Goyal, managing director and fund manager at YourNest Venture Capital.
  
• The move gives a lot of clarity to foreign investors and will help late-stage companies raise capital, says Abhimanyu Bisht, general partner at CapFort Ventures.
  

The startup industry has faced multiple hurdles in the last one year — the fallout of the banking crisis triggered by the collapse of US’ Silicon Valley Bank on top of funding winter and rapid down-rounds. The Central Board of Direct Taxes (CBDT) has now changed its rules in relation to angel tax in a move that is expected to ease foreign investments and provide relief to the beleaguered startup industry.

One of the changes to the angel tax is to include five more valuation methods in addition to the existing discounted cash flow (DCF) and net asset value (NAV) method for resident investors. In addition, it said that price matching for resident and non resident investors would be available with reference to investment by venture capital (VC) funds or specified funds.

Karthik Reddy, managing partner of Blume Ventures and chairperson of industry body IVCA said that it’s an inclusive approach that will facilitate ongoing investments in the country.

“The notification from CBDT and Ministry of Finance has been well received by the PE/VC industry as it provides more clarity to Indian startups and investors in relation to section 56(2)(viib). The proposed norms aim to expand valuation methodologies and eliminate price differentials between resident and non resident investors,” Reddy added.

New beginnings

Budget 2023-24 had proposed that any shares issued to non resident investors above the fair market value (FMV) will be subject to angel tax creating obstacles for foreign investments in Indian startups. The tax was earlier imposed only on resident investors. Fair market value shares refer to the estimated price at which shares of a company would be sold in an open and competitive market between a willing buyer and a willing seller.

With the recent notification, several foreign investors including sovereign wealth funds, pension funds and endowment funds have been left out of the purview of the angel tax. Broad-based pooled investment vehicles or funds where the number of investors in such a vehicle or fund is more than 50 and which fulfills certain conditions have also been excluded.

Sunil Goyal, managing director and fund manager at YourNest Venture Capital said that the CBDT has been listening to the industry.

“I am very happy that the funding obstacle that had come by will be removed through the CBDT notification. However, there is still a challenge in the proposed guidelines. The number 50 is restrictive. It is an arbitrary number that needs to be going anyway. Normally the number of investors is much lesser,” said Goyal.

A push to late-stage funding

Most experts, however, believe that the government has taken a step in the right direction. The startup funding that hit a high during the pandemic has been suffering on several counts as VCs and private equity (PE) investors tighten their purses amidst high inflation and high interest rates in major economies and as they get more stringent with startups, demanding profitability.

In the first quarter of 2023, Indian startups raised $2.1 billion. In the same quarter last year, they raised $9.3 billion — registering an over 77% fall. The last time the quarterly funding was lower than $2.1 billion was in the second quarter of 2018 – when it was at $1.7 billion.

The worst-hit have been late-stage deals. According to a report by PricewaterhouseCoopers, late-stage funding in India startups declined 52% in 2022. However, the proposed guidelines are expected to bring some relief.

“I feel what's been done will really help especially late-stage companies to raise capital because it basically gives a lot of clarity for foreign investors. What we have been calling the funding winter, means that funding has been a little slow in terms of late-stage investments from foreign investors. This could help in increasing the funding being received by companies that are typically in the Series C round of funding,” said Abhimanyu Bisht, general partner at CapFort Ventures.

Bisht adds that a lot of companies have been trying to raise funds in the late stage due to many factors including delayed public market entry. While PharmEasy and Udaan have delayed their public market debuts, the stock markets have turned tougher for internet-based companies like Zomato, Nykaa, Paytm and more, which have shed a large chunk of their value since listing.

“Anyways, if you see the public markets also, we are seeing a lot of positive inflow of foreign institutional investors in the last two-three months. But I think that that trend could further increase,” opined Bisht.

While foreign institutional investors (FIIs) have been net sellers this year, the tide has turned in May with a change in interest rate cycle. Experts hope that some of the renewed interest will spill over to the unlisted markets with the latest changes in angel tax norms boosting sentiments.