India has seen a dramatic increase in the number of start-up companies over the past decade, and with the government rolling out even more policies benefiting them, the boom is set to continue. And lawyers are finding they are playing a critical role in the development of this sector.
By Aparna Sai and Ranajit Dam
India’s start-up scene is booming. A report by KPMG earlier this year the number of early-stage companies in the country had grown seven-fold in the past decade, from around 7,000 in 2008 to approximately 50,000 by the end of 2018. A combination of factors – including a massive spike in Internet usage, rising literacy rates and the increasing urbanisation of India – had contributed to this trend, said the Big Four firm, which said it saw start-ups mushrooming in areas like artificial intelligence (AI), Internet of Things (IoT), finance, healthcare, biotechnology, education, agriculture, logistics and more.
But it’s not just the number of start-ups that makes the landscape today vastly different from what it was a decade ago; lawyers working closely with early-stage companies say that the past year or two have seen these companies become increasingly sophisticated. “Start-ups and founders have matured – they are now more aware of the macro trends affecting them and are a bit more pragmatic in their outlook,” says Kaushik Rajan, COO of Tatva Legal’s Hyderabad office. “The lending crunch that affected NBFCs did impact some of the fintech ventures and they had to rethink their strategy, which meant that their story also evolved. Similarly, e-commerce platforms are also sensitised to the rejig in foreign exchange laws that impacted Amazon and Flipkart late last year and online pharmacies are more aware of the judicial pronouncements that impacted them.”
Vinayak Burman, managing partner at Mumbai law firm Vertices Partners says that the start-up ecosystem has also been expanding into exciting new areas. “Start-ups, with the backing of investors, have been increasingly breaking through inflexion points in emerging areas such as AI, IoT, FinTech, EdTech, HealthTech, AgriTech, ConsumerTech, unmanned aerial vehicles and more,” he says. “This has certainly led to moving away from the traditional approach and development of innovative business with technology being a disrupter, enabler and an aggregator, as the case may be. Interesting questions have also been posed considering the current regulatory regime and the nuances around the ease of doing business in the country. All-encompassing growth in the digital and internet space has also provided the necessary impetus to the start-up ecosystem to scale-up their growth and reach, at both, investor as well as consumer end.”
Mithun V Thanks, a Mumbai-based partner at Shardul Amarchand Mangaldas, has seen three important trends in the past year. “First, there have been significant investments by large funds in tech start-ups (for example, the Softbank Vision Fund),” he notes. “Secondly there have been strategic investments made by start-ups for inorganic integration/ growth – examples are Flipkart-Liv.AI, Ola-Ridlr, -TicketNew-Paytm, Ola-Foodpanda, Jio-Saavn, Swiggy-Scootsy to name a few. Finally, we have seen minority positions taken by marquee investors in large scale start-ups, such as Berkshire Hathaway in Paytm.”
Thanks said that health-tech, and e-pharmacies have been key growth sectors, with the emerging trend of sizeable celebrity investments and co-branding endorsements, while FinTech continues to attract and retain significant investor interest. ”That said, the key focus in the last year, given that it was a year leading up to keenly watched general elections, was on market consolidation. Mid-sized acquisitions of $30 million to $50 million seemed to be the flavour of the season, with investors using their existing investments in India as a platform to acquire new businesses or products, and integrate them into super-apps, where consumers are already on-board,” he adds.
SHOT IN THE ARM
Within Prime Minister Narendra Modi and his BJP government being re-elected recently, lawyers say that start-ups are set to receive increasing policy benefits; there is also hope that some problems related to implementation during the government’s previous term will be ironed out during its second innings. “With the government at the centre having an absolute majority, the key initiatives such as Startup India and Make In India, coupled with relaxation in certain regulations pertaining to foreign direct investments, clarifications starting to come on the angel tax front, widening of the definition of the term ‘start-up’ and consequent relaxations in compliance requirements under applicable laws, resolution of the Mauritius tax conundrum, renegotiation of India-Singapore DTAA and introduction of General Anti Avoidance Rules (GAAR), will be seen to play a far more significant role as contributors to the start-up growth story,” says Burman. “The expectations are that the government will not only continue these, but also to take these initiatives to the next level in order to address industry-specific challenges.”
Thanks says that the BJP’s re-election brings hope for both continuity and change for start-ups in India. “During the government’s first stint, the Startup India initiative was launched, but criticised heavily in its implementation, especially in meaningful capital deployment. This was perhaps what led the Prime Minister to comment on the floor of the Parliament on June 25 (in the first session of the new Parliament) on the need to consciously move from ‘Make In India’ to ‘Start-up in India,’” he notes. “The BJP’s 2019 manifesto also promised significant investments to achieve their goal of establishing 50,000 new start-ups by 2024. A new seed start-up fund is also to be allocated. The BJP government has emphasized support for defence start-ups, artificial intelligence and the use of deep-tech for agriculture via such funds.”
However, tax benefits to start-ups were poorly implemented during the last term, he adds. “Hopefully this will change. Ease of doing business initiatives, particularly on the labour law compliance front were improved significantly during the previous term,” says Thanks. “This trend should continue to extend to other legislations as well – nothing makes an entrepreneur smile more than an effectively implemented single window clearance, but the proof, in this case at least, will truly be in the pudding – the pace of preparation, consistency and quality of it!”
Rajan says that the BJPs’ re-election has a “positive impact” overall, as the government is perceived as being pro-business. “There were issues around angel tax which recently got assuaged,” he notes. “However, there are two potential areas of concern. First, the proposed legislation on data privacy and how start-ups will handle such infrastructure costs; and second, GST compliance for early-stage start-ups. If the government sends the right signals and frames policies to back it up, these should also be streamlined. The upcoming budget is an opportunity to set the right tone and expectation.”
Anirudh Rastogi, founder of Ikigai Law, says he expects continuity in the government’s policies with regard to start-ups. “There are all signals that the government will continue to promote the industry. Government bodies such as Startup India have done a good job in creating an interface between the industry and the government. The central government’s emphasis on the industry has led to a healthy competition between state governments to raise their profiles as being start-up-friendly,” he notes.
So where do lawyers see the work coming from? Thanks at SAM says that a lot of focus for the firm’s lawyers when it comes to start-up-related work in recent times has been in areas such as logistics, commercial real estate, FinTech, EdTech, FoodTech, and shared economies, such as student housing and shared workplaces. “Advice sought from us depends on the stage the start-up is in its life cycle,” he says. “Our role can range from pre-incorporation advice, where founders are uncertain of the regulatory environment, or want to pencil down their inter-se arrangements, to advising on early-stage fundraises, limiting founder liability, advising on the inter-se rights and obligations between investors or shareholders, and in the odd errant cases, advising on winding up operations and employee or stakeholder pay-outs.”
He adds that irrespective of the stage at which a start-up operates, start-ups are increasingly looking to protect their intellectual property by expending resources by making appropriate applications with the concerned authorities; and align their operations with data privacy laws, which is increasingly becoming a concern.
For Burman at Vertices, a significant chunk of the work is coming from the banking, financial services and insurance sector. “We are also supporting technology-based businesses in areas such as FinTech EdTech, ConsumerTech, AgriTech, along with sectors like pharma, healthcare, manufacturing and e-commerce,” he says. “Like our practice areas, our clients look up to us for advice at all stages. Starting from incorporation, seed capital stage, various series of funding from Series A to all the way to growth capital, general corporate advisory, complex structuring to dispute resolution, we have been successful in adding legal and commercial value to advice they seek.”
Rastogi says that Ikigai is advising a number of digital platforms and fintech businesses and seeing increased activity in e-sports and gaming, InsureTech and agriculture. “We are best known for our work in highly-complex and emerging technology sectors such as aviation and aerospace, new media and online content and blockchain,” he notes. “Each start-up is unique, and as such, their legal needs are varied depending upon where they are in their life cycle might. For instance, start-ups that have just begun may need validation of their business models. They may want to put in place co-founder agreements, ESOPs, brand protection strategies and template business contracts. Start-ups that are raising funding are looking for help with the transaction. Some start-ups might be operating in very challenging regulatory environments, or, in sectors where there is no real law or regulation to speak of – these companies are looking for advice on how to navigate this legal uncertainty. For instance, some start-ups – like those in the drones or blockchain space in India – operate in a sector where there is no clear regulation, and sometimes hard to predict what direction the regulation might take. For such startups, the challenge comes from navigating this uncertainty, and making business decisions in such a regulatory environment, planning for various regulatory scenarios, and even be willing to engage with the law-making process. On the other hand, there are also start-ups that want to enter into very highly regulated sectors – FinTech start-ups for instance – the set of legal challenges that they face come from the very fact that these sectors are very extensively regulated.”
Rajan at Tatva says that FinTech, tourism aggregators, logistics, food, healthcare, agrochemicals, e-vehicles, EduTech and e-pharmacies are the sectors the firm is seeing traction in. “While in some cases, they require our advice in relation to only fund-raising, we engage with some of them at a deeper level to validate their business model from a legal perspective, and to tie in the loose ends,” he says.
THE ROLE OF LAWYERS
So what role do lawyers see themselves playing in the sector as it develops over the next decades? “There’s a lot of potential in harnessing the needs of a growing young population and the start-ups which keep evolving to solve relevant problems will most likely do well,” says Rajan. “Law firms need to think beyond offering vanilla ice cream – they need to top it up with chocolate sauce. The role of a lawyer may evolve to that of an advisor or a mentor, or a business partner who understands the trigger points of the start-up’s business.”
Burman says that the regulatory environment surrounding the area is at a promising stage. “We are witnessing change of traditional mindset of the regulators,” he notes. “Regulators are moving towards being receptive to best international practices and creating a conducive investment regime. Proposed Regulatory Sandbox by the Reserve Bank of India seems to be a strong indication. The gradual shift from the erstwhile trend of the business-to-consumer pattern is emblematic of the surge of the fintech era that is underway in the start-up eco-system.
He adds that lawyers in this growing start-up ecosystem are required to not only provide traditional regulatory advisory but also provide customised solutions in terms of sustainable business models which are most likely to withstand competition in an ever-disruptive environment. “Lawyers will have to actively participate in bringing their commercial value addition on the table,” Burman says. “In order to do so, we must effectively manage the time and resources and focus on critical areas, including introduction of technology such as effective data management, AI, standardisation and digitalisation of standard processes. One of the reasons why we have managed to succeed in advising a plethora of companies in such a short span is because we believe in being close to the ground to understand the actual need of the client and be able to advice in a manner which has a solution-based approach at all points of time.”
“Tongue firmly in cheek, we are now in the age of consolidation, with the start-up boom age waning more than it is waxing,” says Thanks. “Following this trend, and if we are to peer through our ‘Nostradamus eye-glass,’ we anticipate small to mid-sized acquisitions increasing, with well-funded start-ups looking to refine their existing operations inorganically, increase offerings in allied business and launch new products and services. At the other end of this spectrum, this is also likely to be accompanied by initiatives by bigger industry players, across most sectors, to lead aggregation or consolidation drives with start-ups.”
He adds that experienced lawyers in this space will continue to serve as mentors or advisors to founders and investors alike. “As I keep telling my clients – what is keeping you up all night, we are likely to have seen before, and now sleep better for it,” says Thanks.
Rastogi of Ikigai feels that start-up work has increased significantly in the last three to four years and will continue to grow in the foreseeable future. “A significant part of the work that we do for start-ups involves navigating continuously evolving, often challenging, regulatory environments,” he says. “More and more start-ups are willing to interface with regulators and take on the task of shaping policy in their respective sectors, and here lie some of the biggest opportunities and challenges as well. Lawyers will have to learn to engage deeply with business and product teams and regulatory processes when working with disruptive tech start-ups and that capability is what sets us apart.”
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