Should I invest in US startups using Republic
Should you invest in US startups using Republic as an Indian? Are Indian nationals allowed to invest through Republic?
We cover the legal as well as risk aspects of investing through Republic as an Indian resident.
We have covered how reporting for foreign stocks works in 2 of our earlier articles. Linking them here and here. This article specifically looks at what Republic is doing and whether that works for Indian investors.
Republic and SAFE agreement
First up, here's what you need to know about Republic. Republic as a platform allows you to enter into a 'SAFE' contract. A Simple Agreement for Future Equity. Focus on the word future - we'll delve into this in more detail below.
A Crowd SAFE is an investment contract between investors and companies looking to raise capital. Individuals make investments for the chance to earn a return—in the form of equity in the company or a cash payout—if the company is acquired, goes public, or sells all of its assets.
Investors using the Crowd SAFE get a financial stake in the company, but are not immediately holders of equity. Investments are converted to equity if certain “trigger events” occur, such as the company’s acquisition or IPO.
Here's the thing - you are not actually purchasing shares of the company. You are purchasing a right to purchase shares or benefit from future trigger events. You are entering into a Futures contract outside India.
Foreign Exchange Management Act (FEMA) implications
FEMA specifically disallows resident Indians to trade in any foreign derivatives (other than for hedging purposes).
A futures contract outside India would almost certainly fall within a foreign derivatives contract.
'Foreign exchange derivative contract' means a financial transaction or an arrangement in whatever form and by whatever name called, whose value is derived from price movement in one or more underlying assets
So you may be violating FEMA provisions if you invest in startups through Republic. If you are investing through Republic, might be time to reconsider.
Let's say you are a Non Resident Indian who managed to invest through Republic before you became a Resident and the pesky FEMA regulations started applying to you. You still need to be mindful of certain risks associated with Republic.
These risk factors have been picked up from Republic's website:
Speculative Investments in startups, early-stage ventures and emerging technology companies are speculative and these enterprises often fail. Unlike an investment in a mature business, where there is a track record of revenue and income, the success of a startup, early-stage venture or emerging technology company often relies on the development of a new product or service that may or may not find a market. You should be prepared to lose your entire investment.
Illiquidity Your ability to resell your investment in the first year will be restricted with narrow exceptions. You may need to hold your investment for an indefinite period of time. Unlike investing in companies listed on a stock exchange, where you can quickly and easily trade securities, you may have to locate an interested private buyer to resell your crowdfunded investment.
No voting rights Investment instruments hosted on Republic are typically held via the Crowd SAFE, which does not provide voting rights to investors. Investors may receive voting rights if that instrument converts to stock, but crowdfunding investors’ voting rights will mostly likely be diluted when as the company raises additional funds. In addition, crypto-assets typically do not have voting rights and owning a token will not give you influence over the token maker or seller.
Cancellation restrictions Once you make an investment, you can cancel the investment at any time and for any reason up to 48 hours before the campaign deadline. Some campaigns may have multiple deadlines around rolling closes. Investors should pay attention to notices companies provide regarding rolling closes.
Valuation and capitalization No exchange or other secondary market is expected for securities sold under Regulation CF. Companies fundraising via Regulation CF are often early-stage startups and are unlikely to have substantial operating or financial histories. There is limited–if any–information for valuing securities offered through Republic and there is a substantial risk that the price of securities purchased on Republic may exceed their value and any amount for which they may eventually be resold. Furthermore, securities sold on Republic may provide investors with inferior terms than similar securities provided by a company in other offerings.
Limited disclosure The company must disclose information about itself, its business plan, the offering, and its anticipated use of proceeds, among other things. It’s important to note that an early-stage company may be able to provide only limited information about its business plan and operations because it is still developing its operations. The company is also only obligated to file information regarding its business annually, including financial statements. Under certain circumstances the company may cease to publish annual reports and investors may have no information rights.
Investment in personnel An investment in a startup, early-stage venture or emerging technology company is also an investment in the founding entrepreneur(s) and/or the company’s management. Being able to execute on the business plan is an important factor in determining whether the business will be viable and successful. A portion of each investment may be used to fund salaries. Investors should carefully review any disclosure regarding the company’s use of funds.
Possibility of fraud There is a risk that a company raising on Republic engages in fraud. Republic vets the companies they host, but there is no way to control the actions of a company once a campaign ends and Republic cannot verify everything.
Lack of professional guidance Many successful companies partially attribute their early success to the guidance of professional early-stage investors (e.g. angel investors and venture capital firms). These investors often negotiate for seats on the company’s board of directors and play an important role in providing additional resources, contacts and experience in assisting early-stage companies in executing on their business plans. An early-stage company primarily financed through crowdfunding may not have the benefit of such professional investors.
So before you invest in startups through Republic, just think twice:
Am I violating any Indian legal provisions?
Is it worth the risk?
For the record, we think Republic is an excellent platform for investors outside India who have a large risk appetite. Retail deserves better access to startups. However, we are just not in a position to achieve this in India.