Solving insolvency norms for start-ups: Government to pitch in

By Snigdha Kalra

Unwell start-ups can now breathe a sigh of relief with the government easing insolvency norms for start-ups. This comes as a benefit for small start-ups and companies. On Friday, the 16th of June, the Insolvency and Bankruptcy Board of India (IBBI) notified the rules for fast-track insolvency. The notification stated that the resolution will be completed within 90 days, as against the earlier stated 180-day time frame. 

The notification also specifies the conditions under these norms would apply. The first clause includes firms whose share capital is less than Rs.50 lakhs, with an annual revenue below Rs. 2 crores and total borrowings underRs. 2 crores. Also included are firms that are enlisted as small companies under the Companies Act, 2013. The last condition makes provision for unlisted firms possessing total assets less than Rs. 1 crore.

Treading new ground

The start-up culture in India has gained momentum over the past couple of years. A large majority of these start-ups end up in huge losses. This is primarily because there exists a huge difference between ‘starting’ and ‘establishing’ a business. This leaves the founders with no other option but to wind up their company under pressure from creditors and investors. According to data analytics company Tracxn, 140 such firms were shut down in 2015. The number went up by more than 50% in 2016, when 212 companies had to meet with the same fate. The start-up system in India stands on precarious territory, with more than 80% of the firms shutting shop within three years of starting up.

The most famous example from last year has been the grocery delivery start-up, PepperTap. Started in 2014, it was able to raise $51 million of funds from big investors. Yet, in April 2016, it closed down owing to unsustainable business practices and extremely fast growth in a volatile environment. This shows how sometimes even the most stable-looking startups may not be able to survive the competition.

Why will these laws help?

In such a volatile ecosystem, it is necessary that exit laws be made as easy as entry laws. The earlier laws involved cumbersome formalities and excessive delays. The long proceedings led to a fall in the value of the company, proving harmful for both founders and investors. This difficulty in exit was the reason why many startups were unable to do so, choosing instead, to operate even at an insurmountable loss.  

Thus, an easy exit plan is essential to a startup from the very beginning. It attracts investors who are assured the safety of their returns in the case of losses. It is also helpful for the founders, who can wind up and pitch a new business idea easily, in case things don’t work out well.

Implementation of the law

Under the new regulations, a creditor or debtor needs to file an application with the National Company Law Tribunal (NCLT) for dissolution of the company. This must be accompanied by the proof of the default and disclosure of the financial claims due. Once this is done, an Interim Resolution Professional (IRP) will be appointed by the NCLT. If the IRP thinks that the fast-track process is not applicable for a particular case he can get it converted into a normal corporate insolvency resolution process.

On the contrary, if the IRP thinks that fast-track resolution is applicable, he must appoint a registered valuer within seven days of his appointment. The valuer will decide the value at which the company will be liquidated.

This new law passed by the government will give a push to the ease of doing business initiative of PM Narendra Modi and encourage more people to become entrepreneurs. The easy entry and exit laws will give a boost to the startup ecosystem, and these norms are a step in that direction.

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