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The End of the Cowboy Days of Angel Investing in India

Jun 26 2013, 19:46   |   By SME Mentor

By Ajeet Khurana

Three months ago, in an article on SMEmentor, I had given P Chidambaram an angel investor's thumbs up for the union budget. The budget had recognized the value and contribution of angel investors, and the finance minister had talked about SEBI formally recognizing angel investor groups. Today, June 25, 2013, that has come true. In its board meeting, SEBI recognized, defined, and proposed regulations for individual angel investors, corporate angel investors, and angel pools. One way or another, this is going to have far reaching consequences.

In a sense, I see the present regulations as giving birth to the Indian angel investor. That thought is going to provoke some outcry from my angel investor colleagues who will say that, "angel investors have been around for decades!" That's true. In fact, I made my first angel investment in 1998. But the introduction of specific regulatory provisions for angel investors in India is going to make the recent past seem like the cowboy days of angel investing.

Other than the entrepreneur, there are three interested parties in this game. Let us examine the positions of each, and then see what the present proposal leads to.

Angels Would Like Tax Incentives or at Least Some Kind of Pass Through Status in the Case of Angel Pools

Angels assume risk in very early stage businesses. In many parts of the world, they are provided tax breaks for their activity, which is seen as critical to capital formation. But the Indian regulatory and tax system did not even recognize the existence of angels. The present SEBI move is important as it presents the first step for getting angels "into the system."

The Tax Man Is Worried That the Route of Angel Investment May Be Used as a Front to Launder Money

It would not be uncommon for an angel investor to invest in the company that has shares of face value Rs. 10, book value Rs. 10, but priced at Rs. 2000. The nature of valuations that some companies command at the early stage, make this inevitable. But this behavior also permits companies to launder black money from their promoters, who may re-route it as an angel investment. This was the fundamental premise of the "angel tax" that Pranab Mukherjee had proposed in the budget speech in March 2012. In the example that I listed a moment ago, Rs. 1990 (computed as Rs. 2000 - 10) would have been subject to a 30% tax at the hands of the investee company as per the provisions of the "angel tax."

SEBI Is Worried About Mis-selling, Scams, and Irrational Investment Schemes in Angel Investments

SEBI is the regulator of the investors, issuers, and intermediaries in India. Angel investments can definitely add a new dimension of headache to the regulator. Especially when ideas like crowdfunding, online fund raising, cross border angel investments, and angel networks are gaining ground. So SEBI wants to ensure that:

(i) Angel investments are genuine and not fronts for bypassing regulations of investing into related entities.
(ii) Genuine angel investors are making informed decisions.

What Has SEBI Decided in its Board Meeting of June 25, 2013?

The concerns of all three parties have been addressed by SEBI. Of course, it remains to be seen whether they have the intended consequences. SEBI proposes to view angel activity with the same prism as venture capital activity. So, similar regulations apply. For instance, SEBI has proposed minimum tangible assets requirements for individual investors, maximum limits for revenues of the investee company as well as group turnover of investing company, not to mention the minimum amount and tenure of investment. For complete details, read the minutes of the SEBI board meeting..

What Is the Outcome of SEBI's Proposals?

> Hue and Cry by Angels: No one wants to be told what to do. As a result, angel investors are going to make some noise about the regulations. As I read the present proposals, I feel confident that some amount of tweaking of the rules is likely. This will especially be in the area of individuals and angel networks (e.g. Mumbai Angels), as regulations in that area are not clear. But the likelihood of regulations being removed entirely is close to zero.

> The Emergence of Retail Participation in Angel Funds: With clarity by SEBI, Angel Funds can now tap into the retail HNI market in the same way as PE funds used to until SEBI made the minimum investment ticket Rs. 1 crore. This will bring more capital supply into the early stage ecosystem, which will be healthy for the entire ecosystem - especially for the entrepreneur.

Final Words
It is not as if the SEBI regulations have changed the rules of the game. Instead, SEBI has introduced rules where none existed. This will cause some pain at many levels. However, I believe that regulations have turned out to be a necessary evil in our financial markets. I predict that today's decisions will be seen as giving birth to the Indian angel investor. I am not happy with some of the specific proposals, but I am happy with the overall direction.

~ Ajeet Khurana mentors start-ups. An angel investor, trainer, author, entrepreneur and digital marketer, he is a member of the screening committee of Mumbai Angels, one of India's oldest angel networks. He is on the boards of Carve Niche Technologies and Rolocule Games, You can reach him on LinkedIn and Twitter.

You can send your feedback on smementor@moneycontrol.com or simply post comments below


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