India: SIDBI'S COVID-19 Assistance Scheme: A Rigid Framework In Illiquid Times

1. INTRODUCTION

In a robust response to industry calls for urgent assistance to start-ups impacted by the COVID-19 pandemic, the Small Industries Development Bank of India ("SIDBI") has rolled out the COVID-19 Start-up Assistance Scheme¹ (the "CSAS").

2. HIGHLIGHTS OF CSAS

2.1. Targeting

The CSAS has laid down several guardrails in order to identify the start-ups appropriately:

(a) Recognition as a 'start-up' by the Government²;

(b) Funding by an Alternate Investment Fund ("AIF") registered with SEBI;

(c) Incorporated for less than 10 years;

(d) The promoter or founder of the start-up should have invested their own capital in the business;

(e) Demonstrated innovative measures for ensuring business continuity during COVID-19 period;

(f) Undertaken adequate measures and ensured employee safety and their financial stability;

(g) Minimum employee base of 50, which may include contracted employees³;

(h) Minimum turnover between INR 10 to 60 crores (approximately USD 1.3 to 7.8 million) in the financial years 2018-19 and 2019-20;

(i) Positive unit economics; and

(j) Positive net worth.

The following categories of start-ups are not eligible under CSAS:

(a) written off by AIFs;

(b) in stress due to factors other than COVID-19; and

(c) have existing working capital facilities with a bank.

2.2. Evaluation

Eligible start-ups looking to obtain a working capital term loan under CSAS are required to fill up an 'application form cum credit appraisal memo'⁴ and a 'self-assessment tool'⁵. The credit appraisal memo, amongst other business aspects, requires the following key information:

(a) The promoter(s)' bio-data and net-worth statement;

(b) Details of litigation against the start-up, its promoters, directors, partners and proprietor;

(c) The willingness of existing investors to invest additional funds to manage the temporary liquidity crunch on account of COVID-19; and

(d) Any withdrawal or deferment of the funding commitments from existing or new investors due to COVID-19.

The credit evaluation will be done by a recommendation committee comprising of 3 members from SIDBI and its nominees, and 2 members from venture capital industry, with the final sanctioning authority being the internal credit committee ("ICC") of SIDBI.

The entire process of application, approval and grant of loans has been made completely digital, including meetings between the ICC and the start-up/VC investor through video conferences, and digital execution of loan agreements.

2.3. Key Terms

Financial assistance available to start-ups is limited to INR 2 crores (approximately USD 260,000) per start-up. The loan can only be used for working capital requirements, such as payment of administrative expenses, salaries, rent, payment to vendors, and also against goods and services tax refund. The loan monies cannot be used to repay any debts including venture debt, and the promoters and investors are restricted from liquidating their stakes in the start-up without SIDBI's consent.

Some of the other terms of the loan are set out below:

(a) Maximum term of 36 months;

(b) Maximum moratorium period of 12 months;

(c) No prepayment charges;

(d) Repayment within a maximum of 24 instalments;

(e) Interest rate of 10.5% per annum at reducing balance;

(f) Equity kicker up to 10% of the loan amount at a 50% discount to previous investment round; and

(g) Conversion of defaulted instalment(s) along with accrued interests, penal interests and all other costs and charges into equity capital of the start-up 'at par'⁶, in case of continuing default.

2.4. Security

SIDBI is seeking a first charge on the current assets of the start-up, and if available, additional security interest in movables, intellectual property and promoter shares.

An additional security stipulation is in the form of a 'keyman insurance' to the extent of the amount disbursed, to secure the loan. The loan shall carry the following insurance: (a) key-man insurance assigned to SIDBI; and (b) all employee term insurance up to INR 10 lakhs (approximately USD 13,000). 50% of the cost of premium for the said insurance will be borne by SIDBI and the other 50% is to be borne equally by the investor(s) and the start-up.

2.5. Deadline

The aim is to provide quick working capital loans within the next 45 to 60 days, and the eligible start-ups are required to make application under CSAS within 30 days of launch (i.e., by May 04, 2020).

3. INDUSLAW VIEW

CSAS is a welcome proposal launched by SIDBI which recognises the extraordinary circumstances around COVID-19 and the resultant cash-crunch faced by several companies in the start-up ecosystem. It allows SIDBI to step in and lend to start-ups on an urgent basis. This can prevent knee-jerk down-rounds and help protect the management and angels from being wiped out. From a company perspective, it provides some measure of interim stability and ensures continuity of services and employees.

Further, by excluding entities which already have working capital arrangements with banks or are otherwise in danger of a write off, CSAS guides the recommendation committee to lend to those entities which are truly in need of a lifeline due to COVID-19.

There are however a few wrinkles in the scheme which may need clarification or modification:

AIF-Funded: The requirement that the start-ups should be funded by at least one AIF registered with SEBI, while understandable as an objective criterion, excludes many Indian start-ups which are backed by overseas VC firms, boot strapped or funded by angels.

Focus on Employees: Although CSAS provides that the requirement to have a minimum employee base of 50 employees may be relaxed on a case to case basis, the rationale for determination of this threshold is unclear. Concerns have been expressed that such a high threshold may disqualify many start-ups from applying under CSAS as many early stage start-ups, and even some growth-stage pure tech start-ups do not have 50 employees.

Unit Economics Criteria: The criteria that only start-ups with positive unit economics are eligible to apply may disqualify many start-ups as unit economics are not a uniformly applicable measure across verticals and may not apply to IP-heavy early stage start-ups.

Net-Worth and Turnover Criteria: Although the positive net-worth criterion seems reasonable, it may also prove to be an overly simplistic way of assessing pre-COVID-19 stress. A minimum turnover of INR 10 crores (approximately USD 1.3 million) may be anachronistic in the 'new age economy', and might prove too high for tech start-ups. A greater deal of flexibility in assessing pre-COVID-19 stress could have been permitted especially since the recommendation committee will have reputed venture capital investor nominees who understand the ecosystem well.

Interest Rate and Security – Comparison with SIDBI's SAFE Scheme: SIDBI has also launched the SIDBI Assistance to Facilitate Emergency response against Corona Virus Scheme⁷ ("SAFE Scheme") to grant loans to micro and small enterprises ("MSEs") which are offering products or services related to fighting COVID-19. Under the SAFE Scheme, MSEs may avail collateral-free loans up to INR 50 lakhs (approximately USD 66,000) at a fixed interest rate of 5%.

It is noteworthy that while the purpose of the SAFE Scheme is to allow MSEs to acquire equipment, plant and machinery, and other assets required for production or delivery of services, SIDBI is not creating any charge on these equipment and assets. Under CSAS, SIDBI will have a charge over not only the current assets of the start-up, but it may also require the start-up to hypothecate or pledge its intellectual property and/or promoter shares in the start-up. Although the interest rate charged under CSAS is lower than the rate of interest charged by banks, it is unclear why the interest rate under CSAS is more than twice the SAFE Scheme interest rate of 5%. When one considers the equity kicker in CSAS, this difference appears harsh.

It is understandable that SIDBI wants to relax requirements for MSEs making equipment to fight the pandemic. However, a certain degree of alignment between the two schemes in 'lifeline' terms may be necessary for start-ups struggling to survive. This would realistically augment the efforts being put in by the investor community as well, including the Action COVID-19 Team⁸ and the Start-up Lifeline Infusion Program⁹.

Footnotes