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Why investors play an important role in a startup

This article initially deals with what is a startup, its origin and secondly, how its inception helps in the economy of a country and thirdly, what are the steps involved for a successful startup (basically it will include under its ambit who are investors and their role in a startup).

Thursday June 22, 2017,

8 min Read

What is a startup?

The term ‘startup’ has multiple definitions. It could be defined as a budding company whose sole objective is to compete with the existing company or to aim a position in the market. It could also be defined as an emerging companies or small businesses venturing into the market and offering services and products that no other company offers. Or it could simply mean a newly established company (as cited in the Oxford English Dictionary). One needs to be grateful to the current Prime Minister of India, Narendra Modi for initiating the Startup India project. It has indeed helped many entrepreneurs to lay down the foundation of their businesses and assist them in meeting their desired goals for their startup company. The Ministry of Commerce and Industry in the notification dated 17th February, 2016 described an entity as startup-

a) Up to 5 years from the date of its registration or incorporation

b) Its turnover has not exceeded rupees 25 crore for any of the initial five financial years and

c) The company is working to mature their skills, innovation, deployment, development or commercialization of new services and products.

Does a startup boost the economy of a country?

Generally, it is construed that startup would not work especially in a developing country or a third world country because it requires huge amount of funds while it generates insufficient revenue. However, such misconception is not always conclusive or true. For instance, Infosys which started small, incorporated with a capital of only rupees 10,000, in the current scenario earns revenue up to US dollar 10.1 billion having various assets and acquiring many foreign companies. Another perfect illustration would be Alibaba, a China based company with continuous progress and development has been deeply rooted and entrenched in various country providing services to the consumer.

The prospect of startup is amicably flourishing. It is persistence that startup triggers economic growth and development of a country. If summarized it could be two tier development, they are-

1) Technological development: With the upcoming startup, came new technology which has further assisted in commercialization of a business. The increase in commercialization, the higher is the possibility of earning profit in a business, the higher the profit the greater will be the revenue and taxes generated. Hence, technological advancement has significant impact on the economy of a country.

2) Innovative development: Technological development further triggers innovation and competitiveness in skilled work and labour. This emphasize that it creates employment opportunities with aspiring individual hunting for it and ultimate production of lucre and excellence. Excellence comes with new ideas and innovation at workplace. In pursuit of their career employees tend to give good performance. Demand in higher qualification and vocation also enhances due to higher rate in employment thereby gradually eradicating the problem of illiteracy and poverty. In conclusion startup has become directly or indirectly viable solutions to all are problems.

Overall, it improves the seller and consumers relationship. The greater the quality of goods and service provided the higher will be the demand and supply. In order to meet the demands the companies and industry will try to expand. The more they expand, industrialization is set in motion. Moreover, it looks like a chain reaction which eventually leads to the growth of an economy.

What are the requirements for incorporating a startup in India?

A startup can either be incorporated under the Companies Act, 2013 or the Startup India portal. If the startup is incorporated from the MCA website as per the Companies (Incorporation) Rules, 2014 with recent amendments in 2016 Notification, then subsequently it can get recognition under the Startup India portal. Online submission has done away with tedious and time consuming paperwork. It is pertinent to observe that before the incorporation of a company it ought to raise capital. Hence, investors are essentially an important element for any startup. They have an important role play as they are the ones who generate capital for new ventures.

Now, who are investors?

A person or any corporation who allocates capital to incorporation or startup with the agenda of financial return is an investor. There can be different types of investor, for instance mutual funds, hedge funds, Venture capital, angel investor etc. These investors can definitely help the startup to raise capital for their businesses. Startup can also elevate their capital from other sources, for example, shareholders fund (equity and preference both), long term borrowing, debentures, current liabilities, public fund, bank loan etc. However, there are degrees of risks involved for investing in a startup. Not many investors will be in consonance with the idea of investing in a startup. Opinions would differ. Some investor would have lackadaisical attitude as to not to fund the startup whereas some would be willing to invest. Hence, the concept of angel investor and seed funding is prevalent in the current market. Angel investor also known as seed investor are affluent individual or entrepreneurs who renders capital for a business startup, usually in quid pro quo of convertible debt or ownership equity or as agreed upon by the parties (as specified in the contract). Notwithstanding, in the context of business and risk management there are varied investor preferred over other as per the best options available to a startup. The Startup India project has given the list of SEBI registered venture capital fund (VCF) and alternative investment funds (AIF) to give assistance to the startup. To simply state AIF and VCF are investment funds registered under their respective SEBI regulations. Moreover, existence of foreign direct investment in the likes of Foreign Capital Investor (FVCI), foreign angel investor has increased the availability of investor to a startup. In fact, the RBI in their recent notification prescribed that the FVCI requires no prior permission from the central bank to invest in startup [Refer to notification dated October 20, 2016 on Investment by FVCI.

What is the role of an investor in startup?

To commence with investor plays a vital role in a startup, although they too get their benefits depending on the successful functioning of a startup. They support as a backbone to the entrepreneur.

Issues which an investor would help to resolve:

• Firstly, they will provide capital to start the business.

• Secondly, they assist in business- plan for a startup.

• Thirdly, they are profit oriented hence they will ensure that capital is invested in the correct way. In other words they advise you to manage the funds accurately as their own money is at stake.

• Fourthly, they aim at long term benefits and attempt to create goodwill of the company in the market which would further attract more investor to invest and thereby, increasing the capital inflow. They are an evangelist to the upcoming startup.

• Lastly, they help in earning maximum profit with least damages and losses (basically risk management) thereby generating surplus and revenue for the socio- economic development of a country

As mentioned above the primary issue will be to raise capital for the startup. However, in an investor’s perspective they focus on minimum loss caused to them while investing in a startup. There are investors who will not be willing to invest larger amount unless shown a promising benefit and therefore they invest in smaller proportion in case of avoiding any major future losses if occurred. Capital sometimes raised are insufficient for a seedling company, hence the company opts for small amount of investments to raise their capital. Some investors who have surplus in their savings choose to invest into risk markets rather than keeping that same money idle. These investments in turn help the new entrepreneur to enter the gateway of capital market. Gradually, in long term the startup acquires a financial position, smooth working of business, stabilization in the market and a team to assess the risk involved in any other entrepreneurial venture. If noted more revenue (income) leads to more profit, more profit leads to accumulation of surplus, accumulation of surplus leads to distribution or usage of surplus, which then leads to expansion of business, expansion in business leads to increase in net worth which would then elevate the GDP of a country. As specified above it attracts more stakeholders and the investors. Eventually, when the business prosper loyalty and confidence increases towards the startup which then creates satisfaction. Corporate image and competitive advantage is then enunciated.

To conclude with experienced investors (who are willing to invest) prudently invest in the startup company, as it is easy to invest in the startup which has market value or the face value as low as compared to the well-established companies in the market hence, avoiding the damages. Despite argument that there are perils and impediments involved while investing in a startup, such misconception has come to rest by the major advantages and alteration caused by the current government. The government has proposed special provisions for startups under the Make in India policy granting them 100% exemption from tax for the first three years out of five years starting from April 2016 to March of 2019. 

This article has been contributed by Himanshu Jain, CEO at LegalRaasta, an online portal for GST Software, GST Return Filing, GST Registration.