Pros and Cons of opting for a flip structure by an Indian Startup
It can be said that more startups in India are moving towards adopting a Flip structure which permits them to raise more capital from foreign investors and enables them to expand their business globally. Earlier, the government to reduce the capacity of the foreign shift of businesses and to imply more tax norms on foreign investors introduced the angel tax on inward investments.
Adopting a flip structure, a startup may operate its business through a cross-border merger where the company registered in one country either opens a subsidiary or becomes a subsidiary of a company in another country. As per observed shifts of Indian entities to flip structure, it was concluded that startups gained more flexibility to raise funds from foreign investors despite Indian tax norms and they are able to access global markets extensively.
Although there are benefits associated with flexibility and governance, there are certain risks and complexities also involved in adopting a Flip structure by a startup. Some of the common hurdles in adopting a flip structure in India include regulatory approvals, tax implications, and shareholder dilution & approval requirements.
Understanding Pros and Cons of Flip Structure for Startups
Pros :
Despite challenges faced by way of regulations and internal dilution, a Flip structure can be considered an attractive option for startups to look to foreign resources for raising capital and expanding their product market. Some linked benefits of holding a flip structure by startups in India also include :
- Access to Foreign investment: With links and connections, startups are able to tap into foreign capital markets and list their companies abroad to raise more funding for their business. This can be a significant step for boosting the growth of the startup.
- Access to Foreign markets and resources: By linking to multinationals and known corporate giants, startups can access global market resources and can expand their business with innovations.
- Flexibility in governance and choosing compliance structure: With a flip structure, startups can choose the right governance and jurisdiction suitable for their business. This will help them to expand their business in the market where legal norms and governance suits their business the most.
- Receiving higher Valuation: Compared to Indian Angel investors, ideas and innovations of startups can receive more appreciation and investment from foreign investors depending on the use case of the product and services the startup may offer. This will potentially attract more investors to their proposition.
Cons :
By incorporating into a flip structure, Indian startups will certainly enjoy favoritism in jurisdiction and governance, but opting for this structure has certain cons also to consider :
- Regulatory Control and Tax Implications: On receiving investments from foreign markets, more tax implications and control of authorities would lead to more time-consuming and costly compliances for the startups even if the entity is on a low yield.
- Complications in Shareholding: Opting into a flip structure may be opposed by the current shareholders and lenders, considering the decision as non-beneficial to their interest in the ownership or their investment in the business.
- Risk of losing control over entity: Listed on foreign exchange, there can be a risk of the domestic investors losing the entire entity if there is some misconception or missed compliance as per the foreign regulations.
- Lack of faith by investors: Catering to the needs of domestic investors or favoring the foreign market for product innovation and expansion, focusing on a single market at any time can create a negative impact on the other side investors of the startups which can certainly lose the interest of any of the side investors. Thus, opting for a flip structure requires proper management of the interest of both domestic and foreign investors which could be complicated.
While to restrict unaccounted inflows into Indian entities by direct participation on the board of startups, the government made changes to Section 56 of the Income Tax Act by placing clauses of taxability on the purchase of shares at a premium by foreign investors in India.
All in all, it should be a balanced act of decision for Indian startups to choose a flip structure. It does offer certain advantages by providing greater flexibility and control over the choice of governance. But on the other side, the decision can also put the business into negative terms of high compliance costs, tax complications, and the creation of negative perceptions of domestic or foreign investors at any time.
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