In today's rapidly globalizing economy, many Indian startups especially from the SaaS domain are considering the benefits of incorporating in the United States. This primer seeks to answer three critical questions for those considering this step: Why should you incorporate it in the US? How can you do so? And why is it important to incorporate early?
I. Why incorporate in the USA?
Market Size & Potential
The USA accounts for 40% of global software purchases in 2021. 1 By incorporating in the US, you gain access to a vast and high-spending market, creating more opportunities for your B2B startup.
Pricing Arbitrage
Our experience with SaaS companies reveals that as a rule of thumb, a dollar sale in India equates to ~$2.5 sale in Southeast Asia and Africa, ~$3 in the Middle East, and ~$7 in the USA. In fact, one of our portfolio companies saw a remarkable revenue increase by charging 15 times their original Indian pricing in the US market. This higher pricing results in greater revenue and profitability, as costs remain in Indian Rupees.
Customer Acquisition:
Challenges with customer acquisition can vary between India and the USA. Indian buyers may need long-term relationships before purchasing, while US customers may close software sales quickly if value and trust are conveyed effectively. Establishing trust with US clients is easier with a local presence. Consequently, setting up a company in the USA and integrating it into the US customer network can result in a faster sales cycle and higher pricing.
Funding and Valuation:
Establishing a company in the US can improve access to global funding, increase business valuation, and provide flexibility for potential future overseas listings. Tracxn data indicates that there are around 10,632 VC funds in the US, compared to a smaller pool of 1,654 Indian VC funds. 2 3.
II. How to Incorporate?
Once you have confirmed that a US incorporation aligns with your business goals, you can proceed with establishing your company in the United States. Here are the general steps that the founders should anticipate:
Step 1: Avoid Directly Registering a Delaware C Corp
The RBI has issued regulations which prevent creating a US entity directly from India, as it would trigger Round Tripping. Round tripping occurs when money flows out of India and then returns to the original Indian entity. 4
So, if you plan to operate in India and the USA, it's best not to set up a US entity directly, even though the USA allows foreign nationals to start businesses easily. Therefore, online services like FirstBase or Stripe Atlas might not be suitable, as they don't consider RBI round-tripping rules.
Step 2: The Workaround
To avert round-tripping, Indian lawyers and startups have historically employed three methods:
Gifting Shares: In this approach, someone would create a US entity and gift you the shares of the entity. This approach is now disallowed due to the RBI's recent statement in August.
ESOP Transfer: Uncommonly used, this method transfers US entity ownership to Indian founders via ESOPs. Tax inefficiencies and other commercial issues make ESOPs impractical, and this step is seldom employed.
Establishing Indian LLP: Founders create an LLP (“Founder’s LLP”) in India, dividing its ownership among them. This LLP then owns the US Holding company. Recently, many founders have chosen this route. Nevertheless, potential regulatory scrutiny and adverse tax implications for individual investors may arise. Additionally, indirect shareholding in a company could hinder enforcing contractual obligations on promoters. 5
Step 5: Setting up a New Indian Entity
Now that you have established a Founder’s LLP in India and then set up your Holding Company in the US, the next step is to create a New Subsidiary in India under the holding company.
However, if you already have a company (“old Indian Company”) registered in India, you cannot make it a subsidiary of the holding company as this would trigger round-tripping again.
Therefore, you need a new Indian subsidiary Company for the Holding company. 6
Step 4: Wind down any “Old Indian Company”
The Old Indian Company will have no use now and will have to be wound down. During this process, customer contracts will shift to the US Holding Company, while Indian employees and their contracts will fall under the new Indian subsidiary. 7
Why Incorporate Early?
More relationships more complications
As your company grows in India, you will add investors to your cap table, acquire more customers, and engage with various vendors. They will all be legally related to an Indian Entity.
Transferring all these relationships to a US entity becomes increasingly complex as more entities get involved. Furthermore, some stakeholders may be reluctant to shift their contractual relations to a US company.
Indian VCs and SEBI Restrictions
Indian VCs might be hesitant to move their investment, as they could face challenges holding shares in foreign entities. SEBI imposes a 25% capital limit for each India Registered VC fund, meaning that a fund cannot allocate over 25% of its corpus to entities registered outside India. 8
Furthermore, there is a cumulative limit at the national level on the capital that can be invested in foreign entities by all Indian VCs & AIFs combined. We have already reached that limit, and SEBI has not increased it. 9. This has meant all new foreign investments are put on hold until SEBI changes its mind.
In conclusion, it's crucial for SaaS founders targeting North America to transition to a US entity early and secure funding from US VCs. This strategy streamlines your focus, allowing you to concentrate on growing your business in the US.
Closing Remarks
If you're building in the Cloud Software or B2B SaaS space, then we should definitely catch up!!
You can reach out to me at dishan@fortytwo.vc.
Footnote
https://www.grandviewresearch.com/industry-analysis/enterprise-software-market
https://tracxn.com/d/investor-lists/Venture-Capital-Funds-in-United-States
https://tracxn.com/d/investor-lists/Venture-Capital-Funds-in-India
https://taxguru.in/rbi/tripping-provisions-odi-rules.html
https://www.mondaq.com/india/contracts-and-commercial-law/1289422/to-offshore-or-not-to-offshore-externalisation-dilemma-of-indian-startups
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https://www.mondaq.com/india/securities/1225956/sebi-modifies-guidelines-for-overseas-investments-by-alternative-investment-funds-and-venture-capital-funds
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Hi Dishan,
I'm the founder of a early-stage SaaS startup that's currently based in India. We're targeting the US market, and we're considering incorporating in the US. Your blog post has been very helpful in understanding the benefits of doing so.
We're particularly interested in the potential for higher pricing and increased revenue that you mentioned. We're also concerned about the challenges of customer acquisition in the US, and we think that having a local presence could help us to overcome those challenges.
We're still in the early stages of our planning, but we're definitely considering incorporating in the US. Thanks for your helpful insights!
Best regards,
Rishika, CometLabs.