The startup evolution is increasing at breakneck speed and India is becoming the global start-up hub. The Ministry of Corporate Affair (MCA) and the Government has brought ease of doing business and many schemes but investing in a startup company in India requires certain compliance with several regulations and laws, including the Companies Act, 2013, the Securities and Exchange Board of India (SEBI) regulations, and the Foreign Direct Investment (FDI) policy.
Every startup requires capital funding and investments in order to run and scale up its business operations. The start-ups require to abide by the regulations per the law when they receive any investment to scale and promote business in the market. Start-ups need to keep the target audience ready, the financials, projected growth etc. to attract angel investors and funding.
Pre-investment or pre-funding refers to the process of raising funds for a startup before the launch of its product or service. It is a way for startups to gather the necessary resources to bring their idea to market and validate their business concept. The funds raised during this stage can be used to cover expenses such as market research, product development, hiring a team, and building a minimum viable product (MVP).
Pre-funding can be done through a variety of methods, including grants, angel investment, seed funding, and crowdfunding. The goal of pre-funding is to attract enough investment to bring a product or service to market and build a user base. In some cases, pre-funding can be critical to the survival of a startup, especially if it requires significant upfront investment to bring its product to market.
It is important to note that pre-funding is a high-risk stage of startup financing, as there is often little to no revenue or proof of concept. Investors who participate in pre-funding are typically looking for high returns on investment, which can only be achieved if the startup is successful.
A comprehensive business plan that outlines the start-up's products or services, target market, marketing and sales strategy, management team, financial projections, and other key aspects of the business.
1. Valuation report
A valuation report is a document that provides an estimate of the worth of a company, asset, or investment. This report is used to determine the market value of a business or asset, and it is a critical tool for many financial decisions, such as mergers and acquisitions, fundraising, and financial reporting.
The start-up needs to have Valuation Report by a Registered Valuer who is registered with Insolvency and Bankruptcy Board (IBBI), where the valuation is done through different methods of valuation, such as Discounted Cash Flow Method (DCF), Net Asset Value method (NAV) or Market Value method (MV).
2. Term sheet
A term sheet is a document that outlines the key terms and conditions of a proposed investment or financing agreement. It is a non-binding document that serves as a starting point for negotiations between an investor and a company seeking funding. A term sheet typically includes the following elements:
Investment amount: The amount of money the investor is proposing to invest in the company.
Valuation: The pre-money valuation of the company, which is the value of the company before the investment is made.
Ownership percentage: The percentage of ownership in the company that the investor will receive in exchange for the investment.
Preferred Stock: The terms and conditions of the preferred stock being offered to the investor, such as the liquidation preference, conversion rights, and voting rights.
Board of Directors: The composition and responsibilities of the company's board of directors, including the number of seats allocated to the investor.
Management Rights: The rights and responsibilities of the company's management, including the right to make decisions and control the operations of the company.
Protective Provisions: Provisions that protect the investor's rights, such as anti-dilution provisions, rights of first refusal, and co-sale agreements.
Exit strategy: The terms and conditions of the investor's exit from the company, including the right to sell their shares and the process for doing so.
Milestones: Key milestones the company is expected to achieve during the investment period, such as revenue targets and product launches.
Closing conditions: The conditions that must be met before the investment is completed, such as regulatory approvals and completion of due diligence.
The term sheet is a critical document in the investment process, as it sets the stage for the final investment agreement. It is important for both the investor and the company to carefully review and negotiate the terms outlined in the term sheet to ensure that their interests are protected and aligned.
Post-investment/ funding in a startup refers to the period after an investment has been made in a company. During this stage, the company is expected to use the funds to scale its operations, build its product, and grow its business.
Some of the key activities that occur during the post-investment stage in a startup are Operations, Financial management, Board representation, Fundraising, Exit strategy. The post-investment stage is a critical time for a startup, as it is when the company must demonstrate its ability to execute its business plan and deliver value to its investors. Success during this stage is critical to securing additional funding, building a sustainable business, and achieving the desired exit.
Conduct a Board meeting by sending a notice at least 7 days prior to the date of the meeting for the Board of Directors to present and get approval for raising the funding rounds, present the financials, bank statements, cash flow records, approve the draft of the offer letter. Also, call for an EGM/shareholders Meeting to pass the special resolution for the allotment to be made before making the fund-raising approval subject to shareholders approval.
Call for an EGM to pass a special resolution for preferential allotment in the meeting of the shareholders and file e-form MGT-14 (special resolution). After filing of MGT-14, Circulate the PAS-4 (Offer letter) to the identified people and receive the application money which to be kept in a separate bank account.
File Return of Allotment in e-form PAS-3 within 30 days from the date of allotment and the amount can be utilized only after filing of the e-form PAS-3 with MCA.
The share certificates must be issued within 2 months ( 60 days) from the date of allotment of shares and duly updating the same as records in the Register of Members.
Compliances under FEMA Act, 1999:
FC-GPR (FOREIGN CURRENCY- GROSS PROVISIONAL RETURN) filing to be made with the RBI online on FIRMS (Foreign Investment Reporting and Management System) platform, when the startup Indian company has received any funding in form of foreign remittance from a foreign investor/ company.
Filing FC-GPR – form is to be filed as per the law issued by the Reserve Bank of India (RBI) wherein, when the Indian Company receives the foreign investment, and against such investment the Company will allot shares to a foreign investor, the Company is required to file details of such allotment of shares using the form FC-GPR. Below are the steps in brief:
Register as business user: submit an authorisation letter & PAN card of the user.
Login to Single master form (SMF)
FC-GPR Details to be filled in such as:
Entity details – details of the Company CIN and pre-fill tabs
Issue details - Date & nature of issue, reference no. if any subsequent filing
Details of the foreign investors
The consideration (amount of remittance)
Shareholding pattern
Particulars of the issue
Note: The Post-transaction = Pre-transaction value of shares + Value of shares reported in the form.
4. Submission of the form with below attachments:
Copy of FIRC (Foreign Inward Remittance Certificate)
Copy of KYC (Know Your Customer) report of the remitter.
Declaration by authorized representative of the Indian Company
Certificate from Company Secretary per format under RBI user manual
Valuation Report by Chartered Accountant/Merchant Banker
Copy of FIPB approval (if required)
Board Resolution for allotment of securities along with list of Allottees.
Letter of Debit Authorization.
Declaration for conversion of CCPS
Pricing guidelines declaration
Reason for any delay in submission, if required.
Further, the securities shall be allotted within sixty days from the date of receipt of the application money and after filing of FC-GPR the share certificate shall be issued updating the same as records in the Register of Members.
Delay of filing in FC-GPR or reporting would attract late submission fee (LSF) and compounding offense with the RBI as stated under FEMA Act, 1999 and notification or circulars of the Government in this regard.
Incorporation of the Company: The first step towards investment in an Indian startup company is to incorporate it as a private limited company or a limited liability partnership (LLP) with CRC (MCA).
Capital Structure: The company must comply with the minimum capital requirement as prescribed by the Companies Act, 2013 if any. The company can raise capital through equity shares, preference shares, debentures, and bonds.
Foreign Direct Investment (FDI): If the investment is from foreign investors, the company must comply with the Foreign Direct Investment (FDI) policy of India. Foreign investors can invest in Indian startups either through the automatic route or through the approval route, depending on the nature of the business.
Securities and Exchange Board of India (SEBI): If the startup company intends to raise funds from the public through an Initial Public Offer (IPO), it must comply with the regulations prescribed by the Securities and Exchange Board of India (SEBI).
Due Diligence: Before investing in a startup company, it is important for the investor to conduct a thorough due diligence of the company's financial and operational status. This includes reviewing the company's balance sheet, income statement, cash flow statement, and other important documents.
These are some of the key compliances that must be followed while investing in an Indian startup company.