Explained: Why some Indian tech startups are 'reverse flipping' now

India's best-known fintech startups, and also others, engaging in what is popularly called a ‘reverse flip’ to move their holding parent entities back to India from countries such as the US, and Singapore? Image: Shutterstock
 
Why are some of India's best-known fintech startups, and also others, engaging in what is popularly called a ‘reverse flip’ to move their holding parent entities back to India from countries such as the US, and Singapore? It can be a fairly complex, time-consuming process, but these companies—Groww, Pine Labs and Razorpay are in the news—feel it's worth the trouble. Flipkart too, India’s biggest e-commerce company, now part of Walmart, is rumoured to be preparing to flip back, ahead of an IPO.

Keyur Shah, partner and leader, Financial Services Tax, EY India, explains the timing and the process in a recent interview with Forbes India.

Q. The historical reasons for the US or Singapore holding entities.
KS: Earlier, tech or a fintech startups, more fintechs, were operating in areas that were fairly complex for an overall investor understanding. The founders were often returning Indians, or the startups required venture capital (VC) funds or investors who were not very large but understood the fintech ecosystem fairly well.

And their need at that time, essentially, was structures that they understood and most of them were predominantly based in the Silicon Valley or overseas. Investors were very comfortable when the entity they were investing in was based in a jurisdiction they understood. This is why some of the large fintechs, including the likes of Razorpay and Pine Labs, were set up outside India, and got funded by private equity (PE) funds or VC firms in those jurisdictions.

But these startups or fintechs were focussed on India; their biggest business came from India. All of these entities, therefore, had a structure where the promoters were based out of India or were NRIs, and they held shares in a US or a Singapore-based entity. Then there was an Indian entity below it, which was the main operating entity.

Also, at that point in time, the prevalent feeling was that if I wanted to do an exit or listing in some form, then the valuations I could get were much better if I was a US entity or a Singapore entity. Which is why there was a larger impetus to set up these entities and these kinds of structures.

Also, in India, the regulatory framework at that time was not very robust—both, the Reserve Bank of India and the legal framework—in terms of investor protection and so on. Therefore, these structures have evolved.

Q. Why’s the ‘reverse flip’ picking up now?
KS: Over time, a few things have changed. One is, as is evident, the investor’s comfort of investing into India has changed, and we see a lot of investments coming into India directly. The VC and PE funds have understood India; they've understood how investments work in India.

The other thing that has changed is valuations and IPOs. If you are doing an IPO from an India perspective, at least the perception is that the valuations are far better. And therefore, taking an Indian company public sounds like a good answer.

The third thing is that when you are a large company—which many of these fintechs and startups have become—and most of your business is in India and you go public in India, regulators also look at it favourably. There is also the overall concept of a nationalist approach, where you feel proud of being an Indian promoter, having listed an Indian company.

Therefore, what people have started doing is flip the structure—where there was a US or a Singapore-based holding company—in which the Indian [operating] company becomes the main entity and the [foreign-based] holding company folds, or ‘reverse flips’ into, the operating company.

Also read: How India became the world's third largest startup hub in 15 years

Q. What are the complexities involved?
KS: When this happens, the investors get shares in the Indian company. This can happen in many ways. The most complex way is through cross-border mergers. Recent media reports have said that in the case of Pine Labs, the Singapore entity has merged into the Indian company. This is a cross-border merger, and it can be fairly complex and involves multiple regulatory approvals. In fact, till a few years ago you could not do a cross-border merger when you had Indian companies involved. That has changed since the Companies Act 2013.

The other way is a simple share swap, where shareholders of the holding company get shares of the subsidiary and, therefore, they swap the shares.

However, in both cases but more so in the latter, this can result in a significant tax liability, like we saw when shareholders of PhonePe apparently paid thousands of crores of tax when the reverse flip took place.

Q. Do the startups stand to gain or lose anything?
KS: Predominantly, these companies were those that had their operations in India and therefore, from an operating perspective, they weren’t losing out on much. In fact, reverse flips can bring in some level of operational cost efficiency, because they are now not running a US entity and an India entity.
It isn’t an easy process, because either you have to go to the courts or do complex share swaps. It is an expensive and time-consuming process. Overall, I don't think they end up losing much by doing the reverse flip, because essentially they’re going back to their roots.

Q. Which startups are doing this? More mature ones, perhaps?
KS: As recently as four years ago, most of our startup clients wanted to have a holding company based in Singapore or the US, and a subsidiary in India, even though the large operations were carried out in India. The perception was that valuations and exits would be better if you had a holding company outside India, and it also offered investor comfort.

Now, most entities we speak to don't want a complicated structure. They feel that regulators will be happier if there is a simple India entity, and investors now are also comfortable with India. Increasingly, we don't see that much of a need for setting up a holding company overseas.

Are we seeing more mature companies wanting to do the flip? I think the answer is yes. Companies that have reached some level of maturity and are looking at listing in the near future are the ones that are biting the bullet now. At least the view is that an India valuation will be a better answer, or an India listing will be a better answer.

For some of the smaller companies, one must remember that when they set up this structure, unwinding it is not a cakewalk. So, unless the articulation of the benefits of restructuring is very clear, people will generally not do this just because others are doing it. They'll have to take a really hard look at their structure and figure out whether it makes sense, given their outlook for the next three to five years, from a business and a listing perspective.

Immediate statistics aren’t available, but broadly, if you look at some of the existing players, at least 35 to 40 percent of them would have had a holding structure, which was based outside India. That is coming down now.