Incentivising reverse flipping

Historically, many Indian fintech companies have chosen to incorporate Delaware, Singapore, and other international jurisdictions. In my experience, half or even less time was required to close a new round of investment in a startup based in Delaware C or in Singapore versus a similar one in India, and that reduces founders’ anxiety. It saves time and simplifies company documentation, making governance straightforward. But that is gradually changing, especially in the Indian fintech world.

For fintech startups to scale and succeed in India, they will have to partner with entities that are regulated (read banks, non-bank financial companies, insurance companies) and possibly hold licenses themselves (read as NBFC, banks or distributor of financial products).

The Reserve Bank of India rightly holds a high standard of ownership for regulated entities that are in the payments and banking business. Their stance has insulated Indian banks from many global shocks in the past – so this is a worthwhile buffer. It also potentially helps them protect the financial system from being used for money laundering and other criminal activities and protect customers’ data and financial interests.

This means that fintech companies operating in India as subsidiaries of foreign incorporated entities find it difficult to partner with banks and obtain licenses.

reverse flip

So, what do foreign fintech companies do? reverse flip. In recent years, we have seen an interesting trend – the return of offshore listed companies to India. This is known as reverse flipping. For the Indian fintech industry, which is constantly evolving, flip flops are catching up to be just another perfect example of this.

There are major trade-offs to a reverse flip for employees, the company, its shareholders, and future funding sources. Employee incentives may need to be reset due to the new issuing entity. Even if the accrued value is processed, employees may still have to deal with a new accrual schedule.

But when a company changes residence, it results in a taxable event for its shareholders, and that can be the tricky part. The new domicile may have different tax laws compared to the previous one, and this may have tax implications for shareholders in international and Indian jurisdictions.

Tax shields accumulated in foreign jurisdiction may be lost as a result of reverse flip. For later-stage companies, these tax shields may be as valuable as raising an additional round of financing.

A reverse flip may make it difficult for the company to access foreign investors and capital markets in the future. Since foreign investors are still less familiar with the structures of India-based companies, this can slow down the investment process, ultimately creating hurdles. In essence, a reverse flip may make international capital markets less accessible to the company.

This is where the government has to step in and put in place certain mechanisms, where the reverse flipping process can be simplified and accelerated, together with the relevant regulators. Furthermore, companies and boards considering a reverse flip should obtain comprehensive legal and accounting advice before pursuing this route.

In short, flip flops are a very interesting trend in the Indian FinTech industry. While companies initially chose to incorporate abroad due to various factors, regulatory requirements are now pushing them to move back to India. However, there are significant trade-offs involved. Given the regulatory benefits around better control and oversight of the financial system, now is the time to ease processes that can encourage the fintech ecosystem.

The author Sandeep Patel is the Asia President and Partner, QED Investors