Startup Fundraising is primarily done through venture capital and private equity. It is essential for a founder to have a thorough understanding of the mechanisms by which a startup can raise funds through Private Placement and contractual arrangements such as a Share Subscription Agreement (SSA). This article examines the process of raising capital through the issuance of shares to a new investor, as well as the factors that founders must consider before entering into such a transaction.

Private Placement for Startup Fundraising

Section 42 of the Companies Act, 2013 deals with the private placement of shares. Private placement refers to the issuance of shares to a select group of investors without making a public offer. This section establishes rules and guidelines for private companies issuing shares to new Indian investors. Any offer to the shareholders other than the existing shareholders needs to be approved by special resolution in accordance with Section 62 (1) (c) of the Companies Act.

Procedure of private placement for startup fundraising

Identify the investor

The offer of private placement for subscribing to the shares can only be made to the “identified persons” whose names are recorded by the company before the invitation to subscribe.

Offer letter-cum-application

The next step in Private Placement is to prepare a consolidated offer letter-cum-application that must be filled in the form PAS-4 in order to circulate amongst the investor to whom the offer for issuing shares is made.

Approval from Shareholders

To issue shares to a new investor, an extraordinary general meeting must be held with the existing shareholders. A special resolution must be passed for a Private Placement. This resolution must be filed with the registrar before the offer letter and other documents can be issued. Upon obtaining approval from the shareholders and the registrar, the offer letter cum application must be circulated to the investor(s) to whom the offer is made. The company needs to keep complete records of the Private Placement in Form PAS-5.

Separate Bank Accounts

The consideration amount for a private placement must be received in a separate bank account, other than the company’s bank account with a scheduled bank. The amount must not be paid in cash, but only through demand drafts, cheques, or other banking channels. The company must keep records of all such payments, and must use the funds only for allotment. The amount cannot be used prior to filing the return with the registrar.

Allotment of Securities

The allotment in private placement of securities must be completed within 60 days of receiving the application money for the said securities. If the company fails to provide the securities to the new investor within the stipulated time, it must refund the amount within 15 days from the end of the 60-day period. If the company fails to refund the amount within the stipulated time frame, it is liable to pay interest on the amount to the investor at a rate of 12% per annum from the end of the 60th day.

File of return of allotment with Registrar

Pursuant to the Companies (Prospectus and Allotment of Securities) Rules, 2014, a return of allotment of securities must be filed with the registrar within 15 days of allotment in Form PAS-3, along with the due amount and a complete list of securities holders. In the event of a default by the company in filing the allotment of securities in a private placement, the promoters and directors of the company shall be liable to pay a penalty of Rs. 1,000 per day for each day the default continues, up to a maximum of Rs. 25 lakhs.

Important Points to be aware of before issuing shares through private placement

Number of Subscribers

Pursuant to the new amendments to Section 42 (Private Placement), effective from August 2018, an offer cannot be made to more than 50 persons or such higher number as may be prescribed. Rule 14 of the Companies (Prospectus and Allotment of Securities) Rules prescribes this number as 200. Any offer made to Qualified Institutional Buyers (QIBs) and shares allotted to employees under the stock option scheme shall not be taken into account. There can be no public announcement for a Private Placement.

Valuation of Securities for startup fundraising

Private Placement requires the valuation of securities in accordance with Companies (Registered Valuers and Valuation Rules) 2017. Rule 14 Companies (Prospectus and allotment of securities) – valuation to be done at least 30 days before the general meeting approving the issue is to be held.

Personal Liabilities of Promoters and Directors

In the event of a failure to file a return or allotment, or make an offer or acceptance of money in contravention of Section 42 of the Companies Act, 2013, promoters and directors may be held personally liable and fined up to 25 lakh rupees (for non-filing of return) and 2 lakh rupees (for offer or acceptance in contravention).

Share Subscription Agreement for startup fundraising

A Share Subscription Agreement (SSA) is a legal contract between an investor and a startup that outlines the terms of the investment. The SSA is typically used in the early stages of funding when the startup is seeking seed or angel investment. The SSA includes the following information:

• The amount of money being invested
• The number of shares being issued
• The rights and obligations of the investor and the startup
• The valuation of the startup
• The exit strategy for the investor

The SSA is an important document for both the investor and the startup. It protects the interests of both parties and ensures that everyone is on the same page before the investment is made.

Share subscription Agreement when necessary in startup fundraising.

In case the company wants to raise money through the issuance of shares it seeks money from investors other than the founders. Upon the issuance of such claims, the capital pool of the company becomes larger, this would result in the dilution of the shares that the existing investors already hold up. Hence, the anti-dilution rights if held up by any existing shareholder becomes important.

Important Clauses in Share Subsricption Agreement for Startup Fundraising

Condition Precedent

This clause in the Share Subscription Agreement (SSA) is significant because it delineates the terms and conditions that must be satisfied for a transaction to occur. It is from the perspective of both the investor and the company. It is typically done after the due diligence process, as it helps the investor and the company to address any red flags that may arise thus ensuring that the investment is safe.

Representations and Warranties

It is also known as the saviour clause in the Share Subscription Agreement (SSA), as this clause tends to give the guarantee and protection that saves the investor or company from potential fraud. The clause states that the company is duly certified, registered and complies with the law of the land. It creates trust between the company and the investor.

Effective Date and Execution Date

Although the terms “execution date” and “effective date” may seem to be synonymous when drafting a Share Subscription Agreement (SSA), they are not interchangeable. The execution date is the date on which the agreement is signed by both parties, while the effective date is the date on which the agreement becomes legally binding.

Confidentiality

Before entering into a Share Subscription Agreement (SSA), investors typically want to review the company’s financial statements. However, doing so could potentially expose the company’s trade secrets. To prevent this, it is important for both parties to enter into a confidentiality clause. This clause will legally bind the parties to keep all confidential information confidential.

Cost in

A Share Subscription Agreement (SSA) includes various cost components such as stamp duty, accountants’ fees, and attorneys’ fees. This clause will help the parties to decide who is responsible for paying these costs, thus avoiding any future conflicts.

Indemnity

As discussed above, the representations and warranties clause guarantees protection to the investor and the company. However, if this clause is breached, the indemnity clause in the Share Subscription Agreement (SSA) can be used to cover such circumstances. When drafting the clause, it is important to define who the indemnified parties will be, what will be considered a loss, and list all the details as per the agreement.

Share Issue and Subscription for Startup Fundraising

The clause will specify the number of shares to be issued by the company, the number of shares to be subscribed by the investor, and the percentage of the share capital that the investor will be entitled to after subscribing.

Closing

The closing clause specifies when the transaction will be completed. In the case of a Share Subscription Agreement (SSA), the transaction is considered complete when the shares are subscribed. The closing clause is also contingent upon the fulfilment of the conditions precedent clause. The transaction is considered complete when the conditions precedent clause has been acted upon and complied with.

Termination

The termination clause of a Share Subscription Agreement (SSA) outlines the conditions, events, and procedures that must be met in order to terminate the agreement. Termination may be initiated by either party for a variety of reasons, including breach of representations and warranties, material adverse change, or any other condition agreed upon by the parties. It helps to rescind the agreement wherein all obligations, promises, rights, and duties arising from the agreement are extinguished.

Implications for the Founders of the Startups to keep in mind while issuing shares for startup fundraising.

It is essential for founders to be cognizant of the practical implications of raising funds for startups, as new investors will be subscribing to shares the founders are bound to lose control of the entity. The share capital of the company will be larger than before, and the startup must grow as expected. The growth must be justified by the increasing valuation of the company in order to prevent a down-round or dilution financing. 

Key considerations while drafting a Share Subscription Agreement for startup fundraising.

• Critical clauses such as vesting rights, voting rights, exit mechanisms, tag-along and drag-along rights must be aligned in a synchronized manner among various transactional documents, such as the Shareholder Subscription Agreement (SSA), Shareholder Agreement (SHA), and Share Purchase Agreement (SPA). 
• The parties should be identified correctly for each part of the transaction. 
• It is imperative to ensure that the proper regulatory compliances have been done under the FEMA, RBI, SEBI and Companies Act. 
• Accurately record the information for the number of shares issued and the payment amount.
• List down the pre and post-investment capitalisation tables in the agreements. 
• It is imperative to elucidate the mechanism of closing a transaction, as merely stating closing actions is insufficient. 
• When identifying the appropriate stamp duty to be paid, it is imperative to pay heed to the documents that are being transferred from one state to another. This is because the stamp duty rates vary from state to state, and it is important to pay the correct amount in order to avoid any penalties

Conclusion

Raising money by issuing shares to investors is a major milestone for startups. By following the steps outlined in this comprehensive guide, you can confidently navigate the share issuance process and attract the right investors to support your startup’s growth. Remember to conduct thorough research, seek professional advice when needed, and build strong relationships with investors to ensure long-term success.

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