What policy initiative would boost angel investing in India?

In absence of tax rebates for angel investments, capital gains tax parity with listed stock, is a key policy change that will help boost angel investments in new ventures in India

The recent Budget has mentioned that angel investor pools will now be able to organize themselves as a Category I Alternate Investment Fund.

As I had mentioned in an earlier post Angels can organize themselves in Category I AIF Fund, this measure looks set to be a non-starter because of limited applicability of the framework to individual angel investments

What are other countries doing?

Various countries primarily offer tax rebates or credits for angel investors who invest in start-ups and new ventures under varied formats

What could we do?

In India, we face a dichotomy as the government is currently tackling larger issues of tax compliance and non-reporting of wealth and income, so a rebate or a credit looks counter intuitive

A start could be made through capital gains tax parity

1.     Making capital gains tax on angel investments at par with capital gains tax on investments in listed companies or mutual funds

2.     Ability to set off profits from one investment with losses from another

Key is to differentiate between tax evasion and new venture funding 

The government’s concern that angel investments should not become another format for unaccounted money flowing into questionable companies is valid.

However, the key here will be to differentiate between investments made in small enterprises for the purpose of tax evasion and smart money invested in new ventures by angels who invest to grow fledgling ideas into companies

Defining new ventures and angel investments

The policy will require a robust definition for both new ventures and angel investments.

Some thoughts on this are:

Define new ventures as:

A company registered in the past 5 years

A company not promoted by another company/ group of companies with more than INR 25 crore annual revenue

Set limits for tax parity on angel investments as:

Maximum limit of INR 1 crore of investment per annum per individual

Investment to be done only as an individual and not as a company

Some more debate is required on how we could make both these definition more robust, do respond with your comments on this

Will more angels start investing only because of the capital gains parity?

Angels will not invest in riskier start-ups purely because of the parity, but this will ensure they are not deterred by the higher tax they will otherwise pay on their profitable investments

A stock market investor in India today expects a minimum of 15% on his investments, as opposed to a developed market where they might be happier with a lower rate.   

A new venture has to be able to provide at least 30% returns to to attract investments. This number actually gets compounded when one factors in the high rate of failures of new ventures and the lack of exit options for the investor.

Moreover, angels take a portfolio approach in their investments, expecting only 20-30% of their investments to make up for the losses of the rest of the companies.

Both the capital gains parity and a set off feature will better the investors’ chances of improving returns on new venture investment.

This will also ensure the angel investor is not getting discouraged by adverse taxation while deciding on an already risky investment option.

In conclusion

If the government is unable to look at these two measures currently, in my view it is best that angel investments be left to evolve on its own without too many policy frameworks.

Without a detailed thinking through, wrong policy making might actually become a hindrance to a fledgling source of clean and smart money flowing to new ventures.