Most Indian startups run for years before making their first profit, and it’s not necessarily because their business models are unsound.
Zerodha CEO Nithin Kamath says that Indian startups continue making losses for many years mainly for tax reasons. He says that it’s more worthwhile for founders to have the valuations of their businesses rise instead of taking money out of their business from any profits they might make. This is because of differential tax rates for capital gains and dividends for founders in India.
“If you take money out of a business as dividends, the effective tax rate is 52% (25% corporate tax + 35.5% on personal income). Through capital gains, it’s just 14.95% (with cess). Why does this matter?” Kamath posted on X.
“Here’s what you should know if you invest in IPOs. If you’re an investor (especially a VC), the math is simple: reduce corporate tax by showing minimal profits or losses. Spend (Burn) on acquiring users, build a growth narrative, and then sell shares at a higher valuation while paying much lower tax. This spending also makes it harder for competitors to survive. To be clear, we’re not discussing R&D spending here, which, incidentally, is very low in India (0.7% of GDP). What’s often overlooked is that VCs are essentially playing a tax arbitrage game. Look at most VC-backed businesses listed in the last few years, the reason they show little or no profit is partly due to this. Once you run a business this way, it’s extremely difficult to switch. Every startup that’s 7-8 years old from the time of raising the first round faces constant pressure from VCs for an exit. With almost no M&A opportunities in India, IPO is often the only way out. The government probably designed this tax arbitrage to incentivize companies to spend money and not just accumulate and distribute,” he exlained.
Kamath though said that he wasn’t sure if it was the right thing to do. “But I’m unsure if the balance is correct. I think it’s also creating businesses that aren’t very resilient. One prolonged market downturn, and many of these unprofitable companies would struggle to survive. Two things that make this more interesting: Unprofitable growth gets valued at much higher multiples than steady profits. A company doing ₹100 cr revenue with 100% growth might get 10-15x, while a profitable one with 20% growth gets 3-5x. So VCs aren’t just saving on tax; they’re in essence creating a 3x higher exit valuation. If you’re competing against someone burning cash, you almost have to match it to defend market share, even if you don’t want to, because of the quirks I mentioned above,” he added.
Kamath does have a point. A startup founder can end up being worth a lot more if the valuation of their business rises. Early-stage businesses are valued based on their revenues, so startups look to maximize revenues instead of making a profit. On the other hand, if they made profits, not only will revenues decrease — their sales will fall if they raise prices — but they’ll also have to pay a much higher tax rate on the money they get from their businesses. Kamath himself has chosen the other approach — Zerodha has never raised external investment, and the co-founders give themselves Rs. 100 crore salaries. It might not necessarily make financial sense, but Zerodha seems to have taken a relatively unique path as it has built its business over the last decade.