Opinion: SEBI’s angel fund norms a good step but need tweaking

SEBI’s move to define investment guidelines for angel funds is very welcome move.

After some ill-conceived moves like tax on startup investments in the earlier budget, attempts to change policy with retrospective effect, etc. which dismayed the investor community, angel investors and entrepreneurs, this shows clear thinking and some thought out attempt to clarify  and address some key issues.

The fact that angel investors are being recognized as a distinct category is good. This will mean that going forward, angel investors can in an organized manner represent themselves, be involved in policy making and give feedback on proposed measures in future.

Positives

• Enabling startups and SMEs to list on the institutional trading platform (ITP) will mean more exit opportunities. This has been one of the biggest dampeners to early stage investment and proliferation of the startup eco system in India when compared with Silicon Valley in the US. While we need to wait and see how this works and whether the ITP succeeds, the initiative is very welcome. Worldwide success of such platforms have been muted.

• By laying boundary conditions, the government has tried to address the abuse of the angel investment route for questionable money transfer transactions (for instance between an industrial group and politicians where the industrial group invests huge amounts as angel investment for a negligible stake in a company promoted by politicians). So some of the qualifying criteria mentioned are welcome.

• By classifying angel funds as alternate investment funds (AIF), angel funds can enjoy pass through taxation benefits and avoid double taxation.

Negatives

• Some of the limits and restrictions mentioned don’t make sense. For instance, the Rs 25 lakh minimum amount required by an angel investor to invest in a  fund will exclude lots of people who want to invest a lower amount but still want to have a play or participate in the startup phase. To have Rs 25 lakh of post-tax money means Rs 37.5 lakh in pre-tax earnings. Why have this at all? Even if a fresh engineer wants to invest Rs 1 lakh, as long as the angel fund is willing to accommodate, it should be fine.

• There are incubators and accelerators who put in as little as Rs 5 lakh in a seed startup or a paper business plan but they do so in multiple companies and many a time exit within three years at The Series A or Series B stages.  So, the restriction that, “ investment in an investee company by an angel fund shall be not less than Rs 50 lakh and not more than Rs 5 crore and shall be required to be held for a period of at least three years” does not make sense. Even many angel investors and funds exit at the Series A or Series B stages in less than three years – either because they want liquidity to invest the same in other  startups or they are forced by Series B investor to exit as the Series A investor does not want too many shareholders or names in the cap table and wants the equity between the founders and Series A only.

• Excluding relatives makes no sense at all. The first port of call for angel investment is friends and relatives. Why would I not angel fund my brother or in-law since I know them well, trust them and am willing to help and mentor them and I know their full strengths and weaknesses. This will encourage round-tripping wherein I ask someone else to invest in a startup founded by my family member and in turn I invest in their family member’s startup.

I do hope some tweaking and modifications on these regulations are done based on the feedback received. I would have also liked to see some more incentives to promote angels investments by giving tax concessions for angel investments since it is highest category of risk (as an investment class). As an angel, when I exit and make money, I am happy to pay the tax but, it is likely that majority of angel investments will be write-offs. Against this back drop , the government should recognize the role played by angels and startups in providing employment and creating opportunities which cannot be done by traditional, established companies which more often than not have a freeze on hiring, are looking to cut costs and reduce manpower. Therefore, treating this as socially beneficial investments and allowing tax benefit during the year of investments but recouping when exits happens will be a welcome measure.