India's Unicorn Nomads: Examining Economic and Innovation Concerns

The global stage witnesses India's startup prowess with awe, but a recent report reveals that a staggering 56 percent of India's 108 Unicorn startups have chosen foreign shores as their headquarters.

According to Report of the Expert committee on 'Onshoring the Indian Innovation to GIFT International Financial Services Centres Authority (IFSCA), “While exact data on the number of India startups that have flipped or externalized to foreign jurisdictions is not readily available. Estimates suggest that 56% of 108 Indian Unicorn startups are domiciled in offshore jurisdictions. United States of America, Singapore and United Kingdom are some of the most popular examples of countries to which Indian entities have ‘flipped’.”

This movement raises concerns as it shifts ownership to foreign entities while retaining value in India, and relocates management, intellectual property, and capital abroad. 

However, these overseas-flipped startups remain rooted in India in terms of management, operations, and employees.

As India's entrepreneurial stars rise overseas, questions mount about the economic, technological, and diplomatic consequences of this emigration. In this article, lets read about what is the impact of Externalization on the Structure of the Company and On the Economy of the nation.

What Concerns Do Flipping Raise?

Indian startups are increasingly establishing Holding Companies (HoldCos) abroad, driven by enticing factors like tax advantages, regulatory flexibility, and foreign investment prospects.  

According to the 2023 Global Unicorn Index by Hurun, Indian founders lead in creating unicorns abroad, mainly in the USA (64) and the UK, along with a few in other countries.

“The externalization/flipping of startups impacts the Indian economy in several ways. One, a direct consequence of flipping is the brain drain of entrepreneurial talent from India. Young, skilled, and innovative founders relocate to overseas jurisdictions, which results in loss of human capital, stalling of innovation and technological advancements within the country. Two, flipping of startups results in value creation in foreign jurisdictions rather than in India. Home grown innovative ideas and disruptive technologies contribute to the startup ecosystem and economic growth of other countries. It also results in the loss of Intellectual Property and Tax Revenue for the country,” says the IFSCA Report.

Explaining Externalization: The Domicile Split of Indian Unicorns

The Indian startup ecosystem’s largest exit, the sale of Flipkart to Walmart, was the sale of an externalized firm. Flipkart had been a Singapore headquartered company for most of its existence.

What is Externalization or Flipping?

Externalization, also known as flipping or offshoring, entails the migration of an Indian startup's operational base to foreign jurisdictions. The process involves shifting a company's headquarters to a foreign location, merging financial metrics offshore, and transferring ownership and intellectual property to an overseas entity. Ultimately, this practice transforms an Indian startup into a wholly-owned subsidiary of a foreign corporation, while founders and investors maintain ownership through the foreign entity by exchanging shares.

Effect of flipping/externalization on the structure of the company?

“This trend of Indian startups flipping overseas is a cause of concern because it effectively transfers the ownership of an Indian startup to an overseas entity, whereas the value continues to be vested with the Indian entity. Moreover, such acts of externalization result in the movement of management, intellectual property, value creation, capital raising, etc. from India to the overseas jurisdiction,” says the Expert Committee Report. 

However, most of these flipped startups still continue to be Indian businesses as - Majority of the management comprises of Indian citizens; Majority of their business operations continues to be in India; and Majority of their employees are in India.

What Are the Consequences for Flipping of India’s Unicorns on its Economy?

According to the report, the phenomenon of externalization, wherein Indian talent and startups seek opportunities abroad, raises important questions about its impacts on the nation’s economy and its position in the global market. The report highlights key impacts of Externalization on Indian Startups.

I. Economic Loss and Brain Drain of Entrepreneurial Talent

The growing trend of Indian startups establishing Holding Companies (HoldCos) abroad has raised concerns about the economic repercussions. This phenomenon leads to the migration of founders and key managers to foreign jurisdictions, resulting in a significant brain drain. The departure of skilled and innovative minds deprives the Indian economy of their potential contributions, hindering innovation and technological advancements.

II. Detrimental in Value Creation

Externalization poses a risk of eroding value creation within Indian startups. As startups and talented entrepreneurs move overseas, they take with them their innovative ideas and technological expertise, weakening the growth potential of Indian startups. A study of India's unicorns reveals that 56% of these startups are domiciled outside India, potentially hindering the domestic startup ecosystem's growth.

III. Impairing India’s Soft Power — Reduced Influence in Cross-Border Financial Inclusion Initiatives

The externalization trend could impact India's digital diplomacy efforts. By relocating abroad, Indian startups may inadvertently contribute to other countries' tech ecosystems, diminishing India's global influence. This move could affect India's involvement in cross-border financial inclusion initiatives, hampering its ability to drive inclusive finance agendas globally.

IV. Loss of Intellectual Property and Technology Leakage

Indian startups are drawn to externalize due to the stronger Intellectual Property (IP) laws and enforcement in foreign jurisdictions like the USA and Singapore. These jurisdictions provide better protection for innovative products and technologies, leading startups to safeguard their IP abroad. Disparities in IP protection levels between India and these jurisdictions further drive this trend.

V. Tax Revenue Loss

Startups moving their holding companies to low-tax jurisdictions abroad may pay significantly lower taxes than if headquartered in India. This poses a risk to India's tax revenue, affecting investments in critical areas like infrastructure and social programs.

VI. Wealth Concentration and Inequality

Externalization may exacerbate wealth inequality by concentrating profits among a select group of shareholders, executives, and investors. This can leave the broader population with limited access to wealth creation opportunities, deepening economic disparities.

While externalization promises short-term gains for entrepreneurs, it raises substantial concerns for India's economy and future. Brain drain, loss of intellectual property, diminished value creation, and negative effects on local employment are among the pressing challenges stemming from this trend.

The landscape of Indian startups is undergoing a paradigm shift, as the allure of foreign pastures drives a growing number of Unicorns to establish overseas footholds. While this may paint a rosy picture in the short term, the long-term implications are sobering. The brain drain of visionary minds, erosion of homegrown innovation, and waning influence on the global stage present a challenging horizon.

As Indian startups chase the mirage of externalization, the committee constituted to onboard the offshore made several key recommendations to reverse the flipping of Indian startups. Read about the recommendations of the committee in the next article.