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Fund raise compliance

Presented by CA Sambhav Mehrotra

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Topics for Today:��- Compliances and procedure for fund raising for StartUps – our role ��- Critical requirements and professional support required ��- Benefits of single point POC and how to leverage �

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DISCLAIMER

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Why fund raise and importance of Compliance�

• Funding is key for any startup to expand its horizon of products and resources.

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• Pitching for investments and getting a deal is one aspect, but the legal & compliance side is something that founders find complicated. Our role is to make the language simple

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• It is pervasive for companies/cofounders raising capital to be aware and ensure compliance for a smooth business. Spreading this awareness is our “Dharma”

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India enters 37 years of demographic dividend

• China entered this stage in 1994 — 16 years after Deng Xiaoping’s economic reforms started in December 1978. Although its growth accelerated immediately after the reforms, the years of demographic dividend helped sustain this rate for a very long period. In the 16 years between 1978 and 1994 (post-reform, pre-dividend) China saw eight years of double-digit growth. In the 18 years since 1994 there have been only two years when China could not cross the 8% growth mark.�

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Why is it now or never:

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Start-ups and MSME will be a major catalyst for this demographic dividend efficiency and effectiveness

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Various Stages of Funding

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The Stages

1. Problem/Solution Fit
2. Minimum Viable Product (MVP)
3. Product/Market Fit
4. Scale
5. Maturity

Seed Funding, Friends and family, Angel rounds

Series A, Series B ….

IPO, Merger e.t.c

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Funding Deal

Sequence

PRE DEAL

DURING DEAL

POST DEAL

• How much to raise, which investors to approach; Lead Vs. Co-lead Investor

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• Finding the right investor: Portfolio of the investor

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• Type of Instrument

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• Term sheet and valuation

• Due Diligence – Legal, Tax, Financial, Commercial

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• Finalization of Transaction Documents (SHA, SSA), Conditions Precedent and Pre money Compliances

• Conditions Subsequent

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• MCA filings and Post money compliances

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Professional required/Activities Involved

Law Firm

Company Secretary

Registered valuer under IBBI/Merchant Banker/CA

RBI compliance – CA/CS

Due Diligence experts

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Legal Activities��Term sheet : Prelude to shareholding agreement��Shareholder's agreement: A shareholder’s agreement is a contract between the company and its shareholders. It outlines the rights, obligations of the shareholders and provisions related to the management and the authorities of the company. The purpose of the agreement is to protect the interests of the shareholders��Cofounders Agreement: A Founders’ Agreement is an official contract that is signed between all the co-founders of a firm. This document states all the responsibilities, ownership, and initial investments made by each of the founders of the company. It is advised to make a founders’ agreement at the incorporation stage of an enterprise as it will lay out the responsibilities and roles of each of the co-founders including reverse vesting terms if any.�

This Photo by Unknown Author is licensed under CC BY-SA

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Key Clauses:

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• Parties
• Cap table pre and post
• Type of instrument
• Founders vesting
• ROFR – Right of first refusal
• ROFO- Right of first offer
• Tag Along
• Drag along
• ESOP Pool
• Board rights
• Information rights
• Reserved Matters

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This Photo by Unknown Author is licensed under CC BY-SA

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Startup India Registration��Startup India Recognition�Under the StartUp India Action Plan, start-ups that meet the definition as prescribed under the relevant notification are eligible to apply for recognition under the program.� �Startup India: Tax Exemption under Section 56 of the Income Tax Act (Angel Tax) – Prior to angel tax abolishment �Post getting recognition a Startup may apply for Angel Tax Exemption.� Eligibility Criteria for Tax Exemption under Section 56 of the Income Tax Act:��- The entity should be a DPIIT recognized Startup�- Aggregate amount of paid up share capital and share premium of the Startup after the proposed issue of share, if any, does not exceed INR 25 Crore.�

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This Photo by Unknown Author is licensed under CC BY-NC-ND

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Valuation Requirement�

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Our view “was”��A company shall not require a valuation report from a merchant banker if the company meets all the below parameters:

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The company is a startup recognized by DPIT under Startup India.

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Has applied for Angel Tax Exemption under section 56 of income tax act and has file duly signed declaration to DIPP that it fulfills the conditions.

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ANGEL TAX ABOLISHED

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BUT…

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Valuation steps:

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Following are the steps in the valuation exercise:

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• Formalizing the projections for the company (To be provided by the management)
• Study the industry in which the organization operates.
• Analysis of the projections/ business plan; and discussions with management to gather clarity around the same.
• Selection of appropriate approach(es) and methods to be used for valuation based on above information. (DCF under Income approach is the most suitable method of valuation for startups)
• Identify the risk-free rate as on the valuation date.
• Identifying multiples, and computing value
• Value conclusion
• Submission of Draft Valuation Report and discussion thereupon
• Issuance of Final Report

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(Though practically it works in reverse direction ☺ )

Valuation Guru Mantra

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Team.Traction.Market Size

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Secretarial Compliances for fund raise:�

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Change in Authorized Capital

• Drafting and alteration in MOA of the Company, if required;

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• Drafting of board and shareholder resolution to get approval on such alteration

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• Drafting and issuance of notice of general meeting

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• Filing forms to ROC for change in authorized capital

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Obtain Approval of existing shareholders to Issue fresh Shares to Investors

• Drafting of Board and shareholder resolution to take approval to issue fresh Shares to investors

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• Drafting of Notice of general Meeting

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• Drafting of private placement offer letter to investors in Form PAS-4

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• Drafting of Form PAS-5 to record the name of investor and its identification

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• Filing form MGT-14 to ROC for preliminary approval of shareholders within its prescribed period (within 30 days of the GM).

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• Issuance of private placement offer letter to investors in Form PAS-4 along with part B

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Allotment of Shares

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- Drafting of Board resolution for allotment of share

- Filing necessary form PAS 3 to ROC within prescribed timeframe

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Share Certificate Issue

- Preparing and Issuance of Share Certificate within 60 days of Allotment of Shares to the investors/ 6 months in case of CCD’s

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Share Stamping

Share stamping is mandatory and the process varies from state to state.

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RBI Compliance

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- Filing of FCGPR form/other applicable forms to RBI within stipulated timelines (30 days from date of allotment)

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- Refund of excess money if any to investors within 15 days

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Ensure generation of UIN/FCGPR reference number from RBI through the AD Bank

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Statement of Financial Transactions (SFT) – Form 61A

• Applicability:

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• Due Date: 31^st May of the immediately following financial year
• Late Fee: The late fee for filing this is ₹ 500/1000 per day. Also, inaccurate filing may attract a penalty of ₹50,000 here
• As per rule 114E of the IT rules 1962, a Reporting Entity is required to file a Statement of Financial Transaction (SFT) in form 61A.

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RBI FLA Compliance

• What is FLA?� The Foreign Liabilities and Assets (FLA) return is an annual submission to the RBI by Indian entities with foreign investments, capturing their foreign liabilities and assets.
• Who Must File?� All Indian companies and LLPs that have received FDI or made overseas investments must file by July 15th each year(provisional/audited). In case of provisional filing, audited ones need to be filed by 30^th September
• Why It Matters:

Compliance: Required under FEMA regulations.

Data Collection: Helps RBI monitor foreign investments.

Penalties: Non-compliance can lead to fines and restrictions on future investments.

• Filing Process:

Data Collection: Gather details on foreign investments and assets.

Submission: File the return online via the RBI’s FLAIR portal.

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ESOP Life Cycle

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Due Diligence

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• Legal Due Diligence

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• Financial Due Diligence

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• Secretarial Due Diligence

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Consequences of

01 Legal Penalties & Fines

The Company and Directors will be subjected to penalty / fine under all the applicable provisions of Companies Act, 2013 which will result in huge expenses for the Company.

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Section 42:

a) non filing of eform PAS 3 within 15 days of allotment the company, its promoters and directors shall be liable to a penalty of Rs.1000/- per day during which such default continues but not exceeding Rs. 25,000/-

b) An offer or acceptance of monies in contravention of this section, the company, its promoters and directors shall be liable for a penalty which may extend to the amount raised or Rs. 2 crores, whichever is lower, and the company shall also refund all monies with interest @ 12% pa from the 60th day of receipt of such subscription money.

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02 Investor Disputes & Loss of Trust

Non-compliance can lead to disputes with investors, damaging the company's relationship with them. Investors may lose trust in the company's management and governance, leading to strained relationships, potential legal actions, or even withdrawal of investment.

03 Reg Flags in the due diligence of next funding Round

Non-compliance can damage the company's reputation, both within the investment community and among customers, partners, and stakeholders. Negative publicity, loss of credibility, and a tarnished reputation can have long-term consequences for the company's growth, market position, and business relationships.

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It raises red flags in the subsequent funding round and thereby the incoming investors loose interest.

Non-compliance of Statutory Funding Provisions

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Common pitfalls:

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• Call for money prior to private placement/pre money compliance

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• Not opening new bank account for call for money during private placement

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• Utilizing investment prior to filing form for allotment

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• Non compliance of agreement terms e.g amendment of AOA, D&O insurance e.t.c

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• Share stamping not done (upto 10 times penalty)

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• Non compliance of SFT filing

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• Non compliance of RBI/FEMA provisions

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• Outdated valuation reports

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• Absence of ESOP pool / ESOP policy

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• Dispute due to no cofounders agreement

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• In the matter of Anbronica Technologies Pvt Lt Vs. Registrar of Companies, NCT of Delhi & Haryana, the Company was levied penalty of Rs. 400,000/- and each of the promoter director were levied a penalty of Rs. 200,000/- each for non compliance of sec 42 r/w sec 446B, wherein the issue of CCD was carried out through Tyke Platform and the issue was oversubscribed exceeding 200 members.

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• In the matter of Konwert India Motors Pvt Ltd Vs. Registrar of Companies, Coimbatore, the Company was levied penalty of Rs. 200,000/- and each of the 2 directors were levied a penalty of Rs. 100,000/- each for non compliance of sec 42 r/w sec 446B, for circulation of offer letter before filing of eform MGT 14 for reporting the special resolution passed at the extra ordinary general meeting director were levied Rs. 100,000/- each for non compliance of sec 42 r/w sec 446B, for circulation of offer letter before filing of eform MGT 14 for reporting the special resolution passed at the extra ordinary general meeting

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In the matter of Payswiff Technologies Private Limited Vs. Registrar of Companies, Hyderabad, the Company was levied penalty of Rs. 80,00,000/- and each of the 5 directors were levied a penalty Rs. 20,00,000/- each for non compliance of sec 42 r/w sec 446B, for failure to deposit the subscription money in seperate bank account and for utilization of funds before filing of efom PAS 3

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Thank You

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