Will SVB Collapse Accelerate Reverse Flipping Of Startups To India?

Amid the doomsaying and talk of the potential disruption expected with the collapse of Silicon Valley Bank, there could be a silver lining for Indian startups.

Even as the US Federal Reserve has stepped in with emergency measures to ease fears, the SVB collapse is likely to push Indian regulators to create pathways for startups to ‘reverse flip’ to India.

Indian startups with their registered HQs outside India would be keeping a close eye on the Indian market and how Indian regulators and the government react to the SVB collapse. Even though the worst potential impact on startups has now been avoided, the collapse is likely to force the hand of the Indian government and regulators such as the Reserve Bank of India (RBI).

Investors and financial experts believe that the RBI and the Indian government now have a very credible reason to push for improved ‘ease of doing business’, especially when it comes to banking norms and taxation related to capital flows for Indian startups.

And one of the solutions being put forward is the Gujarat International Finance Tech-city (GIFT), India’s first International Financial Services Centre (IFSC), which has eased capital inflows for foreign investors, BFSI companies and funds.

Silicon Valley Bank & Reverse Flipping?

While there’s already talk about the Silicon Valley Bank episode pushing ‘flipped’ Indian startups to redomicile or move back to India, the issues that drove companies overseas continue to persist.

India’s banking norms, particularly regulations around remittances and receivables from overseas markets, has been a thorn in the side for Indian startups looking to conduct business globally.

Flipping, or in other words registering a headquarters outside India, is all too common among unicorns as well as early-stage ventures. In the past, Indian investors and VCs have claimed that flipping erodes the innovation value chain and forces India to relinquish valuable IP, data and revenue.

Speaking to Inc42, Gopal Srinivasan, the chairman and managing director of TVS Capital Funds, said he believes that Indian founders are economic freedom fighters.

“That’s why we said let’s raise only rupee capital and let all the profits of investment stay in India. It’s great to hear the stories of unicorns, soonicorns and decacorns, but when you realise that all profit has gone to some American pension fund or some foreign investor, what economic problems are we solving in India?” Srinivasan said.

He added that besides backing entrepreneurs, TVS Capital Funds is on a mission to create the enabling environment for startups to keep their money and value in India.

While most investors believe that India has come a long way when it comes to ease of starting a business, there are persistent issues that come up during a startup’s lifecycle, which make running a startup in India more complicated than it seems.

Analysis by Inc42 shows that 20 out of the 108 unicorns in India are headquartered overseas. The flipped structures are more predominantly seen in the enterprisetech or SaaS sector. A whopping 75% of these are based in the US, and a majority come from the enterprisetech sector.

Startups have routinely spoken out about the heavy documentation and compliance burden when running global operations from India. One of the key challenges in running a global tech business from India involves the ability to make and receive payments in US dollars.

In many cases, the finance teams of SaaS customers in the US or Europe do not want to deal with the red tape and the compliance hurdles in the Indian banking system and prefer their vendors to have local bank accounts.

For example, the startup’s US-based parent entity collects the revenue in the US account, while the go-to-market or sales and product development happen through the Indian entity. This is generally seen as a cost-saving exercise by many SaaS companies.

Nasdaq-listed Freshworks is a prime example of an Indian company run out of a US HQ. In fact, Freshworks has exposure to SVB, though it claims it is minimal and won’t see any major disruption from this exposure.

Investor Pressure To Flip

Of course, in other cases, investors themselves push for Indian startups to register outside the US, particularly at an early stage. Indeed, investors such as Y Combinator impose this as a condition for funding.

There are other factors too. For instance, non-residents are taxed at half the rate or 10% versus 20% for residents from a capital gains perspective, which means investors are more comfortable buying equity in foreign companies. Besides this, there are hurdles when it comes to exit pathways for investors as well since many M&A deals in India require NCLT approval, which can take anywhere from a year to 18 months and come with a high tax burden.

Given that investors are more keenly eyeing any potential exit opportunities in 2023 to book profits, this long waiting period for M&As can derail deals.

Experts we spoke to believe it is important that India relaxes banking norms for Indian startups or creates exceptions for startups, so that they are not forced to flip their structures or open bank accounts in other geographies for overseas transactions. This can either be done through existing banks such as SIDBI, which already has a key role in the startup ecosystem as an LP for domestic AIFs.

“Such policies will retain the innovation value chain within the Indian economy, and propel the Indian banking industry to the next phase by making it more global,” according to a former investment advisor and the founder of a Delhi-based early-stage fund.

For now, though, without any changes to how banking is conducted, there’s not much that startups can do besides swallowing the tax pill and setting up in India, or continuing to rely on flipping to avoid these hurdles.

“Even after all these problems at Silicon Valley Bank and its complete collapse, it’s still preferable to register in the US for most startups as these problems in terms of remittances and LTCG won’t go away immediately,” the early-stage investor quoted above said, adding that even if investors don’t pressurise startups, it makes more business sense in many cases.

More than anything it reduces the costs involved in sales reconciliation, annual renewals and multi-year deals.

GIFT Could Solve The Flipping Puzzle

Despite urging Indian startups to register in India, the Indian government has not exactly solved the problems that continue to make flipping more desirable. One solution put forward by investors is extending the GIFT IFSC’s special exemptions for financial services firms to startups.

The Economic Survey 2022-23 recommends easing the procedures for capital flows, citing the example of the US and Singapore. The establishment of GIFT City has already eased some of these capital flow issues for financial services firms.

Silicon Valley Bank’s collapse could be the perfect opportunity to bring these exemptions to startups.  Siddarth Pai, founding partner of Bengaluru-based 3one4 Capital believes that the government can look at GIFT as a counterbalance to banking regulations that startups might consider unfriendly.

“The real opportunity for India amid the SVB collapse is in putting GIFT IFSC at the heart of Startup India. GIFT IFSC allows several advantages for startups going international, such as dollar accounts, no regulatory approval for foreign investments, etc. Indian startups headquartered overseas should be allowed to redomicile to GIFT in a tax-free manner, similar to the 2021 scheme announced for funds. Extending this to startups will usher in Startup India 2.0 and allow Indian startups to truly compete internationally from India,” Pai told Inc42.

Given that the banking and taxation reforms that startups want will need several months to implement, it does look like GIFT IFSC could be the answer to the problems that startups have faced so far in redomiciling. It has been suggested in the past, but at this moment, the SVB collapse offers the perfect opportunity for the GIFT to become real for Indian startups.