Historically, many Indian fintech companies chose to incorporate Delaware, Singapore, and other international jurisdictions. In my experience, half or even lesser time was required to close a new round of investment in a Delaware C- or Singapore-based start-up versus a comparable based in India, and this reduces anxiety for founders. It’s time-efficient and it simplifies the company’s documentation, which makes governance straightforward. But that’s gradually changing, especially in the Indian fintech world.
For fintech start-ups to scale and succeed in India, they will have to partner with regulated entities (read banks, NBFCs, insurers) and potentially themselves assume licences (read become NBFC or banks or distributor of financial products).
The RBI, rightly so, holds a high bar for ownership of regulated entities operating within payments and banking. Their stance has insulated India’s banking from several global shocks in the past — so this is a worthwhile bar. It also potentially helps them protect the financial system from being used for money laundering and other criminal activities and protect customers’ financial data and interests.
It does imply that fintechs operating in India as subsidiaries of foreign incorporated entities find it hard to partner with banks and gain licences.
Reverse flip
Then, what do foreign-incorporated fintechs do? They reverse flip. In recent years, we’ve seen an interesting trend —companies incorporated abroad moving back to India. This is known as reverse flipping. For the Indian fintech industry, which is constantly evolving, reverse flipping is catching up to be just another perfect example of this.
There are major trade-offs of reverse flipping for employees, the company, its shareholders, and future sources of financing. Employee incentives may need to be reset due to the new issuing entity. Even if the accumulated value is addressed, employees may still have to contend with a fresh vesting schedule.
But when a company changes its domicile, it triggers a taxable event for its shareholders, and this could be the tricky part. The new domicile may have different tax laws vis-à-vis the previous one, and this could have tax implications for the shareholders in the international and Indian jurisdictions.
The accumulated tax shields in the foreign jurisdiction might be lost as a result of reverse flipping. For later-stage companies, these tax shields may be as valuable as raising an additional round of funding.
Reverse flipping may make it harder for the company to access foreign investors and capital markets in future. With foreign investors still remaining less familiar with the structures of India-based companies, it may slow down the investment process, eventually creating hurdles. In essence, reverse flipping may make international capital markets less accessible to the company.
Here’s where the government should pitch in and put in place certain mechanisms, whereby along with the respective regulators, the process of reverse flipping could be simplified and accelerated. Further, companies and boards considering reverse flipping, should get thorough legal and accounting advice before pursuing this path.
In summary, reverse flipping is an interesting trend in the Indian fintech industry. While companies initially chose to incorporate abroad due to various factors, regulatory requirements are now driving them back to India. However, there are significant trade-offs involved. Given the regulatory benefits around controlling and monitoring the financial system better, now is the time to ease the processes which could encourage the fintech ecosystem.
The author Sandeep Patil is Head of Asia & Partner, QED investors
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