Whenever a start-up decides to enter fund raising process, the founders must know about the various compliances laid out in the Companies Act, 2013. Compliance ideally means abiding by various rules and procedures prescribed by law. Failing these, a company might be subjugated to heavy penalties.
Raising funds through issue of shares is only allowed when to private limited companies in India. There are various modes of fund raising, but the most preferred these days is through issue of fresh equity/ preference shares in return for these funds. This helps reduce the debt on the books of the Company with no liability to repay back at a specific interest rate. However, repayment comes in the form of profit-sharing through payment of dividends and/ or remuneration in some form.
This blog lists down and briefly explains the pre funding and post funding compliances that every start-up in India seeking investors must undergo.
Pre Funding Compliance
There are two ways to raise funds- private placement procedure and rights issue. In Private Placement, securities are issued to an investor or a pool of investors (as against offering securities to the public) as a means of raising capital. Rights Issue is undertaken when the shares are being issued to the already existing investors as a means of raising additional capital from the same investors. The process involves the following:
1. Increasing the Authorized Share Capital
The very first compliance involves increasing the authorized share capital of the company- which is the maximum number of shares that a company can issue. Subscribed capital shows the portion of authorized capital that the investors have agreed to subscribe to and it cannot exceed the authorized capital.
2. Conducting a Board Meeting
You will also need to conduct a Board Meeting wherein matters in relation to fund raising are to be discussed. A necessary resolution has to be passed in that regard. Matters like valuation report, list of allottees, offer period, finalizing the draft offer letter, finalizing the notice of EGM etc. need to be discussed in this very important pre funding compliance in India.
3. Conducting an Extra-Ordinary General Meeting (EGM)
An EGM is conducted to pass a special resolution for the private placement offer. Necessary Ministry of Corporate Affairs (MCA) forms like MGT-14 and PAS-4 containing the private placement offer is sent to the investors/ allottees along with a certified true copy of the special resolution.
4. Issuance of Offer Letter
On getting the approval, the private placement offer letter cum application is to be given to the proposed investors/ allottees within 30 days, in writing or through electronic mode. You will also need to file a complete record of the private placement with the Registrar of Companies. Once this is complete, the company can receive funds from the investors.
This sums up the list of pre funding compliance that needs to be fulfilled.
Post Funding Compliance
Even after receiving funding from the investors, the company still has to fulfil a list of post funding compliance. This ensures smooth functioning in the long run. Certain other compliances are optional depending upon the nature of transactions.
1. Allotment of Shares
The shares must be allotted to the investors within 60 days of receiving funds through private placement. Also, within 30 days of such allotment, a return of allotment must be filed with the investors.
2. Issuance of Share Certificates
Creation and issuance of a share certificate is another important post funding compliance wherein a document is issued by the company as an evidence that investor named in the certificate is now the owner of the shares of the Company. This certificate officially makes them the shareholders of the Company. In case of a foreign investor, few additional compliances need to be observed as per the guidelines issued by the Reserve Bank of India for fund raising.
In case the founders of the start-up have already prepared Share Subscription and Share Holder’s Agreement that covers the transfer restrictions on issues shares, exit rights to the investors, vesting schedule, affirmative voting matter and more, then there is an additional post funding compliance in Indiathat needs to be fulfilled. The Articles of Association (AOA) need to be amended in such cases.
Moreover, if the incoming investors are requesting a board seat, then an optional compliance of addition of director needs to be undertaken.
Apart from these compliances, there are certain documents that, though not mandated by law, are necessary to formalize equity financing transaction. We suggest you get proper knowledge of these documents required to seek funding from start-ups.