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Lessons from the SVB Debacle

March 14, 2023

The Silicon Valley Bank debacle contains many lessons for Indian startups and policymakers. Indian startups that opened bank accounts with SVB because they were domiciled outside India or had business interests outside must examine their overall strategy. Any startup with most of its business, human capital, and expansion interests in India must be registered here because it can understand the risk of doing business in India implicitly and have command over the resources here. This is true of any startup anywhere in the world – it is prudent to be registered in the economy it is connected with strategically.

Many Indian startups re-domiciled elsewhere due to the pressure from overseas investors, primarily led by Y Combinator, as a pre-condition to funding their ventures. These investors did not trust the Indian tax and regulatory system because of their many difficulties in moving capital in and exiting. Overseas investors can attach pre-conditions of this sort with enormous consequences largely because of the scarcity of domestic capital availability. This shortage of domestic capital has adverse effects, not only for the startups themselves but for the country and its growing startup ecosystem, and must be resolved quickly. For example, large institutions like LIC have almost no stake in the $136Bn that has entered India's startup ecosystem since 2014 - most of which is from overseas.

Startups opening bank accounts outside India must understand the risks and the financial, regulatory and compliance frameworks there. Conversations with these startups also reveal that they opened overseas bank accounts due to the difficulty in transacting in foreign currencies in India. Startups with global businesses face numerous challenges in moving their foreign earnings into the country and sending capital out. This is a solved problem for Indian software services companies that operate in multiple countries. They have EEFC accounts whereby foreign currencies can be maintained in Indian bank accounts and remitted directly when needed. There is an urgent need to offer this solution in the context of startups with global businesses, so they can move capital in and out in foreign currencies after following KYC and other procedures, thus eliminating the need to maintain foreign bank accounts.

Regarding raising capital, the procedures to raise money from overseas investors into Indian bank accounts are lengthy and cumbersome. This increases the liability on startups and overseas investors due to the protracted procedures, and there are enough horror stories on this aspect. While RBI has certainly eased up some of these procedures, a fair amount remains to be simplified because the downstream banking systems are unable to appreciate RBI's liberalization measures and take undue time for processing.

The solution is simple. Foreign investors from all countries who are a member of  IOSCO can participate freely in Indian stock markets by registering and completing KYC procedures with depositories regulated by RBI. A similar dispensation must be available for all overseas investment into Indian companies, listed or unlisted like startups. The depositories will complete the KYC, hold the shares on behalf of the overseas investors, and in case of a sale, can repatriate the funds immediately because they already hold the necessary and verified documentation to execute. This process can be made available to simplify incoming investment procedures.

GIFT City is India's answer to the current export of Indian financial transactions overseas, and it must step up to solve this problem of incoming investments as well. GIFT City and the Indian banks registered there must immediately allow all the Indian startups with SVB accounts

to open an account, bring their money in, and remit it again for payroll and other overseas expenses without undue restrictions. GIFT City has the unique ability to be its own regulator, free from restrictions by RBI. It's a golden opportunity to scale up, respond to this crisis by assisting Indian startups, and become a steady partner of Indian ventures with global businesses.  

Policymakers must appreciate one crucial issue. Most of these startups have been launched by engineers and younger entrepreneurs, for whom it is their first business venture. They do not fully understand regulatory frameworks and how to deal with banks. They face a fair amount of agony and anxiety at the prospect of bringing in overseas investment and running a global business from within India. Policymakers and government, namely the Finance Ministry, CBDT, and RBI, are creating an unnecessarily difficult environment for these young ventures, all seeking to comply with the regulatory and compliance frameworks. There is an urgent need to simplify these frameworks and reduce the friction to the movement of capital. GIFT City is a golden opportunity to do this now as the alternative, the Indian banking system, is more entrenched and may take longer to put this in motion.

As India expands its economy, Indian companies must be empowered to grow into global giants by allowing them to transact in foreign currencies, as Indian software services companies can. Startups must also re-examine their strategies and be cautious when they operate bank accounts overseas when their business is in India. They may get lulled by the ease of domiciling, doing business and operating overseas, forgetting that at the time of exits or taking big decisions, if they happen to have all their business in India, all of these factors will mitigate against them. PhonePe made the extraordinary decision of re-domiciling in India, where investors paid hefty taxes. The tax regime must also be examined and simplified to allow more startups to re-domicile in the country easily.

There are many lessons for all Indian stakeholders here. Startups must focus entirely on the country they are operating in. Regulators must improve the EoDB and not create an unnecessarily hostile environment for entrepreneurs. The SVB situation provides all the stakeholders with a unique opportunity to fix some of these problems and accelerate the growth of the Indian startup system.

Originally published in The Financial Express

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