The topic here focuses on the Risks of high finances faced by startups due to legislative and policy changes:
First of all, let us understand what is a startup and how it works
A startup is a growing company. It is based on a unique idea around a product or a service. To make it successful, it will need proper planning, market research, scalability, resources, etc.
A startup has three main functions:
- It provides a vision to a product with its unique characteristics;
- It creates a proper structure of the business model considering customers, distributions, and finance of the company.
- To understand the business model with regards to customers’ behavior i.e. is it acceptable in the marketplace by the customers or not?
A new trend in clothing, food, and cosmetics goods startup which we can see is that they offer customized products. This is a new evolution and as the products are more customer-centric, people are prone to go for such products.
In India, a very good example of it is SkinCraft. It was started in 2018 and now it is a well-known product. Its success secret is its satisfied customers, working on customer feedback, and its excellent marketing strategy.
Let us try to understand how legislative and policy changes can cause higher costs to the startups:
To start a new startup or business, it has to go through many risk factors but out of all the risks, the greatest risk is the Legislative and Policy Risk. These risks are also known by the name Regulatory Risk
Legislative risks are regulations enforced by the government which can bring some significant changes. These changes can cause harm to the business. It can create huge misery for the investors. These risks are mainly caused by changes in government policies and regulations.
The policies which affect the most are related to Tax regulations and Trade policies. Although there are many schemes around tariffs and subsidies, there are changes that can still cost startups to pay a higher cost. This is the most important factor which investors consider while evaluating whether to invest in a particular startup.
Even after all the efforts taken by the Government to boost the growth of startups and businesses, the regulatory environment can cause the biggest risk. Starting a business is a lengthy procedure. If any company wants to avail of tax exemptions, one has to be to qualify an eligibility criterion (which is not difficult to achieve).
The government of India has taken several initiatives to encourage the growth of start-ups by providing easier IPR facilitation, a favorable taxation system, and easier compliance for the setting-up company, etc. Even after all the provisions made by GOI the start-up needs to face various obstacles like funding, insufficient skill, lack of marketing strategies, etc. On top of that, start-ups are under an obligation to operate in compliance with the laws and follow ethical behavior.
India still ranks 137th of 190 countries in the World Bank’s Starting a Business Ranking index.
Every change in the policy can create a problem for the companies. For example; a policy change in the excise duty on rubber from 20% to 30% will lead to an increase in the cost of rubber. Hence, prices will increase in the market.
The Startups which suffer the most because of legislative risk are in the Healthcare industry. Drug manufacturers and healthcare providers both need to go through legal issues related to Medicare, insurance coverage, license, documentation, and other customer payment issues.
Varun Gera, CEO HealthAssure says:
Varun Gera – CEO HealthAssure
All startups are challenged by regulatory, compliance and other elements in the early few years distracting their focus from their objective and being successful. Healthcare startups are no different and have to face a few more regulatory challenges in the form of licenses and other tedious regulatory requirements, especially for setting up a primary care centre. Other regulatory challenges faced by healthcare sector include increased cost due to service tax on essential products like insurance and other health service businesses providing healthcare to the public. Also, there is a requirement of licences for health service providers associated with insurers even though insurers themselves are already regulated.
Dr Adarsh Somashekar – Director and Consultant Pediatrician
He told ENN – “Healthcare companies face regulatory roadblocks at different points throughout establishment. Starting with the registration formalities, a typical new hospital requires clearances from at least 30 different agencies. This includes both local and central government agencies. Diverse procedural requirements, like X-rays, lab machines, pharmaceuticals, etc., call for unique approvals. The narcotics licence for controlled usage of drugs and pollution control mechanism certification, among many others, require separate clearances. In short, these take anywhere between three to six months for completion”
Regulatory/Legislative Risk factors mentioned include:
- Political instability
- Legal and regulatory constraints
- Local product safety and environmental laws
- Tax regulations
- Local labor laws
- Trade policies
- Currency regulations.
The start-ups should always go through all the legal requirements before starting a startup. Otherwise, the consequences can cost it a huge amount.
The startup should be aware of the licenses which need to be applied for as it is the most basic step taken before running a company. If the company has not obtained the proper license and still tries to run the company, they will be paying a huge amount in compensation for it. Even if the proper documentation of permit for the particular startup is not being done then also the consequences can affect the company adversely.
Gaining a license from government authority is not an easy task. It requires patience and sometimes a good amount of money in return.
Some of the licenses required by the companies are registration certificates, GST registration, FSSAI license, import and export code, Udyog Aadhar registration, etc.
Licenses obtained for goods and services like alcohol/ alcoholic beverages, electricity, guns, drugs and medicines, prohibited crops like marijuana or opium, tobacco, food products, human organs, etc is not an easy task and working for it without a license can end up the startup founder in the jail with a huge penalty fee in return as it comes under crime.
We all know that advertising and marketing are considered the most effective source to sell products in the open market and to reach the maximum crowd. Although if the false claims, obscene, scandalous, or seditious are promoted through ads it can be a crime and can led a startup in a danger or on the verge of finishing it in a snap.
Some examples of prohibited advertisements are – “Tobacco Prohibition Act” prohibits all kinds of direct or indirect advertising of tobacco and tobacco products in all media,
The World Health Organization has also prohibited the sale and marketing of infant formula like Nestle faced a lot of criticism worldwide for being accused of violating ethical marketing codes and manipulating customers with misleading nutritional claims about its baby milk formulas by comparing it with mother’s milk.
Myntra was forced to change the appearance of its “M” logo after an FIR was launched against it saying that its mark was obscene because it resembles a woman.
In the era of digitalization, data is the most important asset for companies. In the Covid-19 era, we can see everything is online. Everyone is doing transactions and purchasing online. In this way, the government keeps bringing changes in the laws so that no misuse is done by the company to customers’ data and any third party. If the company doesn’t abide by the law they need to pay huge charges with some serious damage to its reputation.
This broad interpretation by the Supreme Court led to a stream of initiatives by the government towards Personal Data Protection laws.
- Current laws prevalent in India
- The Personal Data Protection Bill, 2019
- The Salient Features of the Bill
If fails to abide by these laws, a startup will need to go suffer penalties, such as
- Penalties for contravening certain provisions of the Act is punishable with a fine of Rs 15 crore or 4% of the annual turnover of the fiduciary, whichever is higher, and
- Failure to conduct a data audit, punishable with a fine of five crore rupees or 2% of the annual turnover of the fiduciary, whichever is higher.\
Political risk is a common risk that causes the business to pay a higher value. Political, social, and institutional instability can create radical changes in the business and economic landscape in which local firms and multinationals compete with each other. The companies which understand these risks and work to manage them can be successful.
The political risk can be direct or indirect. The case of expropriation is an example of direct risk. On the other hand, when a rule of law is violated by a third party – an indirect law.
We should have the capability to analyze them and try to search for certain tools to manage them. Each type of political risk has a set of determinants that we need to monitor, but this will only be possible after careful identification of these risks.
Example
Wal-Mart Stores Inc. outlined certain political risks it faced in its fiscal 2015 10-K filing with the SEC under its operating risk section. In its risks associated with suppliers, Wal-Mart mentioned potential political and economic instability in the countries in which foreign suppliers operate, labor problems, and foreign trade policies and tariffs that have to be imposed.
In its regulatory, compliance, reputational, and other risks section, the company outlines risks associated with legislative, judicial, regulatory, and political/economic risks. Risk factors mentioned include political instability, legal and regulatory constraints, local product safety and environmental laws, tax regulations, local labor laws, trade policies, and currency regulations. Wal-Mart mentioned Brazil specifically, and the complexity of its federal, state and local laws.
If the marginal tax rates are high it The high marginal tax rates can disrupt work, saving, investment, and innovation, and also some specific tax preferences can affect the allocation of economic resources.
CORPORATE TAXATION AND ITS IMPORTANT
Corporate taxation asks for 33.3% – There are some other taxes in consideration like if the entrepreneur wants to create a company or expand the company or to invest in any country. If we talk about France, the amount can go over 60% of its pre-tax net profit. Thus, the corporate taxes are all paid by the business. The corporate tax also includes employer-borne social security contributions which are paid on payroll, real estate taxes, and many other minor taxes.
Corporate taxation also includes taxes that are indirectly linked to businesses since they affect shareholders and creditors who provide financing. These include taxes on dividends, capital gains, and business-related interest. Many companies also need to pay surtaxes for their product type or exceeding its turnover level.
Whenever we talk about the trade barriers or the adverse impact it makes on small businesses and startups, we only think about the international trade policies
- Trade barriers can cause customers to pay higher prices for goods in need and in return accept the low quality of it.
- Trade barriers generally favor rich and powerful countries as most of the international trade policies and standards are set by them
- Economists generally agree that trade barriers are detrimental and decrease overall economic efficiency.
Trade policies are government-induced restrictions on international trade. Some of these are:
Tariffs
- Non-tariff barriers to trade
- Import licenses
- Export licenses
- Import quotas
- Subsidies
- Voluntary Export Restraints
- Local content requirements
- Embargo
- Currency devaluation
- Trade restriction
The trade policies which affect worst the startup are the costs of foreign or imported goods. A rise in the price of foreign goods can ruin a business or challenge it financially.
Conclusion
I conclude by stating that the new startups should analyze and learn about all the risk factors before starting their own company. The startup should be very well aware of every kind of risk which can come in its way. If we don’t analyze, even a minor risk can take the startup down.
References:
- https://www.investopedia.com/terms/l/legislativerisk.asp
- https://www.investopedia.com/terms/i/investment.asp
- https://www.institutmolinari.org/2015/11/23/taxation-and-its-negative-impact-on-business-investment-activities/
Blog Posted By: Kanchan Rathore, Student Risk Committee Member
