What the angel funding ecosystem has to say about new early-stage investment norms

Earlier this week, securities market regulator SEBI has come up with some significant guidelines for the startup ecosystem in India. These norms aim to boost liquidity prospects for early-stage investors by allowing startups to list without IPOs, but the regulator has also proposed certain restrictions on angel funds that may affect their investments. The proposals, some of which have been discussed for a while, were cleared in a SEBI board meeting held on Tuesday (June 25, 2013). But till date, SEBI has not mentioned a timeline for the implementation of the new norms.

In an earlier article, we have already discussed in details the new guidelines (read here for more on that). And this time around, Techcircle.in/VCCircle has spoken to a cross section of stakeholders – angel funds, accelerators, individual angel investors and also a startup which has recently raised angel funding – to get their views. Here is what they think.

Ashish Gupta, senior MD, Helion Venture Partners

It (the proposed institutional trading platform where startups can list without an IPO) is a good idea as long as there are tight norms for brokers and mutual funds who are not able to sell the shares to their clients, given how tricky startups are. Having minimum net worth norms (for angel investors) is also very important, as is the need to have sufficient experience. Otherwise, inexperienced investors can be conned by companies. Although, there is still that risk, even with the norms in place.

Sanjay Swamy, managing partner, AngelPrime

While the norms do not affect AngelPrime directly, they are pretty reasonable in my view. But I am a little unsure of one thing – why do you prevent investment in a startup that is sponsored or related to an industrial group whose turnover is in excess of Rs 300 crore? If a family member of a large group has launched a technology startup and an angel, who can add a lot of strategic value to the startup's business, wants to get involved, he/she can't do it because of these norms.

While the Rs 2 crore tangible assets cap on individual angel investors makes sense (considering these are high-risk investments), the experience required (at least 10 years before investment) does not. As per this, an individual with net worth of over Rs 100 crore but only 5 years of experience will not be able to invest in a startup, while another with Rs 3 crore net worth and 11 years of experience will be able to do so.

Another thing I feel should be amended is that angel investors cannot invest in startups where they have a family connection. This does not make sense since at the time of starting up, most of the companies take in investments from friends and family. In fact, that is how they survive the initial period of bootstrapping.

Anil Joshi, president, Mumbai Angels

These guidelines were awaited and are fine, on the whole. And the norm that angel investors cannot invest in firms which are more than 3 years old, can be amended. When entrepreneurs start a company, it can easily take them more than three years to reach a stage where they can raise money. Also, Indian entrepreneurs, who have incorporated their companies abroad, will miss out on raising money because investments can only be done in firms incorporated in India.

Also, before any investor comes in, startups do raise some capital from friends and families. SEBI has missed that point although family money is very important for entrepreneurs. There could have been some kind of relaxation here.

Gaurav Kachru, founder, 5ideas.in

This (the proposed institutional trading platform where startups can list without an IPO) is a welcome addition to the potential set of exit options for investors. I believe that the degree of regulatory burden, the cost of transacting and the quality & depth of investors will be critical factors to make this initiative succeed. If it succeeds, it has the potential of far exceeding conceptually similar exchanges like the AIM in the UK. But whether it succeeds or fails, it is a step in the right direction and that the march continues is a good sign overall.

Given that these are trades involving higher capital risk assets with potentially lower compliance & disclosure burdens, SEBI needs to take this step (criteria of who can be an angel investor) to ensure that only sophisticated or experienced investors and professionals, who understand the potential risks, take part in the market. I think this is fair and in line with how other conceptually similar exchanges are managed.

I think these norms are created to protect individual investors. And any regulation created to protect will also cause certain limitations. These individuals also have the option to use a platform like an angel fund or an AIF fund, with experienced fund managers overseeing the allocation of capital. Or they can invest in startups directly without the tax benefits. For the longer-term good, I do believe some of these guidelines are good for the industry as a whole.

VentureNursery accelerator

Overall, it is a positive step and we hope it is implemented well. We hope this would create many more angel funds and see the entry of new angel investors from cities and towns not covered so far. We also welcome the opportunity for HNIs to do co-ordinated investments that will, hopefully, reduce risks, allow financially stable angels to participate and also reduce volatility.

A few things that need a relook include individual angel investors requiring early-stage investment experience, experience as a serial entrepreneur or being a senior management professional with 10 years of experience.

We would also welcome clarity on the following:

3-year lock-in in the investee company: What's the goal here? We feel the market should decide that. If an investee company does well, the fund should be allowed to exit through any of the market vehicles such as secondary sale, strategic sale or merger. Regulator-driven lock-in may introduce distortion and is vulnerable to manipulation and can actually work against startup promoters, who this regulation is intended to serve.

Invest in a company not more than 3-year-old: This can backfire. At what age a company should raise venture money should be left to the judgment of the promoters and the market forces, not to SEBI.

Minimum investment Rs 50 lakh: Again, it should be left to the company and the fund. What if a company needs less money?

Srikant Krishnan, founder and MD, dMACQ Software

As far as India is concerned, we should have legislations which do not restrict in any manner the ability of the qualified angel investors to fund startups. The current regulations impose various restrictions such as net worth, etc., on angel investors. Also, SEBI has not defined what constitutes the 'tangible net worth' – minor matter in the larger scheme of things. If the definition is restrictive – for example, if it only includes freely available tangible assets (and excludes value of tangible property) – this may somehow restrict the investor community.

Similarly, an astute businessman, who may not be a serial entrepreneur or who may not have 10 years of managerial experience, may face some challenge to qualify as an angel investor.

Sabarish Nair, co-founder and CEO, Little1

The guidelines are fair for both investors and startups. For an investor, investing in a startup which is less than 3 years old actually makes the investment more worthwhile as valuations could be more attractive. If a startup has a proven business model and a revenue track record, one may not get the right value for the investment as the valuation tends to get better.

For a startup, three years should be a good enough period to validate a business proposition. It may not be a good enough timeframe for all kinds of startups, but it would ensure that startup enthusiasts have a definite deadline in mind when they make their business models. Perform or perish is a good way of keeping the startup ecosystem on its toes and also ensures that they strive to get better with their performance.

The qualification criteria (for angel investors) is right from an investor's perspective as angel investments are high-risk initiatives and should only be sourced from individuals who are aware of this risk, based on their professional experience or investment experience. I also feel that the holding period of minimum three years gives just enough time to a startup to show value for the angel investor's money. But the bracket of Rs 50 lakh-Rs 5 crore looks a bit stretched as the minimum amount could be even lower. Not all startups are fascinated by the idea of raising large amounts initially and they may want to limit it to a minimum.

Let's also not forget that it's not always money that is a motivator to rope in angel investors. It can be their experience, networks, etc., and SEBI should not deprive smart startup ideas from getting these exposures by adding a minimum amount criteria. On the whole, it is good to come under the purview of SEBI as it shows that India, as a country, is acknowledging the startup community.

(Edited by Sanghamitra Mandal)