Column: Failing those start-ups

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Published: April 8, 2015 12:38:20 AM

Policies that “prevent misuse” and “plug loopholes” must be reviewed for whether they choke business

Our new government has openly expressed its desire to make it easier to do business in India. There is also a stated desire to make the environment welcoming for start-ups. The first item that needs addressing is that in the last few years, under the UPA-II regime, several new laws, regulations and rules have been put in place which are distinctly inimical to start-ups. Many of these stipulations have been created with the stated objective of preventing abuse and plugging loopholes! Because these usually silly rules are justified by this sanctimonious argument, they get embedded in the statute books. Unfortunately, they result in very detrimental consequences for the business environment and, unless attended to immediately, their baneful effect will last for many years.

The government of India prohibits companies from granting options to promoters and independent directors. Now, in most environments in the world which encourage start-ups, there are no such restrictions. A start-up usually is short on cash. Competent independent directors cannot be compensated easily. Hence, companies offer them options. When I started a company in California,  we were short of cash; we compensated independent directors as well as advisory board members and several consultants with options. Even the lawyers who helped incorporate the company took some of their fees in options. The company saved on cash and moved ahead.

Options were routinely handed out to founders (the Indian equivalent of promoters) if for no other reason than that they are effective anti-dilution instruments and keep the founders motivated to make a success of their companies. But then California likes start-ups. When I tried to find out why India does not imitate California, I was told that I was being silly and not understanding India’s complexities. Apparently, some companies and some promoters misuse options. Since I did not understand the complexities, I pushed back and argued that investors are not children and they can protect themselves and if they voluntarily contracted to agree to misuse of these provisions by the promoter, how or why should it bother the government?  I was  informed by my civil servant friend that I was being naïve.

As start-ups grow (those that do not, die out), they keep raising capital at higher valuations. We have a rule (again, less than five years old, distinctly of the UPA-II vintage) that this will lead to a massive income tax bill. Again, a voluntary agreement between investors (those who trust me do not need government protection) and entrepreneurs is stymied, this time by an unwarranted rapacious tax demand. This one, I was able to get to the bottom of. Apparently a powerful politician who was in the bad books of the previous government, was getting companies started by his family members, who were then raising capital at high and undeserved valuations. These were really bribes being paid to the politician. Some bright civil servant went to his political master and said that the tax code could be used to fix the powerful political opponent.

So, for this reason, all start-ups in India are now at a disadvantage and are routinely shifting their registered offices to Singapore. This is how the law of unintended—but in this case, completely predictable consequences—operates. And lets not forget yet another bizarre consequence that this silly Section 56 creates—it makes it appear that it is OK to inflate values and take bribes as long as you pay taxes.

Start-ups need exits. One of the usual ways of exit is to sell the company to a strategic buyer. It is not unusual for the buyer to stipulate that a part of the payment will be made in twelve or twenty-four months, provided the acquired company performs well. You would think that this is obvious and is in any case between the buyer and the seller. But that is where you are wrong. Enter the venerable Reserve Bank of India, a creature of the very venerable Government of India Act of 1935, which, in turn, is an Act of the Mother of Parliaments in Westminster. Reserve Bank does not approve of such contingent payments if the buyer is a foreigner. Again, they worry about misuse. There is no explanation about what the particular misuse may be.

A senior journalist has noted that the tax demand on Cairn (based on UPA-II’s notoriously ill-conceived and tyrannical retrospective amendment) was almost deliberately sent out by our glorious income tax department, just when our finance minister was abroad, trying to reassure investors that we would not be whimsical as we had been in the past. In this context, the following quotation from the late Lee Kuan Yew is worth thinking about: “The average Indian civil servant still sees himself primarily as a regulator and not as a facilitator. The average Indian bureaucrat has not yet accepted that it is not a sin to make profits and become rich. The average Indian bureaucrat has little trust in India’s business community”. Lee Kuan was very perceptive. This is the origin of the civil service’s obsession with “preventing misuse” and “plugging loopholes” even if these actions result in disastrous consequences like wholesale emigration of entrepreneurs.

Even as I was writing this article, I got a pleasant surprise. On TV, I got to watch the venerable commerce secretary of the venerable government of India making a speech which made him sound as though he wanted to encourage businesses in India. The intrepid commerce minister of the present government was sitting on the dais. I was gobsmacked! Does this mean that the government of India will now start treating Indian businesses with support and not hostility? Let us hope so.

For six-plus decades, the Indian civil servant has been trained and indoctrinated to distrust and dislike business promoters, entrepreneurs and all grubby, oily, wealth-creators with what can only be described as a Leftist-Brahminical disdain. Unless and until our political leaders put in the time and effort to examine the seemingly innocuous (but almost invariably business-unfriendly) proposals of civil servants in detail—especially those proposals that are designed to “prevent misuse” and “plug loopholes”—and emphatically fight to create a new ethos, our hopes of creating a prosperous India will get stymied and will stall.

The author is a Mumbai-based entrepreneur

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