May 14,2020 | 9 min read

Legal Process Of Taking An Investment As A Startup

As Blood is to Human Body, Similar is Finance to its Business

Author - Advocate Ishanee Sharma, Associate Veena Chandra

Introduction

Investment is the soul of any start-up or organization that requires financing in return for a stake in the shares/equity of that organization. We don't state it's significant without a reason. A group of individuals with a splendid, workable thought may lose their chance to seize onto the market because of the absence of assets, to begin with, and run. Each start-up has a reason to fill or a plan to lead or change the world. 

These are few most important steps that are to be followed while taking an investment as a start-up:-

1) Do the Research and Prepare a Business Model

Except if you have supernatural powers, an Investor is probably unlikely to invest in your project and would want to know more about the ‘features’ of your business. Numerous individuals will say that composing a marketable strategy at the beginning of the business is fundamental, yet it might be that by and by you just began exchanging without going through months refining your technique. However, when it comes to getting investment, a business plan and other documents are essential ways to communicate your company as an investment opportunity investors shouldn’t miss out on, particularly as they will be inundated with requests for investment. 

2) Registration, Incorporation, AOA and MOA

Though it is not a compulsion, it is advisable to register and incorporate a company in order to be able to accept funding. The list of investors/board members along with the articles of association and the memorandum of association provide legal documentation in the event of any dispute or liability that may arise during the course of business. If a new investor is accepted, changes need to be made in the respective official company documents including the name and duties (if any) of the new investor and his equity share in the company as well as documents held by government offices.

3) NDA-Non Disclosure Agreement 

A Non-disclosure Agreement (NDA) is essential to protect the interests of the company or startup in this case. A company would generally pitch their idea/product to several investors to get the best deal, and in a case where a deal may not work out (which is in most cases), an NDA is the safest bet to protect a company from information disclosed. It is such a type of agreement were both the parties, Investor and startup, need to consent and sign a Non-Disclosure Agreement under which the rights and exclusivity of the meeting and pitch are kept up between both the parties, making sure about the odds of theft of Idea and misuse of it under any condition.

4) Source And Instrument Of Funding

Source of funding means implies from where to get your financing from. This could be an angel investor, institutional investors, venture capitalists (VC), credit sharks, bank loans, private loans, acquiring from friends and family, and so on. It is imperative to recognize at what stage the business is at and the source of funding the business requires. The instrument of funding is the manner by which funding will be received by the organization as far as deposits, assets, innovation, IP rights, and so on. The rules for paying taxes are extraordinary, contingent upon the source and instrument utilized for funding.

5) Company Valuation by CA

One must be ensured that the company’s valuation has been evaluated by a certified Chartered Accountant to ascertain the true equity value of the company for moving ahead to the next step of investing in the startup. Once the company’s valuation has been estimated, the price per share for the company will either be issued at par, discount or a premium.

The Income Tax Act 1961, Section 56(2)(viib) allows registered startups to avail of a tax exemption on the amount of investment received.

6) Due Diligence 

The company must ensure that it complies with all regulations and laws with respect to its business and operations. Due diligences can be a daunting reality for startups hoping to receive investments. They may come across as intrusive, but are essential to any investor.

7) Investment Terms & Negotiations in Termsheets

The term sheet sets out the terms on which your investor is going to give you funding, be that by taking equity in your organization, a convertible note, or another game plan. It will likewise set out any conditions you should meet so as to effectively pick up subsidizing. It will likewise incorporate choices about the weakening of offers and dynamic rights. The term sheet isn't really a legally binding agreement. The term sheet can be prepared by your side or the investor’s, but in either case, it is important to seek advice from a solicitor to ensure that you understand each term, but also so that your lawyer may negotiate the most favourable terms possible on your behalf. Here are the important Investment Terms & Negotiations in Termsheets:-

  • Liquidation Preferences
  • Warrants Coverage
  • Conversion Rights
  • Automatic Conversion
  • Anti-Dilution Rights
  • Redemption Rights
  • Voting Rights
  • Dividends
  • Board Participation
  • D&O Insurance
  • Pre-emptive/pro-rata rights
  • Information Rights
  • Expiration of Letter

8) Share Subscription Agreement 

Provides for the issuance of shares in the share capital of the startup to the investor in consideration of a subscription amount, which is determined as per the valuation of the startup. It also provides a broad outline of what the money will be used for.

9) Shareholders’ Agreement 

The primary purpose of a shareholders’ agreement is to identify the terms regarding the management of the startup, share transfer restrictions and exit rights of the investors. It also provides for the appointment of the investor’s directors on the board of the startup and provides the structure of the board. 

10) The Last Agreement 

A last agreement with the measure of investment in return for equity or shares should be drawn up between the business and the investing party. This agreement affirms that the investor is a shareholder in the organization and the transaction has been recorded in an official report. When the agreement is executed, the payment is made using an escrow account to the organization's official bank account and the organization can use the funds as proposed. The reason for this agreement is to sodilfy the terms and conditions between the parties and reach a consensus on the customized agreement. This understanding will be enforceable, official and considered as the last/final agreement. The new ownership of equity needs to be mentioned in the company’s articles.

11) Dissolution/Exit Strategy

There should always be a contingency plan in case of exigencies. No one intends for a business to shut down, but in the event that does happen, the liabilities and assets need to be distributed to creditors and shareholders/investors. A clause should mention what would happen in the event of a dissolution, merger, sale, etc. of the company. Each party should get their fair share and bear the burden of debt proportionally as mentioned in the agreement. Its is better to have this as a clause than to get entangled into a legal battle of time and resources, financial or otherwise.


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ABOUT THE AUTHOR


Ishanee Sharma

"Established a varied and prestigious client base in the corporate industry. Widespread exposure in the field of litigation comprising of the High courts,the company law tribunal, the Competition commission, Rera tribunals and the Supreme Court of India."

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