Raising Capital or funds is the most important stage for any start-up. It is also the most daunting stage as it means sharing your vision and beliefs with an outside party and letting them assess the value of your business. Uninformed steps raising capital can make you an outsider in your own business and take away your power to decide what is best for your start-up and what is not. Hence, it is important to learn about the various options you have for raising your funds in India so you can make an informed decision. Currently, the major provisions that regulate fundraising in India are provisions of:
- Companies Act, 2013,
- Securities Exchange Board of India Act 1992,
- Securities Contracts (Regulation) Act, 1956,
- Depositories Act, 1996.
The following article will explore the various ways start-up and businesses can choose to raise funds in India. Primarily there are two categories of financing options available to a company- Equity and Debt.
I. Venture Capital/ Private Equity
Venture Capital or Private Equity is usually how most businesses get their first huge influx of capital into their company. Common instruments used in the process are compulsory convertible preference shares and compulsorily convertible debentures. An investor will prefer to enter a binding offer based on a prima facie valuation of your company. After they have conducted thorough due diligence they will be in a better position to negotiate the terms of investment.
Essential documents for Venture Capital or Private Equity are:
- Term Sheet or Memorandum of Understanding: A Term Sheet outlines the intention of the parties to enter into a legally binding contract. It lays down the mutually agreed investment scheme and other legal terms.
- Share Subscription Agreement: The Share Subscription Agreement contains all necessary details about the number and value of shares issued to the investor. The Agreement also details the conditions precedent (conditions that have to be met before the agreement can be effectuated), time frame and details of condition subsequent, set of representation and warranties, etc.
- Shareholders’ Agreement: The Shareholders’ Agreement is the document that signs rights and duties to all the parties.In India, SEBI Act, 1992 and the SEBI (Venture Capital Fund) Regulations, 1996 governs Venture Capital Funding. Any company that wishes to carry out venture capital activities has to first obtain a grant of a certificate from SEBI.
- Securities Contract (Regulation) Act, 1956,
- SEBI (Substantial Acquisition of Shares & Takeover) Regulations, 1997,
- SEBI (Disclosure of Investor Protection) Guidelines, 2000.
Further, the private equity options are governed by the:
- SEBI (Alternative Investment Funds) Regulations, 2012 and are referred to as Alternate Investment Funds.
II. Angel Investors
Industry professionals or business influencers often like to invest in start- ups they see have the potential to be profitable in future. They will make decisions based on the business plan you show them. These investors are usually in a group and are well versed with their research on small businesses. SEBI categorises Angel Investors under the Regulation 19A of SEBI (Alternative Investment Funds) Regulations, 2012 with an amendment in 2013.
I. Bank Loans and Government Schemes
Another popular method of raising capital for your business is through Bank Loans. The Bank will provide you a loan after inspecting your business venture, your balance sheets, account statements, etc. The Banks are not interested in ownership of your company, thus you will remain in charge throughout and will be able to take all major decisions regarding the workings of your business. The loan will be offered to you at a fixed rate. The Bank would require the following documents to process your request-
- Identity Proof
- Address Proof
- Ownership proof
- Business Continuity proof
- Firm constitution
- Financial Statement
- Bank Account Statement
II. Crowdfunding options
Crowd funding refers to the form of financing where the seed funding is obtained through small amounts collected from a large number of people. Such schemes usually operate on internet platforms. Recently, companies specialising in Crowd Funding are coming up, such as Fuel A Dream. In India, Equity crowdfunding is illegal as equity shares have to comply with provisions of the Companies Act 2013. SEBI allows Donation-Based Crowdfunding (issuers receive donation from the grantors) and Reward-Based Crowdfunding (issuers offer rewards like movie tickets, new computer game, download of a book, etc.) Further, SEBI allows only Accredited Investors to invest in crowdfunding projects. SEBI and RBI also released a Consultation Paper on Crowd Funding and Consultation Paper on Peer to Peer Lending respectively.
Legal Agreements in the Fund Raising Process-
There are certain agreements that are important in the fundraising process, hence it is important to understand what is the purpose of each agreement.
- Non-Disclosure Agreement (or NDA): An NDA is important as it helps you protect your business idea. In the process of presenting your business for funding, you are bound to share your unique business proposition as well. There is a possibility that the idea might be stolen. Hence in order to prevent that, entering into NDA is advisable as it makes the other party (investor) liable to not leak the idea and in case of breach of duty, you sue the other party.
- Valuation by a Chartered Accountant: A valuation of your shares or equity value has to be completed by a certified Chartered Accountant. This will help you to then finally issue shares at par, premium or discount to your investors.
- Term Sheet: This is a very important document that contains the details of your agreement, the conditions you have accepted, the mode of transaction, the valuation of your company, voting rights of the investors coming on board, their exit strategy, option for additional funding etc. It is a non binding, time bound document.
- Share Subscription Agreement: The Share Subscription Agreement contains all necessary details about the number and value of shares issued to the investor. The Agreement also details the conditions precedent (conditions that have to be met before the agreement can be effectuated) , time frame and details of condition subsequent, set of representation and warranties etc.
- Loan Agreement: A Loan Agreement is drafted when an investor has decided to lend you money and not buy ownership of your company. You are liable to repay them as per the structure decided in this loan agreement, including the interest rate, time or payment, mode of payment, etc. Another option is repayment through convertible instruments. This allows the investors to later opt-in for shares instead of demanding the loaned amount back.
Major Provisions of Important Agreements:
All the above-mentioned agreements have a few key provisions and clauses. It is important to identify and understand these clauses to know what rights or liabilities you will have by signing the contract.
- Pre-emption Right: This provision offers the investors to subscribe to the new shares that a company issues. This helps an investor maintain their percentage of shareholding.
- Anti-dilution right: This right helps protect investors from the influx of new investors who might have invested in the new round of funding wherein the shares were valued lower. Hence, in case of a new issue, the existing investors will be given a chance to subscribe to the new issue so that they can maintain their shareholding percentage.
- Non- Compete Clause: Investors prefer that the founder of the company signs a non-compete clause that will prevent them from exiting the company too soon and joining a competing industry. A founder is considered to have superior knowledge about the start-up and the initial investors put their money on the founder’s idea, hence if the founder is allowed to switch companies, their investment is at a risk.
- Non- Solicit Clause: In event that the founder does leave, this clause stops them from soliciting employees, suppliers or customers of the start-up.
- Right of First Refusal: This right ensures that every time anyone sells their shares in the start-up the existing shareholders will have the first right to buy it, in case they refuse, then the same can be sold to an outsider.
- Representations and Warranties: These are statements that are presented to the investor and on which the investor can rely upon. These protect the investors from any risk in future as the founder commits to the truth of the representations and warranties statements.
- Exit Clauses: Exit clauses are a group of clauses that map the exit route of an investor who no longer wishes to continue the case. Examples of exit clauses are-
- Breach of Terms: These are a set of terms that are usually found in the Shareholder’s Agreement. In case any of the terms are not adhered to, it allows an investor to invoke their exit rights.
- Material Adverse Effect: This clause specifies that in case any of the statements submitted before being altered or later found to be false, the investor will be allowed to exit the company.
8. Indemnities: This clause is the company’s way of assuring the investor that they abide by the representations and warranties they have submitted and in case of any breach of warranty, they will indemnify the investor.
9. Dispute Resolution: It is prudent to always have a dispute resolution clause as disputes are a foreseeable contingency. Deciding terms of how you want to proceed in case of dispute reduces the certainties around the event. You can suggest an amicable settlement, arbitration clause or mediation clause as your choice of dispute resolution.
10. Governing law: This clause informs all the parties as to which jurisdiction would the contract abide by.
Developing business ideas and propelling a start-up is hard enough already. On top of that finding, the right investor can be a gruesome process. Additionally, the legal aspect of financing is also a complicated process. Hence, learning about various ways one can seek investment and what to expect under each of the options will help you take the next step more confidently.