Startup funding in India at two year low at $2.7 billion: PwC

Startup funding in India during the third quarter (July to September) of the calendar year 2022 hit a two-year low at $2.7 billion across 205 deals, according to a latest report by consulting and audit firm, PwC.

The report, Startup Deals Tracker - Q3 CY22, said that although it has been argued that there is substantial committed capital waiting to be deployed (dry powder) in the Indian startup ecosystem, it is becoming clearer that selectivity in deal making will increase, with a focus on path-to-profitability, especially in growth- to late-stage companies.

This winter arrives at a time when India has emerged as a serious contender to become the world's startup capital, with global capital chasing multi-billion dollar ideas in the world's soon-to-be most populous country.

This raises a question on policy too. More specifically, can India do more in the policy space to make promising startups raise more capital easily to tide over the uncertain funding winter?

Two years ago, the government came out with Press Note 3, aimed at curbing predatory takeovers by foreign entities, and needs to be reviewed in the current economic situation.

As companies across the globe battled the uncertainty that the pandemic brought on in 2020, several economies began to raise concerns about opportunistic takeovers of entities stressed by pandemic.

India introduced the Press Note 3 (PN3) in 2020, which required all foreign direct investment (FDI) proposals from an entity based in a country that shares a land border with India, or where the beneficial owner of such FDI is situated in a country which shares a land border with India — both referred to as "restricted entities" — were brought under the government approval route.

The PN3 expanded the list of countries whose investors are no longer eligible to invest in India under the automatic route. Importantly, for startups, an investment in India now falls under the government route if it is from an entity whose "beneficial owner" is from such a bordering country.

The term "beneficial owner" has different meanings under different laws in India. Depending on how it is defined it could mean: (i) an entity with a prescribed shareholding level in the investing entity (as is the case under the Companies Act of 2013), or (ii) the owner or holder of ultimate control over the investing entity (as defined under the Prevention of Money-laundering Act, 2002). A somewhat similar concept is also used by the Securities and Exchange Board of India (SEBI) to identify the ultimate beneficial owner for the purposes of certain securities laws.

The problem for startups seeking funds is that the PN3 has not defined the threshold for identifying the "beneficial owner". As experts at Khaitan and Co have pointed out, considering that investors often have multi-layered structures, spread across various jurisdictions, this ambiguity has led to a conundrum on the ambit, and method of computation of beneficial ownership.

This ambiguity has also piled up applications from foreign investors seeking the government's approval thereby causing delays, and extension of deal timelines.

It may be about time for the government to clarify on these, and ease some of these rules, for funds to flow in quickly, and enable capitalisation of India's promising startup ventures that are not only pioneering a culture of innovation in the country, but also creating jobs by tens of thousands.

Domestic policy easing can help startups battle the chill during the funding winter that no one is sure of how long it will last.