If you take money out of a business as dividends, the effective tax rate is 52% (25% corporate tax + 35.5% on personal income). Through capital gains, it's just 14.95% (with cess).
Why does this matter? Here’s what you should know if you invest in IPOs.
If you're an investor (especially a VC), the math is simple: reduce corporate tax by showing minimal profits or losses. Spend (Burn) on acquiring users, build a growth narrative, and then sell shares at a higher valuation while paying much lower tax.
This spending also makes it harder for competitors to survive. To be clear, we're not discussing R&D spending here, which, incidentally, is very low in India (0.7% of GDP).
What's often overlooked is that VCs are essentially playing a tax arbitrage game. Look at most VC-backed businesses listed in the last few years, the reason they show little or no profit is partly due to this. Once you run a business this way, it's extremely difficult to switch.
Every startup that's 7-8 years old from the time of raising the first round faces constant pressure from VCs for an exit. With almost no M&A opportunities in India, IPO is often the only way out.
The government probably designed this tax arbitrage to incentivize companies to spend money and not just accumulate and distribute. But I'm unsure if the balance is correct. I think it's also creating businesses that aren't very resilient. One prolonged market downturn, and many of these unprofitable companies would struggle to survive.
Two things that make this more interesting:
Unprofitable growth gets valued at much higher multiples than steady profits. A company doing ₹100 cr revenue with 100% growth might get 10-15x, while a profitable one with 20% growth gets 3-5x. So VCs aren't just saving on tax; they're in essence creating a 3x higher exit valuation.
If you're competing against someone burning cash, you almost have to match it to defend market share, even if you don't want to, because of the quirks I mentioned above.
@RaoSumukh Apps need to make money to survive 😬…if the milkman is regular to the society, you can ask the guard in the morning to approve him on your behalf.
@AmazingCreditC Great way to garner interest, but question is it really worth it? It's just a way to consolidate all your account, which after seeding of PAN card everywhere, is being done by lots of account aggregators already, so don't see point of having another service just for that!
@girdharspeaks@foodpharmer2 The entire issue is capitalism has a natural tendency to corrupt. Once money gets involved, the entire objective function changes drastically.
I see some EV companies trying to make ‘cute’ ads in a bid to grow their stagnant sales.
Pro tip for them: Electric vehicles is a supply chain and manufacturing business. Save the marketing and sales ₹₹ and invest it into supply chains and tech to lower your product costs.