HELPING START-UPS GROW: THE ROLE OF ANGEL INVESTORS
Context:
In today's startup world, getting funding is key. New startups struggle to find investors. This is where angel investors come in. They offer crucial financial support and guidance, helping startups grow. Angel investment is essential in promoting innovation and boosting the economy.
Angel Investors:
An angel investor is a wealthy individual who agrees to invest in a small startup company with limited access to money.
Typically, entrepreneurs themselves, angel investors often have a personal connection with the individual starting the business, such as being friends or relatives.
Role and Faith in Founders:
Angel investors have faith in the company’s founders as well as its business plan.
They provide the funds required for the startup to get off the ground, usually at more favourable terms than other lenders.
Investment Approach:
Angel investors frequently choose to keep their investments hidden.
Their investments play a crucial role in supporting the initial growth stages of startups, contributing to their success.
Qualifying as an Angel Investor
Definition by Invest India: According to Invest India, an angel investor is any person who proposes to invest in an angel fund and satisfies specific criteria.
Criteria for Individuals:
The individual must have net tangible assets of at least INR 2 Cr, excluding the value of their principal residence.
Alternatively, they must possess early-stage investment experience, or experience as a serial entrepreneur, or hold a senior management position with at least ten years of experience.
Criteria for Corporate Bodies:
A corporate body qualifies as an angel investor if it has a net worth of at least INR 10 Cr.
Additionally, an alternate investment fund (AIF) or venture capitalist fund (VCF) registered under relevant regulations also meets the criteria.
Characteristics of a Successful Angel Investor
Commitment Beyond Financial Means:
Angel investors go beyond just funding their startups.
They provide empathy and support in early growth phases, creating a nurturing space for founders.
Valuable Actionable Insights:
Skilled angel investors give startups practical advice, fully grasping their hurdles.
Their knowledge greatly aids in the strategic development of the businesses they support.
Networking Advantage:
Angel investors use their wide networks to connect startups with key resources and chances.
They help startups meet important players, boosting their success potential.
Promotion and Visibility:
Successful angel investors boost their startups' profile using social media and professional circles.
This raises startup visibility, drawing in customers, partners, and new investors, aiding growth.
Long-Term Support:
Angel investors remain with their startups through tough periods.
Their dedication to long-term success builds resilience and stability, key for overcoming challenges and ensuring lasting growth.
Benefits derived from angel investors:
Supporting Early-Stage Startups:
Angel investors offer essential seed money to establish a solid base for new startups.
This early funding is key to launching business activities and driving initial growth.
Credibility Boost:
Angel investors add credibility to startups by investing in them.
Their backing indicates belief in the startup's future, drawing more investors and partners.
Sharing Industry Insights:
By investing, angel investors increase the trustworthiness of startups.
This support shows confidence in the startups' prospects, attracting additional investments and collaborations.
Risk Sharing and Investment:
Angel investors use their personal funds for startups, showing they're ready to face the risks together.
Such shared risks create a partnership atmosphere, encouraging teamwork between investors and entrepreneurs to tackle obstacles.
Providing Invaluable Guidance:
Angel investors provide crucial advice and insights to startup founders.
Their knowledge and skills help shape the startup's strategy, boosting its chances for market success.
Risks Associated with Onboarding Angel Investors:
Pressure for High Return on Investment (ROI):
Large investments from angel investors may lead to demands for high ROI quickly.
Such demands can pressure entrepreneurs, impacting their choices and possibly hindering sustained growth.
Vision Clash:
Picking an angel investor with different goals can cause disagreements, slowing growth.
Conflicting views and approaches may lead to tension, affecting the startup's path.
Ownership Risk:
Trading equity for capital with angel investors can lessen the founder's share in the company.
Reduced ownership can lead to a loss of control in decisions and strategy, risking the startup's independence.
Understanding Exits for Angel Investors:
Exits refer to the process by which angel investors disengage from a startup they have invested in, typically by selling their shares.
Exit Scenarios: Angel investors exit from a startup by selling their shares to another company, other investors, or when the entire company is sold to another entity through mergers and acquisitions (M&A).
Profitable Exits: Angel investors achieve profitable exits when they sell their shares at a higher value than their initial investment, realizing a return on investment (ROI).
Types of Exits: Favourable exits can occur when a startup goes public through an Initial Public Offering (IPO), allowing investors to sell their shares on the stock market.
Impact on Returns:
The timing and manner of exits significantly impact the returns angel investors receive on their investments.
Strategic exits at the right time and under favourable conditions maximize ROI for investors.
Angel Tax:
Angel Tax, as per section 56(2)vii(b) of the Income Tax Act, 1961, imposes a tax on capital raised by private businesses through selling shares to investors above the fair market value (FMV).
The tax is charged at a rate of 30.9% on net investments exceeding the fair market value.
Evolution and Impact:
Introduced in 2012, Angel Tax remained relatively obscure in the startup ecosystem until around 2016.
The funding boom in the Indian startup ecosystem led to increased scrutiny from the Income Tax Department, with Assessing Officers (AOs) questioning the valuations of many startups, resulting in the imposition of the tax.
Expansion and Controversy:
The situation escalated in 2023 when Finance Minister Nirmala Sitharaman extended the tax to non-resident investors, particularly affecting foreign investment in India.
This move occurred amidst a perceived funding downturn, further complicating the investment landscape.
In response to widespread criticism and backlash, the Ministry of Finance intervened, proposing reforms to ease the burden of Angel Tax.
The Central Board of Direct Taxes (CBDT) proposed exemptions for investors from 21 countries, including Australia, the UK, and the US, aimed at mitigating the impact of the tax on foreign investment.
Angel Tax Challenges: Balancing Valuation and Regulations:
Ambiguity in Valuation:
Determining a startup’s fair market value lacks a definitive or objective approach, leading to valuation challenges.
Investors often pay a premium for the idea and business potential at the angel investment stage, further complicating valuation.
Regulatory Valuation Concerns:
Tax regulators evaluate startups based on their net asset value at a specific point, creating discrepancies with investor valuations.
Justifying higher valuations to tax officials proves difficult for several companies, adding to regulatory challenges.
Exemption Notification:
The Central Board of Direct Taxes (CBDT) exempted angel investors from the Angel Tax clause, offering relief.
However, entrepreneurs must fulfil terms and conditions outlined by the Department for Promotion of Industry and Internal Trade (DPIIT) to qualify for this exemption.
Overcoming Regulatory Hurdles:
Entrepreneurs face obstacles in obtaining exemption despite the notification, highlighting ongoing challenges.
Navigating regulatory requirements demands meticulous attention and compliance to secure relief from Angel Tax.
Revised Regulations for Angel Tax: Fostering Startup Growth
Expanded Exemption Criteria:
Previously, angel tax exemption was confined to enterprises with a revenue of up to Rs 25 crores. However, new guidelines have broadened the exemption limit to encompass companies with a turnover of less than Rs 100 crores and a tenure of fewer than ten years.
Tax-Free Investments:
Investments made by listed firms with a net worth of at least $100 million or a total turnover of at least $250 million, along with investments made by non-resident Indians, are now deemed tax-free, encouraging investment in startups.
Definition of Qualified Start-up:
A qualified start-up is one that is registered with the government, operational for less than 10 years, and has generated revenue of less than $100 million during that period, ensuring eligibility for tax benefits.
Implementation of E-verification Mechanism:
The Finance Minister announced the implementation of an e-verification mechanism to verify the identity of investors and the source of their cash in 2019.
This initiative aims to streamline the funding process for startups, reducing scrutiny from the Income Tax department.
Exemption from Fair Market Value Requirement:
Startups are no longer obligated to present the fair market value of their shares granted to certain investors, such as Category-I Alternative Investment Funds (AIF), simplifying the compliance process.
Concerns Regarding New Angel Tax Regulations:
Stringent Eligibility Criteria:
To qualify for the latest exemption, businesses must register with the government as startups.
However, stringent conditions, such as restrictions on investments in automobiles, land, or jewellery, may impose bureaucratic hurdles and hinder eligible startups from availing the exemption.
Potential for Bureaucratic Red Tape:
The eligibility criteria, seemingly aimed at preventing money laundering, could lead to bureaucratic red tape and rent-seeking activities, further complicating the compliance process for startups.
Arbitrary Tax Requests:
While the new standards for angel tax are less stringent, concerns persist regarding the potential for arbitrary tax requests for businesses outside the established startup category.
Taxes are computed based on the sale of unlisted shares above their fair market value, posing challenges in determining the market value of shares that are not publicly traded.
Impact on Investor Confidence:
The arbitrary nature of angel tax regulations may erode investor confidence in startups.
Without concrete measures to address these concerns, investor trust in the startup ecosystem could be compromised, hindering the growth and innovation potential of startups.
Angel Investment Networks:
Angel investment networks serve as platforms that bring together angel investors with the aim of either creating a fund pool for early-stage startups or facilitating connections between investors and startups.
These networks play a crucial role in fostering investment opportunities and facilitating the growth of early-stage ventures.
Functionality and Operations:
Angel networks operate by aggregating capital from individual angel investors to create a collective fund that can be deployed into promising startups.
Additionally, these networks provide a platform where angel investors and early-stage startups can connect, fostering potential investment opportunities.
Criteria and Guidelines:
However, not all individuals can invest in angel funds, as each angel group has specific guidelines and thresholds for selecting angel investors.
These criteria may include factors such as net worth, investment experience, or industry expertise, ensuring that the network maintains a high standard of investment and due diligence.
Angel Investors navigate the Investment Landscape:
Angel investors employ a multitude of channels to identify and evaluate potential investment prospects.
From joining angel groups and networks to attending networking events and leveraging online platforms like AngelList and Crunchbase, angels leave no stone unturned in their quest for promising startups.
Referrals, word-of-mouth recommendations, and engagement with industry-specific organizations further enrich the pool of investment opportunities, enhancing the chances of identifying high-potential ventures.
Angel Investments Contributing to Sustainable Growth:
Angel investors not only fuel individual startups but also contribute to the broader entrepreneurial ecosystem.
By diversifying their portfolios and supporting innovative ventures, angels play a pivotal role in driving economic growth and job creation.
Their contributions extend beyond financial backing, encompassing mentorship, guidance, and industry insights, vital for the success of early-stage startups.
Rise of Angel Investors in India:
Between 2014 and 2022, India witnessed a significant influx of investors across various sectors, including angel investors, venture capitalists, corporate entities, Corporate Venture Capitalists (CVCs), investment banks, accelerators, and incubators. During this period, the total number of investors in India amounted to 9.5K, encompassing a diverse range of investment entities.
Distribution of Investors:
Angel Investors: Angel investors constituted the largest segment, comprising 53% or 5.1K of the total 9.5K investors.
Venture Capitalists: Following angel investors were venture capitalists, representing 23% of the total investor pool.
Corporate & CVCs: Corporate entities and Corporate Venture Capitalists (CVCs) accounted for 9.1% of the investor landscape.
Investment Banks: Investment banks constituted a notable portion, representing 6% of the total investors during this period.
Angel investment through platforms like the Mumbai Angels Network , Angel List India ,BITS Spark ,The Bengaluru Angels ,Calcutta Angels Network ,Chandigarh Angels Network, The Chennai Angels ,CIO Angel Network ,Hyderabad Angels offers high-net-worth individuals a unique avenue to diversify their portfolios while championing innovation. With the potential for significant financial rewards and the satisfaction of nurturing promising ventures, angel investing stands as a compelling proposition for those seeking to make a meaningful impact on India’s startup landscape.
