How to Set Up Your Demat Account for Investing in Startups

The startup ecosystem in India is flourishing, driven by innovation, entrepreneurial spirit, and supportive government policies like Startup India. For high-net-worth individuals (HNIs), investing in startups presents an opportunity to be part of the next wave of business success while potentially achieving significant returns. A demat (dematerialized) account, traditionally used for holding shares and securities in electronic format, now offers an efficient way for HNIs to channel their investments into emerging startups.

In this blog, we will explore how HNIs can leverage their demat accounts to invest in promising startups, examine the benefits and risks, and provide insights into the process in the Indian context.

The Growth of Startups in India

India is home to the third-largest startup ecosystem in the world, with over 90,000 registered startups as of 2023. The sectors driving this growth include fintech, e-commerce, healthcare, education, and clean energy. A significant number of these startups are looking for funding from investors like HNIs, who have both the financial capacity and the willingness to take calculated risks.

HNIs have increasingly become a vital part of India’s venture capital scene, contributing to early-stage funding and scaling opportunities for startups. According to the Indian Angel Network, HNIs in India invested approximately ₹1,200 crore in startups in 2023, with a 15% growth in annual startup investments over the last five years.

Why Startups Appeal to HNIs

1. High Growth Potential: Startups, especially in sectors like technology and renewable energy, offer high growth potential. By getting in early, HNIs can acquire equity in businesses that have the potential to scale rapidly.
2. Diversification: For HNIs with diverse portfolios, startup investments offer an additional asset class that provides diversification beyond traditional investments in stocks, bonds, or real estate.
3. Tax Incentives: The Indian government offers several tax incentives for startup investments. Under Section 54GB of the Income Tax Act, capital gains from the sale of residential property are exempt if the proceeds are invested in startups.
4. Support for Innovation: Many HNIs are driven by a passion for innovation and enjoy backing entrepreneurial ventures that contribute to economic development. Investing in startups allows them to support the next generation of business leaders.

How to Use a Demat Account for Startup Investments

While startups are generally not listed on the stock market, there are ways for HNI demat account for startup investments. Here’s how:

1. Angel Investing via Demat: HNIs often invest in startups through angel networks or syndicates. Upon making an investment, the shares issued by the startup can be held in a demat account. The startup’s shares, once dematerialized, are electronically credited to the investor’s demat account, ensuring easy management and transferability.
2. Startup Listings on Stock Exchanges: SEBI (Securities and Exchange Board of India) has set up the Innovators Growth Platform (IGP) to facilitate the listing of startups on stock exchanges. This platform allows startups to raise funds through the capital market, and HNIs can invest in these businesses through their demat accounts. These companies may have lower market capitalization compared to traditional large-cap stocks but offer higher growth potential.
3. Private Equity and Venture Capital Funds: HNIs can also participate in private equity (PE) or venture capital (VC) funds that invest in startups. These funds often raise money from HNIs and institutional investors, and units of these funds are held in demat accounts. Through such funds, HNIs gain exposure to multiple startups across various sectors.
4. Convertible Instruments: Startups often raise capital by issuing convertible instruments, such as convertible debentures or preference shares. These instruments can later be converted into equity shares, which can be held in a demat account. Convertible instruments offer HNIs flexibility in structuring their investments, reducing risk while retaining the upside potential.

Benefits of Using Demat Accounts for Startup Investments

1. Simplicity: Holding startup shares or convertible securities in demat form simplifies record-keeping. Investors can track all their investments through a single platform and transfer or sell their holdings more easily.
2. Safety: A demat account ensures that shares are held securely, eliminating the risk of losing physical certificates or dealing with fraudulent transfers.
3. Liquidity: Once a startup lists on an exchange, or if there is a secondary market transaction (such as a buyback or acquisition), shares can be easily sold through the demat account. Even if a startup is not listed, selling or transferring shares is quicker and more efficient through the demat format.
4. Transparency: SEBI regulations ensure that transactions through demat accounts are transparent and secure. Investors are provided with periodic statements that reflect their holdings.

Risks to Consider

While startup investments offer lucrative opportunities, they come with substantial risks:

1. High Failure Rate: Not all startups succeed. In fact, according to a KPMG report, nearly 90% of startups fail within the first five years. HNIs need to be prepared for the possibility of losing their investments.
2. Illiquidity: Startup investments are often long-term and illiquid. Unlike stocks in listed companies, startup shares may not have a readily available secondary market, meaning investors may need to hold their positions for several years.
3. Valuation Challenges: Startup valuations can be volatile and speculative. HNIs should carefully evaluate a startup’s business model, team, and market before investing.

Success Stories

Several Indian startups have grown to become unicorns (valued over $1 billion), providing handsome returns to early investors:

• Zomato: When Zomato went public in 2021, early investors, including HNIs, saw their investments multiply significantly.
• BYJU’S: Early HNI investors in BYJU’S witnessed enormous growth as the edtech platform expanded globally and raised billions of dollars in funding.
• Nykaa: HNIs who invested in Nykaa’s early funding rounds saw tremendous returns when the company launched its IPO in 2021.

Conclusion

HNIs in India have a unique opportunity to be at the forefront of the startup revolution. By leveraging their demat accounts, they can not only simplify the process of investing in startups but also contribute to the growth of innovative companies that are shaping the future of the Indian economy. While the risks are significant, the rewards for investing in the right startups at the right time can be immense. With the right research, due diligence, and a focus on long-term growth, HNIs can unlock significant value by supporting emerging businesses through their demat accounts.