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BW Businessworld

Under The Scanner

India’s leading online retailers are being probed for FDI rule violations. But the startup story remains intact

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Year 2015 may go down as a watershed for India’s startups. There were not just new startups with innovative business models springing up every now and then, the excitement around their potential and possibilities for the economy also rubbed on the government to come up with its Startup India Initiative.

It was also the year of risk capital bonanza for startups and early stage investors. As many as 141 online retailers, or eTailers as they are called, raised $3,190 million from a clutch of private equity (PE) and venture capital (VC) funds, both domestic and international, as per data from research firm Venture Intelligence. Of this, as much as $1,394 million was foreign capital, while another $196 million was infused by India dedicated funds. The remaining $1,600 million was co-funded by both foreign and India dedicated funds. In 2014, as many as 82 online retailers raised $3,490 million, while the number of deals in 2013 stood at 45 worth $597 million.

But 2015 was also the year when the long-standing debate on policy relating to foreign investment in e-commerce came to the fore once again. The two Press Notes issued in 2010 and 2012 had categorically prohibited foreign direct investment (FDI) in consumer e-commerce. In 2012, the government had allowed 51 per cent FDI in multi-brand retail subject to certain sourcing conditions.

It all started last May with a petition by the Retailers Association of India (RAI) in the Delhi High Court pleading for a level playing field in FDI norms between eTailers and organised retailers. RAI represents nearly 900 retailers including the big boys of organised retail such as Reliance Retail, Future Group and Shoppers Stop.

In its petition, RAI mentioned instances of eTailers creating alternative structures and avenues to attract foreign investment. It even argued that the FDI policy was silent on the definition of e-commerce as being distinct from what is known as marketplace e-commerce. The court in its order gave the government four months to revert with its decision on the petition.

In November last year, during the course of a hearing of another petition by a retail industry lobby — the All India Footwear Manufacturers and Retailers Association (AIFMRA) — where the Delhi HC ordered the government to probe 21 e-commerce websites for possible FDI norm violations, the government informed that the Enforcement Directorate (ED) was already probing six e-commerce websites to see if they had transgressed the FDI policy. In November again, the Department of Industrial Promotion and Policy (DIPP) in the Ministry of Commerce and Industry issued a Press Note reviewing the extant FDI policy in retail. It allowed eTailers engaged in manufacturing to raise foreign capital without any restriction. However, it recently also said it did not recognise the “online marketplace model” in the country’s FDI policy, raising concerns amongst all stakeholders — entrepreneurs, investors and corporate lawyers who have facilitated transactions in this segment — over the fate of the capital that has so far flown into startups operating in the sector. “E-commerce is a new business model that has come up in the last 5-6 years. The government should have taken adequate steps right in the beginning instead of suddenly waking up now,” says ace angel investor and former Infosys director Mohandas Pai. “Lack of clarity over FDI in this sector is rather hurting the country’s brand image at a time when investments are pouring into e-commerce,” he adds.

“There needs to be absolute certainty or clarity on policy and what investors should do,” says Arvind Mathur, president, PE & VC Association. “At a time when we trying to get foreign capital in the country, it is absolutely pertinent that we have investment stability in the country,” he adds.

Raining Funds
In July 2015 alone, Sachin and Binny Bansal-promoted Flipkart raised $700 million from a slew of investors including Tiger Global and Steadview Capital, among others, while Snapdeal raised two rounds of capital last year from investors including Temasek, PremjiInvest, SoftBank Corp, Sequoia Capital India and Valiant Capital. Other online retailers who grabbed headlines for raising funds last year included Quikr, Oyo Rooms, Pepperfry.com, among others.

Online retail firms are mushrooming across the country as investors are gearing up to grab a slice of the bourgeoning online marketplace segment. This has been so as consumers are increasingly embracing the digital wave in their everyday lives and adopting online shopping to harness the true potential of technology.

According to research and consultancy firm RNCOS, the online retail market in the country is estimated to grow four-fold from the current $3.5 billion (over Rs 21,000 crore) to touch $14.5 billion (more than Rs 88,000 crore) by 2018 with increased penetration of mobile Internet and higher purchases of smartphones.

Under Investigation
Currently, more than 20 e-commerce companies including Flipkart, Snapdeal, Myntra, Jabong and Yepme are under the ED scanner. They are being probed under stringent Foreign Exchange Management Act norms to check if they have violated FDI rules while raising capital from investors. Major etailers, on their part, have approached the Reserve Bank of India to plead their case. “It is currently looking into the matter,” says a top source in the ED on condition of anonymity.

“At a time when the ED has been given the mandate to investigate prominent e-commerce players for FDI law violations, if any, and the government has taken a stand not to define marketplace, there is uncertainty in the market,” says Trisheet Chatterjee, partner at corporate law firm JSA. “Until things are put to rest and clarity prevails, investor confidence may be dampened,” he warns.

Entrepreneurs of online retail firms maintain that they are typically in a technology space as they have only created platforms linking buyers with sellers and are not selling to the consumers.

“E-commerce through pure-play marketplaces are new business models which are here to stay. All they do is provide the technology platform where vendors get connected to buyers in the comfort of customers home or office” says Amarjeet Singh, Partner-Tax at KPMG India.
“E-commerce has been around for the past 10 years. Why hasn’t the government ever taken the initiative to clarify FDI rules around it?” says Sachin Bhatia, former CMO, MakeMyTrip and co-founder and CEO of the dating app, TrulyMadly. The exasperation on the part of entrepreneurs like him is understandable. A hazy policy confounds all stakeholders, startups and investors alike.

If the etailers are found guilty under FEMA, the ED can slap a penalty up to three times the contravention or foreign investment received. “The investigation has been underway for some years now. In fact, a few cases have been made out by our investigating team and now the Adjudicating Officer is analyzing it to take a final call on the penalty amount,” says a top source in the directorate. The Adjudicating Officer generally belongs to the rank of a special director and analyses the investigation report to ensure the case stands the test of law.

According to Amitabh Kant, secretary, Department of Industrial Promotion and Policy, several brick-and-mortar retailers have for long been complaining about the lack of a level playing field vis-a-vis online retailers. “We have taken their views into consideration and issued a Press Note in November 2015 allowing brick-and-mortar retailers to sell online,” he says. The move to allow them to set up shop in the real and virtual space is without any riders. “The only concern is that these retailers will have to keep the government informed while raising foreign investment,” says an officer in the DIPP.

Brick-and-mortar electronics stores like and LG and Panasonic have been protesting against ‘unfair’ competition from online multi-brand electronics retailers, according to a DIPP official. Their main concern is the huge discounts offered by online retailers. According to them, the online sellers offer discounts on the bigger electronics brands, but make a profit on their in-house brand of products. Brick-and-mortar retailers find it difficult to match such discounts. The DIPP, say sources, have given these retailers a patient ear, but no solution is on the anvil.

The Road Ahead
The government has adopted several measures to promote and bolster entrepreneurship in the country with the aim of filling gaps in the economy. Besides the Startup India Initiative which saw participation of several fund managers and entrepreneurs, Prime Minister Modi in his recent visit to the US attended the India-US Startup Konnect 2015 exposition, a first of its kind initiative where India showcased the strengths of its startup ecosystem.

Speaking at the US event, Modi said that the concept of startups went back to the ancient times and that each economic era was defined by the evolution of new ideas and products. “Startups have always been the engines of progress. The mega corporations of today were startups of yesterday,” he said. It was during this visit that the US-headquartered chipmaker Qualcomm announced its $150 million India-dedicated startup fund to invest in emerging businesses. He also recently launched the “Bharat Fund” that is set to provide angel funding to Indian entrepreneurs in social sectors like health, renewable sources of energy and the farm sector. “It is strange that one hand when the government is adopting measures to boost entrepreneurship in the country, on the other it is not coming up with clear funding guidelines ,” says Arun Natarajan, founder at Venture Intelligence.

In a recent study by Nasscom, India was pegged at third position globally with more than 4,200 startups; it was also adjudged the world’s youngest startup nation with 72 per cent of founders less than 35 years of age. So all in all, startups still seem to be the flavour of the season, irrespective of the FDI controversy that has gained everyone’s attention.