Unicorns – Emerging issues for sustainability

– By Mohanish Verma

As per Invest India, India was home to 111 unicorns with a total valuation of around 350 billion US dollars, as on October 2023. Unicorn is a term used in the venture capital industry to describe a privately held startup company with a value of over $1 billion.

As per the Hurun Report the number of Unicorns in order of numbers as on 31st December 2022, was as follows:

CountryNo. of UnicornsUSA666China316India68UK49Germany36

Hurun Report (Shanghai based rich-list provider) found 1361 Unicorns globally with a growth of 29 percent over previous year and a growth of 175 percent since Covid began. This tectonic change is here to stay. Fintech, Blockchain, Logistics were the fastest growing sectors in 2022. Enterprise Services, Healthtech and Cyber security are other areas of fast growth.

Some unique features

As per the startups filings with the Ministry of Corporate Affairs (MCA), in India 16 profitable unicorns cumulatively paid income tax of INR 1,276.6 Cr in FY21. The combined profit of these unicorns stood at INR 5,529.7 Cr during the year. Some other characteristics of these Unicorns are that they are technology driven, have a high proportion of intangible assets and have evaluations based on their market potential and anticipated growth trajectory. Importance of analyzing financial data, examining internal business processes and learning and growth dimensions form an integral part of evaluation.

One critical issue relates to actual earning of taxable profits by these Unicorns. Since taxation is closely related to profits and net incomes, in the traditional taxation principles in most countries, valuation based taxation might need consideration. Another related issue relates to the sources of finance for investment in Unicorns which sometimes fall in the suspicious areas. A more robust mechanism needed by tax authorities to develop fair and transparent regulations.

The perception of a tough and ambiguous tax regime can also result in flipping by several unicorns abroad in order to circumvent regulations. Even countries like China and the USA have not been able to evolve a very convincing and stable guideline in this regard. Simplification and rationalization of compliances can certainly check flipping and provide stability and confidence to the Unicorns in future. Such issues like Angel tax are being directly addressed in India on a regular basis.

Sustainability of the models

The changing patterns of technology based businesses not quickly aiming at profit generation may be an area of concern for tax authorities. They have greater emphasis on valuation of the entity and future market potential. Unicorns may be few in number but are impacting the overall market environment and disrupting the traditional market models based on earning of profits. The taxes for the State may also get deferred or also lost. Is there a need to develop alternate basis for taxing these Unicorns based on their valuation on an annual basis? Tax regimes are sometimes not able to pierce the complicated structures and designs of such Unicorns which also have tentacles across the globe.

In a rapidly changing economic scenario with new market models and large multinationals are already challenging tax regimes across the world. The rationale of Unicorns which exist on the premise of “valuation” needs to be addressed with a fresh perspective. Tax regimes and State regulators have to keep evolving on a real- time basis to remain fair and also ensure that the newly designed market models remain compliant and contribute their share.

Impressive valuation with no profitability even after 20 years is not a traditionally sustainable model. Amazon has been amongst exceptions but most large Unicorns in the USA are persisting with their losses even after 10-15 years. Uber, Snap, Lyft, Airbnb still make losses though their shares and valuation has grown. In Europe, out of top 20 Unicorns, only 4 were found to be profitable in 2022.

In FY 21-22 in India, 31 out of 100 Unicorns were filing profits which is an improvement over 18 out of 100 in the earlier year. The advent of technology has led to such concentration of markets in a few hands. Further the subjectivity of valuation results in great fluctuations in their status and market impact.

What is the methodology for valuation of Unicorns? This is a grey area, which calls for greater transparency. There appears to be a significant element of ambiguity and subjectivity. There is a need for better regulation of valuation authorities and more objective rules with standardization at a global level.

Future perspective

The unique characteristics of Unicorns have thrown up issues which need attention with new perspectives both for business development, sustainability, regulation and also taxation. Recent trends in India show a decline in interests in funding the new Unicorns, reasons for which need to be analyzed. Some issues for consideration can be put in a nutshell as follows:

Fluctuations in shares results in uncertainty and issues of sustainability in the long run.

Arbitrariness in valuation, since the norms and authorities for valuation are not regulated or standardized.

Limited basis of taxation until profitable. Most such entities run into losses for a long time.

Flipping through International entities. This is happening due to lack of global uniformity in laws and coordination.

Disrupting traditional markets and tax bases and emergence of monopolistic trends.

Potential for money laundering. Due to lack of proper regulation, funds can be channeled from suspicious sources in the garb of venture capital.

No global rules for international tax and regulations.

Emergence of new global markets and technology driven rapid changes are throwing up regular challenges for tax regimes, regulators and nation States all over the world. These Unicorns also need clarity, certainty and guidance for the future. Specialized global forums on a real time basis can really help. Failure to rise to the occasion by the global community will only hamper interests of all stakeholders.

(Mohanish Verma is a senior IRS Officer, with specialization in law and technology.)

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