Start up Funding in India
Over the past few years, Startups have made a recognizable impact in the Indian Market. One of the major contributor leading to this development has been the huge funding rounds taken place in the recent years.
In wake of this scenerio, the Hon'ble Prime Minister of India Shri Narendra Modi launched "Startup India", intended to build a strong ecosystem that is conducive for the growth of startup businesses, to drive sustainable economic growth and generate large scale employment opportunities.
Before penetrating deep down the article, let us first understand the meaning of startup and funding.
What is Start Up ??
In simple terms, a start up may be defined as a young company that is beginning to develop and grow, is in the first stages of operation, and is usually financed by individuals or small group of individuals. It could be an entrepreneurial venture or a new business, a partnership or a temporary business organisation, designed to search for a repeatable and scalable business model.
Whilst having a look at the Companies Act, 2013, a start up company means " A Private Company incorporated under the Companies Act, 2013 or the Companies Act, 1956 and recognised as start up in accordance with the notification issued by the Department of Industrial Policy and Promotion, Ministry of Commerce and Industry".
(We would be discussing the process of getting recognition as start up in another article in near future)
What is Funding ??
Funding means the money required to start and run the business. It is the financial investment in the company for product development, manufacturing, expansion, sales and marketing, office space, inventory.
The source of funding differs upon the preference of entrepreneurs, as many startups would not raise the funds from third parties and are funded by their founders in order to prevent dilution in the company, on the other hand many would prefer raising funds from third parties in order to grow their startups in a rapid pace.
Forms of Funding
1) Equity Funding
The equity funding is a low risk method of raising funds for the startups, since the pressure of payment is negligible as compared to any other method. Here, the shares of the company are sold to investor, leading to dilution in the equity and giving the investor, decision making authority in the business. The risk factor for the investor is quite high, since there is no component for repayment of money. The investor involved in such form of funding are usually Angel investors, Family, friends, venture capitalists etc.
2) Debt Funding
Debt in simple terms, means an obligation which is to be paid off. As the word obligation is considered, there is always a risk rallying together. This implies the risk factor for the business raising debt funds is always high as there is an obligation to pay such funds back. Debt funds are secure against collateral making it a low risk investment in view of the investors.
As the line states, "To gain something, you have to lose something", here the investor loses decision making power in the business, for a low risk investment. The investors involved in such fundings are majorly banks, financial institutions, government loan schemes etc.
2) Grants
Grants are basically the rewards provided to the most eligible startups or entrepreneurs in the business competitions organized by various private and government institutions. There is no risk factor involved, alongwith no involvement of outsider in the decision making of the business. the amount of such funding is not so large, but sufficient to gear the startup to the next level. The investor involved in such type of funding are central government, state government, big business houses etc.
Legal Techniques to Raise Funds
The Indian Companies Act, contains numerous ways for a company to raise funds in the market, of which the most commonly used techniques are elaborated below alongwith their pros and cons for a better understanding:
A) Private Placement (Section-42 of Companies Act, 2013)
- Private placement, is the most common and popular method of receiving the funding by a company in the Indian context of business. The process of private placement basically involves the issue of securities only to a selected group of persons (identified investors) not exceeding 200 in a financial year.
- The offer shall be made in a specified form (PAS-4) to the identified investors.
- The company shall make its valuation report from a registered valuer, atleast 30 days prior the date of general meeting to be conducted to issue the shares.
- Company shall open a separate bank account with a scheduled bank for the purpose of receiving the funds through private placement.
- The Company shall not utilize the funds, unless the securities issued, are allotted to the investors and a return of allotment in e-Form PAS-3 is filed with the Ministry of Corporate Affairs (MCA).
- In case the securities are not allotted in 60 days from the receipt of application money, the company is obliged to refund the same within next 15 days, which if not refund will attract an interest of 12% p.a.
- The offer shall be approved by members of the company through a Special Resolution, in the general meeting.
- The maximum offer period for the letter of offer to be open is 365 days, where as there is no minimum period specified in the law.
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2. Have pre-determined contracts, minimizing the investor's risk. 3. Valuation report enables to know the actual value of the company. 4. Any kind of securities can be raised through this method. |
2. Limited number of potential investors. 3. Funds cannot be utilised till the filing of Return of Allotment (Form PAS-3), which is time consuming. |
B) Right Issue (Section 62(1)(a) of Companies Act, 2013)
- Like the Private Placement, right issue is another popular method of raising funds by a company.
- It is very important to note that, unlike private placement, in right issue the offer is made only to the holders of equity shares, on a proportionate basis*.
- No format has been specified for the letter of offer.
- The offer shall be kept open for a minimum period of 15 days and maximum 30 days.
- The offer shall deem to include a right of renunciation, allowing the offeree to renounce the shares offered to him in favour of any other person.
- In case the securities are not allotted in 60 days from the receipt of application money, the company is obliged to refund the same within next 15 days, which if not refund will attract an interest of 12% p.a.
2. Funds can be utilized, anytime after receipt 3. Valuation report enables to know the actual value of the company. 4. No need of shareholder approval, a board approval is sufficient | 2. Offer can be made only to existing members in proportion to their paid-up share capital, and outsiders cant be allowed to participate. (Note- Outsiders may be benefited, by exercising right of renunciation process.) |
C) Convertible Notes (CNs)
- The Convertible Notes is a modern concept in the on going era of seed funding in India, besides it is a very popular instrument for raising funds around the globe.
- A Convertible Note in its pure form is a debt instrument, providing the investor an option for repayment or an option to convert into Equity shares of the company.
- It can also be called a hybrid of debt and equity.
- Having a characteristic of debt instrument, CNs carry an interest rate.
- Convertible notes can be raised both from Resident as well as Non-residents.
- Conditions to raise from Residents :
- It is Mandatory to be recognised as "Start-up Company" with Department of Industrial Policy and Promotion, Ministry of Commerce and Industry.
- An investment of Mininmum Rs. 25,00,000/- can be made in a single tranche from a single person, otherwise the same would be treated as Deposit under the Companies Act.
- Maximum period of conversion = 5 years
- Being a debt instrument, the company needs to pass a special resolution in general meeting before issuance.
- Conditions to raise from Non-Residents:
- It is Mandatory to be recognised as "Start-up Company" with Department of Industrial Policy and Promotion, Ministry of Commerce and Industry.
- For a Non-Resident investor (other than Pakistan/ Bangladesh) shall make an investment of Rs, 25,00,000/- or more in a single tranche..
- Maximum period of conversion = 5 years
- Being a debt instrument, the company needs to pass a special resolution in general meeting before issuance.
- The issuing company shall report inflow of funds to the AD bank in Form Convertible Note (Form CN) within 30 days of issue.
- Company need to make FLA Return reporting on or before 15th July every year.
2. Being a debt instrument involves minimum interference at the initial phase of business 3. Issuer company does not require a valuation base to issue these notes, and can be issued even at an idea stage. | 2. The conversion can only be done into Equity shares, leading to a dilution in the ownership of the company. 3. For issuing CNs a company compulsorily need to be registered as Startup with Department of Industrial Policy and Promotion, Ministry of Commerce and Industry |
The sector of startups in India is booming at a rapid pace with more and more ideas getting converted into a profit and employment generating organizations. Such a development requires a firm legal approach to be followed by the entrepreneurs to maintain a valuable position in the market.
The above blog contains the basics of funding to start and run a company, more details will be shared in the near future. Stay tuned !!
Disclaimer: The contents of this blog has been prepared keeping in view the latest provisions applicable in the country and due care has been taken to ensure the accuracy, completeness and reliability of the data used in creating this blog. Hence no personal responsibility is assumed therefore.
About the Author
The Author of this blog, CS Krunal Charadva is a Company Secretary having an expertise in setting up of new companies and businesses in the country alongwith a wholesome experience in handling matters relating to the Companies Act, RBI (FEMA), drafting agreements, contracts and other corporate compliances applicable in India.
Still having questions in you mind ?? Feel free to share your queries and thoughts at - krunal.charadva@yahoo.com or just whatsapp/ Text/ Call at +91 9711420229
Lets create a healthy business environment together !!
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