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Funding Compliance

Equity funding is the famous source of funding for early-stage businesses in India. Equity funding is the exchange of partial ownership of the company for an amount of funding. We at Wazzeer advice our clients to give a serious thought on advantages and disadvantages associated with Equity funding reason being the compliances involved in this funding source invites the dilution of ownership of the company for the company’s founders. Now, had you assessed this source of funding, let’s look at the compliances involved in processing such funds for company’s use.


As you know receiving equity funds requires an exchange of shares in return, now the process of Issue of shares can be done in two ways Rights Issue, and  Private Placement.


Rights Issue comes into picture If the Shares are to be issued to existing shareholders. Basically, the right to invest further in the company according to their existing shareholding has been incremented.


Private Placement comes into picture when the shares are to be issued to an investor who does not hold any shares in the company. According to Companies Act, at least shares worth Rs.20,000 in face value must be issued to one investor to do this. For e.g. if the face value of shares is Rs.10, at least 2,000 shares need to be issued to the investor to carry out Private Placement. If this is not the case, the shares can be issued through rights issue.


Compliance involved in processing equity funding:


Step 1: Authorized Share Capital Requirement


Authorized share capital: It is a limit up to which shares can be issued by the company. For eg. if the company issues shares at face value Rs.10 and the Authorized share capital of the company is Rs.10 Lac, the company can issue a maximum of 1 Lac equity shares


Paid Up Capital: It is the actual capital invested in the company in terms of face value i.e, while starting up, the company issues shares at face value and a paid up capital of 1 Lac in such a case means that 10,000 shares has been issued (If the face value is Rs.10)


Paid up capital cannot be more than Authorized share capital of the company. Hence if the Authorized share capital of the company is not sufficiently high it is required to be increased first before doing any other compliance to issue fresh shares

Step 2: Prepare draft of offer letter


In case of Private placement, offer letter (PAS-4) is sent either through post or electronic mode within thirty days of recording names of such people, along with the application form addressed to the person to whom the offer is made. In case of rights issue, offer letter must be dispatched to the shareholders at least three days before the opening of issue.


Step 3: Board Meeting


Board meeting must be conducted for approving ‘Letter of Offer’. According to Section 173(3) of Companies Act, a notice should be issued to every director at least seven days before conducting the meeting.

An Extraordinary General Meeting (EGM) is to be conducted in case of private placement. Also, a complete record for private placement must be prepared in form PAS-5. PAS-4 and PAS-5 must be filed with ROC within 30 days of issue of offer letter in GNL-2.  


Step 4: Receive Application money


In case of rights issue, the application money can be paid in the form of cash also. In case of a Private placement though, the share application money should come to a separate Investment account of the company through banking channels only. After receiving application money, the second board meeting is held for approving allotment and issue of shares.



Step 5: Allotment of shares


In the case of Rights issue, the money can be transferred to either company’s main account or a separate investment account but in the case of Private placement, the fund should be transferred to a separate investment account of the company. File with Registrar a return of allotment in E-Form PAS-3 within 30 days of allotment of shares.


Step 6: Issue Share certificate


The company must issue share certificate to the investor within 60 days of allotment of shares. It cannot use the money until the certificate is issued. If the company doesn’t issue share certificate within the specified time, it will have to return the money to investors.



Note, Following documents need to be submitted to RBI in case of Foreign Investors:

  1.  Advance Reporting Form: This form is to be filed within 30 days of receiving funds. This contains information relating to funds as KYC of Investors.
  2. FC-GPR Form: This form is required to be filed within 30 days from the date of issue of shares. In this form Certifications regarding the procedure, compliance needs to be certified from a CS. Along with this, valuation certificate certified by a CA must be submitted. Two documents are required to file this form-FIRC issued by the company’s bank and KYC issued by investor’s bank.
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Funding Compliance, Start up Lessons, Startup Funding Paperworks

At different stages of startup lifecycle, namely – startup and early-stage development, growth and expansion, and maturity, the requirement for funds inevitably comes up. As the meeting of such requirements comes to the mind, entrepreneurs tend to consider various options for sourcing funds. In this blog, we will be looking into such sources for raising funds from.

 

 

Seed Capital and Early Stage Funding stage:

Seed funding when the business is pre-revenue and it may still be developing an MVP. This funding is used by the startup to: cover the initial costs of starting, to invest on the R&D and to sustain the venture. The funding that happens is close to having or already has some revenue but remains unprofitable. Sources of funding in this stage is:

 

 

  • Personal Investment/Bootstrapping: Also, referred to as bootstrapping or self-financing or some call it having “Skin in the game” traditionally available options under this are:
    1. Investment from savings
    2. Borrowing against real estate assets
    3. Liquidating personal assets
    4. Using personal assets as collateral for a loan

 

 

  • Funding by Friends and Family: Though the personal relationship comes handy while raising funds from these parties, potential conflicts can be avoided by securing these investments after performing supporting legal compliance. We suggest you prepare funding contracts that fully discloses the terms of the financing.

 

 

  • Private or Governmental grant funding options: Grants are funds that need not be paid back. Grants usually carry stipulations as to how the grant money can be spent over a specific time period. Qualifying to become a beneficiary of grants is time-consuming and tedious.

 

 

  • Crowdfunding: This fund is raised online by the collective efforts and cooperation of a network of many individuals. There are two types of crowdfunding:
    1. Reward crowdfunding: Startup reward (by offering company’s product or services to the investor for free or at a reduced rate) their investors for making investment
    2. Securities crowdfunding: Startup sells securities in the company in exchange for capital from investors.

 

Equity Funding:

Most common source of funding for early-stage businesses wherein investor gets a partial ownership of the company for the investment made. Various options under this source are:

 

  • Angel investors: These are affluent individuals who are interested in investing privately in small businesses during early stage of growth. Angel investors fund in exchange for convertible debt or ownership equity.

 

  • Venture Capital: VC funds are typically derived from a pool of professionally managed funds contributed by an individual venture capitalist or institutional investors. Funds are invested for exchange for an interest stake in the venture, for the directorship, the right to approve the loan on behalf of the business, the authority of hiring or firing, involvement in business decisions etc.

 

Debt Funding:

Funds are borrowed with the intent to be repaid within a fixed period, with interest. Interest paid on the loan is tax deductible for the borrower.

 

Mezzanine Financing:

Mezzanine financing is a form of debt with warrants or convertible debt, which begins as a loan and later converts to equity if the loan is not repaid or a certain return on investment has not been achieved.


Note, compliance associated with each of these sources of funding is different, in case you are interested we at Wazzeer can offer a consultation on the compliance requirement -> “Get Started!”

 

 

 

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FDI, Funding Compliance

Attracting large-scale Foreign Direct Investment (FDI) and improving India’s world ranking for ‘Ease of Doing Business’ were the driving force behind continual amendments to FDI policy of India. Precisely speaking, DIPP has liberalized the rules such as – startups have been highlighted with specific policies. To know how these amendments could favor your business, stay tuned!


FDI in E-commerce Sectors

Marketplace model of e-commerce can accept 100% FDI, whereas inventory-based model of e-commerce businesses are not allowed.

Restriction of auditing

Foreign investors wanting to get auditing of the Indian investee company by a particular audit firm cannot proceed to do so unless and until a joint audit is conducted wherein one of the auditors is not from that particular audit firm.


FDI in NBFC

Foreign investment in investing companies registered as Non-Banking Financial Companies with the RBI, if overall regulated, then 100% FDI through automatic route is allowed.


FDI on Core Investment Companies (CICs)

Investing companies engaged in the activity of investing in the capital of other Indian companies or LLPs, is permitted to receive FDI under Government approval route, under RBI’s regulatory framework.


FDI in Real Estate Broking Services

Real estate broking service does not come under real estate business, and these service businesses are eligible for 100% FDI via automatic route.


FDI in Single Brand Product Retail Trading

100% FDI is allowed via automatic route. Subject to the following conditions:
  • Products to be sold should be of a ‘Single Brand’ only.
  • Products should be sold under the same brand internationally
  • A nonresident entity is allowed to undertake ‘Single Brand’ product retail trading. The owner can either trade by himself or mandatorily enter a legal tenable agreement executed between the Indian entity undertaking trading of the brand.
  • FDI beyond 51%, and sourcing 30% of the value of good purchased will be frequently checked by statutory auditors from the duly certified accounts which the company will be required to maintain. The relevant entity would be an Indian company.
  • A Single Brand Trading entity operating through Brick and Mortar stores is permitted to undertake retail trading through e-commerce
  • Indian brands should be owned and controlled by resident Indian citizens

FDI on medical devices

The definition of medical devices has been changed, which has brought implications on the type of companies or LLPs that can accept FDI. There are accounting procedures that have been listed out, like – pre-operative/pre-incorporation expenses, Pricing guidelines, issuance of equity shares, import-export etc.,


FDI in Multi Brand Retail Trading

Is permitted if the products are fresh agriculture produce, fishery and meat products, may be unbranded too. A minimum FDI of US $ 100M is a threshold to be met by foreign investors. Out of the investment, at least 50% of total FDI should be invested in back-end infrastructure within 3 years. At least 30% of the value of procurement purchased should be sourced from Indian MSME industries.


FDI in Duty-Free Shops

100% FDI is permitted via automatic route is the shop complies with conditions stipulated under the Customs Act, 1962


FDI in LLPs

  • FDI is permitted via the automatic route in LLPs operating in sectors where 100% FDI is allowed.
  • LLP having foreign investment is permitted to make downstream investment in another company or LLP in sectors in which 100% FDI is allowed
  • Companies or LLPs with foreign investment can convert to an LLP or Companies provided they fall in sectors in which 100% FDI is allowed.
  • FDI in LLP is subject to the compliance of the conditions of LLP Act, 2008.

FDI in Startups

A startup company means a private company incorporated under the Companies Act, 2013 or Companies Act, 1956
  • Startups can issue equity or debt instruments to FVCI against receipt of foreign remittance, as per the FEMA regulations.
  • Foreigners other than citizens of Pakistan and Bangladesh can purchase convertible notes issued by an Indian Startup Company for an amount of INR 20L or more in a single tranche.
  • Startup company engaged in a sector where acceptance of FDI requires Government approval has to get approval from Government to issue convertible notes to a non-resident.
  • Startup Company issuing convertible notes outside India should receive remittance through banking channels or by debit to the NRE/FCNR/Escrow account.
  • Transfer of convertible notes should comply with the pricing guidelines as prescribed by RBI
  • The Startup Company issuing convertible notes should furnish reports as prescribed by RBI

 

 

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Funding Compliance, Secretarial Compliance

Credit goes to Companies (Amendment) Act, 2015 issued by the Ministry of Corporate Affairs (MCA) that made borrowing funds in form of loans from directors, shareholders, subsidiaries etc., easy. Addressing the fact that raising external funds, especially for early-stage startups, is like moving mountains, we at Wazzeer decided to write this blog on how private limited companies in India can accept loans from its stakeholders, with a view to help those in need of one.

 

 

Firstly, to borrow loan from any stakeholder of any amount, board resolution must be passed.

 

 

Secondly, let’s look at the different stakeholders that can loan a private limited company:

 

 

#1: Directors

Directors of the company can loan the private limited company. The director has to provide a declaration that the amount has not been given out of funds acquired by him borrowing or accepting loans or deposits from others.

 

 

#2: Shareholders

  • If the money accepted from members exceeds 100% of the paid-up capital and free reserves, then such shareholders cannot loan.
  • If the money accepted from members does not exceed 100% of paid up capital and free reserve, then the shareholder can loan.

 

#3: Director cum Shareholder

This person can loan, he/she has to provide a declaration that the amount has not been given out of funds acquired by him by borrowing or accepting loans or deposits from others.

 

 

#4: Subsidiary or Any other company

  • Not allowed if any director of the lending company is a director or member of the borrowing company
  • Not allowed if, the director of the lending company, individually, or along with one or more of its directors, exercises or controls not less than 25% of voting rights of the borrowing company
  • Not allowed, if the board of directors, MD or manager of the borrowing company is accustomed to act in accordance with the directions or instructions of the board, or any director or directors of the lending company.
  • If the lending and borrowing company are both private limited companies, then it can give loan irrespective of common directors if in the lending company no other body corporate has invested any money
  • If the lending and borrowing company are both private limited companies, then it can give loan irrespective of common directors if the borrowing of the lending company from banks or financial institutions or anybody corporate is less than twice its paid-up capital or INR 50C
  • If the lending and borrowing company are both private limited companies, then it can give loan irrespective of common directors if the lending company is not in default in repayment of such borrowings subsisting at the time of giving such loan.

 

#5: Employee

Yes, allowed to lend loan, the amount borrowed must not exceed the employee’s annual salary in the nature of interest-free security deposit.

 

 

 

 

 

 

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FCGPR, Funding Compliance

Welcome to this series on Foreign Direct Investments brought to you by Wazzeer. Heard stories of different kinds of FDI’s made in India, this is based on one such story. Ajay who always knew that he would start a healthcare business in India decided to pursue MBA from Wharton School of Business. During his journey in Wharton, Ajay made some new friends, and of them, there were quite a number of foreign friends too. Ajay after graduation, came back to India to set up his business in India. On his way to raise an initial round of funds, reached out to his foreign friends regarding the same.  Ajay, though he had some idea on how FDI works, to be on the safer side, he reached out to Wazzeer. Describing a part of Ajay’s requirement, let’s dive into Episode 1 – Transfer of shares from resident’s to Nonresident’s.


There are basically two options to transfer shares from resident to Non-Resident:


A. Transfer by way of sale:

  1. A person resident in India may transfer to a person resident outside India any share/convertible debenture of an Indian Company whose activities fall under the Automatic Route for FDI subject to the Sectorial Limits, by way of sale subject to complying with pricing guidelines, documentation and reporting requirements for such transfers, as may be specified by the Reserve Bank of India, from time to time.
  2. Which is not possible if, Indian Company is in financial service sectors like banking and nonbanking companies regulated by the Reserve Bank, insurance companies regulated by Insurance Regulatory and Development Authority (IRDA) and other companies regulated by any other financial regulator, as the case may be).
  3. Which is not possible if, the transfer falls within the provisions of SEBI Regulations, 1997.

B. Transfer by way of gift:

  1. A person resident in India who proposes to transfer to a person resident outside India [other than erstwhile OCBs] any security, by way of gift, shall make an application to the Central Office of the Foreign Exchange Department, Reserve Bank of India furnishing the following information, namely:
    1. Name and address of the transferor and the proposed transferee
    2. Relationship between the transferor and the proposed transferee
    3. Reasons for making the gift

 

In case the transfer does not fit into any of the above, either the transferor (resident) or the transferee (non-resident) can make an application for the Reserve Bank’s permission for the transfer. The application has to be accompanied with the following documents:

  1. A copy of FIPB approval (if required).
  2. Consent letter from transferor and transferee clearly indicating the number of shares, the name of the investee Company and the price at which the transfer is proposed to be affected.
  3. The present/post transfer shareholding pattern of the Indian investee company showing the equity participation by residents and non-residents category-wise.
  4. Copies of the Reserve Bank of India’s approvals/acknowledged copies of FCGPR evidencing the existing holdings of the non-residents.
  5. If the sellers/transferors are NRIs / OCBs, the copies of the Reserve Bank of India’s approvals evidencing the shares held by them on repatriation / non-repatriation basis.
  6. Open Offer document filed with SEBI if the acquisition of shares by a nonresident is under SEBI Takeover Regulations.
  7. Fair Valuation Certificate from Chartered Accountant indicating the value of shares as per the following guideline.
  8. In the case of unlisted shares, the fair value is worked out as per the erstwhile Controller of Capital Issue/s.
  9. For listed shares, the price worked out is not less than the higher of average weekly high and low quotations for 6 months and an average of daily high and low quotation or two weeks preceding 30 days prior to the date of making application to FIPB.

 

We at Wazzeer have helped businesses in various sectors to get an end to end legal, accounting, and secretarial works delivered smoothly without hassle. We would be very excited to help you kick your business and thereafter too. So let’s connect -> “Get your Wazzeer”

 

 

 

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Funding Compliance

Fact is, a private company limited by shares can issue debentures and preference shares to raise capital. There are a quite a number of ventures that happen use this route to raise funds, but the catch is the compliance that follows the two routes. Regulations and compliance for each of these routes are what we would be having a glance at. Please note, these are sensitive compliance works, and we strongly suggest you to hire a well-qualified Lawyer for this work, We can help you 🙂 


Situation 1: Raising funds in exchange for debentures.


  • A company may issue debentures with the option to convert such debentures into shares, either wholly or partly at the time of redemption. Section 71 of the Companies Act, 2013 would apply.
  • Provisions of a private placement of securities (Section 42) need to be complied with if debenture proposed to be issued through a private placement.
  • In addition to above, provisions Section 62 needs to be complied with if Issues of convertible debenture are through Preferential allotment.
  • Issue of debenture with the option to convert into shares (wholly or partially) shall be approved by a special resolution passed at the general meeting.
  • Debenture cannot be issued carrying voting rights.


Situation 2: Raising funds in exchange for Preference Shares



  • Preference shares, on the other hand, can be issued subject to the conditions stipulated in Section 55 of the Companies Act, 2013. The procedure of issuance and increase of capital would, however, be governed by Section 62 of the Companies Act, 2013.
  • The requirements/conditions include:
  1. The company not eligible to issue preference shares which are irredeemable.
  2. The issue of preference shares to be authorized by AOA of the Company.
  3. The company can issue only those pref. shares which are redeemable not exceeding 20 years from the date of its issue.
  4. The issue of preference shares to be authorized by a special resolution in the general meeting.
  5. There should not be subsisting default in the payment of dividend on existing preference shares.
  6. Resolution authoring the issue of preference shares to set out matter as prescribed under rules
  7. Price of such shares to be determined by the valuation report of a registered valuer.
  8. Price of a listed company shall not be required to be determined by the valuation report of a registered valuer.


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Funding Compliance

So you have an idea for a company? Have been playing around with it for months? You’ve done the deep soul searching and now it’s time to take the plunge and go all in, turning your idea into a business. Going about the obvious things of picking a name, mapping out the business plans have been keeping you busy off late. But then, even at the slightest thought of the capital, your mind goes blank!

The process is full of mystery and the worst part is that you probably have no idea where to even begin. Raising a seed around can get pretty simple, provided you are following the right steps from day one. Some points to demystify this entire process are :

  1. Track Everyone and Everything: Track 

You will be meeting hundreds of people about your company in the early days before you decide to raise money, and it is likely that your first investors will be people from that time period. Tracking every point of contact with potential future investors will give you a database of people to reach out to when it is the time to focus on your seed round.

 

  1. Analyze the Market. Thoroughly:

Interpreting the existing market scenario is primarily important. Take a call and wait for the market to develop patiently according to your perspective.

 

  1. Stay Connected :

It is unlikely that someone is going to invest right after the first meeting, by just seeing a snapshot of what you have done. Remember, Investors, like to invest in lines, not dots.

You performing over time in a series of dots (follow-up emails, meetings, calls) can help them get connected with you to paint a clearer picture of your team and company. If you are following point 1 correctly, potential investors will feel like they already know you when it’s time to ask for the check.

 

  1. Too many cooks spoil the broth:

Never have more than 2-3 founders. In case you need more experts, you can always hire them. Having one founder is not always the best option. Different outlooks and divided risks is always a favorable position to be in.

 

  1. Keep an eye on your accounts:

Expenses, bills of the previous and upcoming months need to be maintained. This will help you to keep a track of the loopholes in your capital. While going to an investor, show them the accounts and logistically present the number of funds required. This shall give you an upper hand.

 

  1. A Compelling Story sounds good:

Let not your pitch-deck sound like a robot. Use it to show your team’s strengths and why you are taking on this particular challenge. It’s simply about getting the potential investor excited enough to put their money on the line to be a part of the story with you.

 

 

  1. Funds = Bonus:

Raising a startup on the basis of bootstrapping is considered to be an ideal one. Consider the funds as the bonus. This will help you control the company completely without any pressure from the outside investors. Also, it lets you focus on your business more rather than always being in the hunt for an investor.

 

  1. Make sure you are financially stable:

Giving up an existing job to start a venture is not quite a good thing to do. Knowing about the highs and lows of the business, ensure that all your debts are cleared. Also, make sure that the medical insurance, family savings, and credit cards are in place. Moreover, keep a minimum runway of 9-12 months. Once you have got this sorted, it will be easier for you to concentrate on your venture.

 

  1. Gulp down that bitter pill:

It is good to accept that a startup is not working. Knowing that 80-90% of the startups get tossed over, you should not hesitate to make your call and well, move on. As a risk taker, this has to be your last resort but keep in mind that at times you need to let things go

 

  1. Do your own research:

Talk to the alum companies if you are applying to an accelerator. Talk to the portfolio companies if you are planning to raise capital from an angel investor or probably a venture fund. Those are the best source of references you won’t read the news.

 

 

Setting up a startup involves hefty procedures and complex hurdles. We at Wazzeer can vouch for being your most reliable Legal & Accounting Partner; letting your plans align smoothly. Let’s Connect!:)

 

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Funding Compliance

Below are 5 ways to raise funds for a startup to raise funds for your startup without equity or Share options:

 

1)    Bootstrapping your startup business:

 

Self-funding, also known as bootstrapping, is an effective way of startup financing, especially when you are just starting your business. First-time entrepreneurs often have trouble getting funding without first showing some traction and a plan for potential success. You can invest from your own savings or can get your family and friends to contribute. This will be easy to raise due to fewer formalities/compliances, plus fewer costs of raising. In most situations, family and friends are flexible with the interest rate.

 

Self-funding or bootstrapping should be considered as a first funding option because of its advantages. When you have your own money, you are tied to the business. On a later stage, investors consider this as a good point. But this is suitable only if the initial requirement is small. Some businesses need money right from the day-1 and for such businesses, bootstrapping may not be a good option.

 

Bootstrapping is also about stretching resources – both financial and otherwise – as far as they can. Check out these 30 tips to save money and improve your business cash flow.

 

 

2)    Crowdfunding :

 

Crowdfunding is one of the newer ways of funding a startup that has been gaining a lot of popularity lately. It’s like taking a loan, pre-order, contribution or investments from more than one person at the same time.

 

This is how crowdfunding works – An entrepreneur will put up a detailed description of his business on a crowdfunding platform. He will mention the goals of his business, plans for making a profit, how much funding he needs and for what reasons, etc. and then consumers can read about the business and give money if they like the idea. Those giving money will make online pledges with the promise of pre-buying the product or giving a donation. Anyone can contribute money toward helping a business that they really believe in.

 

Why should you consider Crowdfunding as a funding option for your business?

The best thing about crowdfunding is that it can also generate interest and hence helps in marketing the product alongside financing. It is also a boon if you do not sue if there will be any demand for the product you are working on. This process can cut out professional investors and brokers by putting funding in the hands of common people. It also might attract venture-capital investment down the line if a company has a particularly successful campaign. Also keep in mind that crowdfunding is a competitive place to earn funding, so unless your business is absolutely rock solid and can gain the attention of the average consumers through just a description and some images online, you may not find crowdfunding to work for you in the end. Some of the popular crowdfunding sites in India are Indiegogo, Wishberry, Ketto, Fundlined, and Catapooolt. In the US, Kickstarter, RocketHub, Dreamfunded, Onevest, and GoFundMe are popular crowdfunding platforms.

 

3. Govt Programs That Offer Startup Capital:

 

The Government of India has launched 10,000 Crore Startup Fund in Union budget 2014-15 to improve startup ecosystem in India. In order to boost innovative product companies, Government has launched ‘Bank Of Ideas and Innovations’ program.

 

Government-backed ‘Pradhan Mantri Micro Units Development and Refinance Agency Limited (MUDRA)‘ starts with an initial corpus of Rs. 20,000 crore to extend benefits to around 10 lakhs SMEs. You are supposed to submit your business plan and once approved, the loan gets sanctioned. You get a MUDRA Card, which is like a credit card, which you can use to purchase raw materials, other expenses etc. Shishu, Kishor, and Tarun are three categories of loans available under the promising scheme. Learn more about MUDRA.

 

Also, different states have come up different programs like Kerala State Self Entrepreneur Development Mission (KSSEDM), Maharashtra Centre for Entrepreneurship Development, Rajasthan Startup Fest, etc to encourage small businesses.

SIDBI – Small Industries Development Bank Of India also offer business loans to MSME sector. In the US, there is a small business lending fund and a dedicated portal for Government grants available for local businesses. If you comply with the eligibility criteria, Government grants as a funding option could be one of the best. You just need to make yourself aware of the various Government initiatives.



Remember, Start-up process entails complex procedures and many bureaucratic hurdles, entrepreneurs are better off using professional services. Hiring a virtual lawyer and virtual accountant can save time and help ensure that the process goes smoothly. For any Legal and Accounting support, Happy to help you, let us talk! 🙂

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Funding Compliance


Debt financing means borrowing money and not giving up ownership. Debt financing often comes with strict conditions or covenants in addition to having to pay interest and principal at specified dates. Failure to meet the debt requirements will result in severe consequences. This means that the effective interest cost is less than the stated interest if the company is profitable. Adding too much debt will increase the company’s future cost of borrowing money and it adds risk for the company. The company receives a loan and gives its promise to repay the loan.

It includes both secured and unsecured loans. Security involves a form of collateral as an assurance the loan will be repaid. If the debtor defaults on the loan, that collateral is forfeited to satisfy payment of the debt. Most lenders will ask for some sort of security on a loan. Debt funds are preferred by individuals who are not willing to invest in a highly volatile equity market. A debt fund provides a steady but low income relative to equity. It is comparatively less volatile. Debentures are one of the common long-term sources of finance. They normally carry a fixed interest rate and a certain date of maturity. Interest is paid every year and principal is paid on the date of maturity.

Advantages of Debt Financing:-

(a)     to the Company:

(i) Debentures provide long-term funds to a company.

(ii) The rate of interest payable on debentures is usually, lower than the rate of dividend paid on shares.

(iii) The interest on debentures is a tax-deductible expense and hence the effective cost of debentures (debt-capital) is lower as compared to ownership securities where dividend is not a tax-deductible expense.

(iv)Debt financing does not result into dilution of control because debenture-holders do not have any voting rights.

(v) A company can trade on equity by mixing debentures in its capital structure and thereby increase its earnings per share.

(vi)Many companies prefer issue of debentures because of the fixed rate of interest attached to them irrespective of the changes in price levels.

(vii) Debentures provide flexibility in the capital structure of a company as the same can be redeemed as and when the company has surplus funds and desires to do so.

(viii) Even during depression, when stock market sentiment is very low, a company may be able to raise funds through issue of debentures or bonds because of certainty of income and low risk to investors.

(ix) Benefit of Tax: ‘Debt Financing’ or ‘Issuing of Debenture’ results in interest expense for the borrower which is a tax deductible expense. A company can claim an interest as an expense against its profits whereas dividends paid to equity or preference shareholders are paid out of net profits after taxes. In short, debt financing brings tax benefit to the borrower which is not there in case of equity.

(x)No dilution of control: Issuing of debentures or accepting bank loan does not dilute the control of the existing shareholders or the owners of the company over their business. If the same fund is raised using equity finance, the control of existing shareholders would dilute proportionately.

(Xi) No dilution in share of profits: Opting for debentures over the equity as a source of finance keeps intact the profit-sharing percentage of existing shareholders. Debenture holders or financial institutions do not share profits of the company. They are liable to receive the agreed amount of interest only. Therefore, profits are shared among the same number of hands before and after the new project. The profit sharing percentage of individual shareholders would reduce in case if the equity funds are availed.

(b) to the Investors:

It is not only the company but also the investors who are benefited by investing in debentures or bonds.

(i) Debentures provide a fixed, regular and stable source of income to its investors.

(ii) It is comparatively a safer investment because debenture-holders have either a specific or a floating charge on all the assets of the company and enjoy the status of a superior creditor in the event of liquidation of the company.

(iii) Many investors prefer debentures because of a definite maturity period.

(iv) A debenture is usually more liquid investment and an investor can sell or mortgage his instrument to obtain loans from financial institutions.

(v) The interest of debenture-holders is protected by various provisions of the debenture trust deed and the guidelines issued by the Securities and Exchange Board of India in this regard.


Disadvantages of Debenture Finance:

In spite of many advantages, debenture financing suffers from certain limitations. The following are the major disadvantages of debentures:

(a) From the Point of View of Company:

A company suffers from the following disadvantages of debt- financing:

(i) The fixed interest charges and repayment of principal amount on maturity are legal obligations of the company. These have to be paid even when there are no profits. Hence, it is a permanent burden on the company. Default in these payments, adversely affects the credit-worthiness of the firm and even may lead to winding up of the company.

(ii) Charge on the assets of the company and other protective measures provided to investors by the issue of debentures usually restrict a company from using this source of finance. A company cannot raise further loans against the security of assets already mortgaged to debenture-holders.

(iii) The use of debt financing usually increases the risk perception of investors in the firm. This enhanced financial risk increases the cost of equity capital.

(iv)Cost of raising finance through debentures is also high because of high stamp duty.

(v) A company whose expected future earnings are not stable or who deals in products with highly elastic demand or who does not have sufficient fixed assets to offer as security to debenture-holders cannot use this source of rasing funds to its benefit.


(b) From the Point of View of Investors:

Many investors do not find debentures or bonds as an attractive investment because of the following:

(i) Debentures do not carry any voting rights and hence its holders do not have any controlling power over the management of the company.

(ii) Debenture-holders are merely creditors and not the owners of the company. They do not have any claim on the surplus assets and profit of the company beyond the fixed interest and their principal amount.

(iii) Interest on debentures is fully taxable while shareholders may avoid tax by way of stock dividend (bonus shares) in place of cash dividend.

(iv)The prices of debentures in the market fluctuate with the changes in the interest rates.

(v) Uncertainty about redemption also restricts certain investors from investing in such securities.


Eligibility for Debt Financing:

Anyone who is having funds and want to invest into some business plan can invest in debt. There are various types of debentures like redeemable,  irredeemable, perpetual,  convertible, non-convertible, fully, partly, secured, mortgage, unsecured, naked, first mortgaged, second mortgaged, the bearer, fixed, floating rate, coupon rate, zero coupon,  secured premium notes, callable, puttable, etc.

The debenture classification is based on their tenure, redemption, mode of redemption, convertibility, security, transferability, type of interest rate, coupon rate, etc. Following are the various types of debentures vis-a-vis their basis of classification.


Redemption / Tenure

Redeemable and irredeemable debentures

Redeemable debentures carry a specific date of redemption on the certificate. The company is legally bound to repay the principal amount to the debenture holders on that date. On the other hand, irredeemable debentures, also known as perpetual debentures, do not carry any date of redemption. This means that there is no specific time of redemption of these debentures. They are redeemed either on the liquidation of the company or when the company chooses to pay them off to reduce their liability by issues a due notice to the debenture holders beforehand.

 
Convertibility

Convertible debenture holders have an option of converting their holdings into equity shares. The rate of conversion and the period after which the conversion will take effect are declared in the terms and conditions of the agreement of debentures at the time of issue. On the contrary, non-convertible debentures are simple debentures with no such option of getting converted into equity. Their state will always remain of a debt and will not become equity at any point of time.


Fully and partly convertible debentures

Convertible Debentures are further classified into two – Fully and Partly Convertible. Fully convertible debentures are completely converted into equity whereas the partly convertible debentures have two parts. Convertible part is converted into equity as per agreed rate of exchange based on an agreement. Non-convertible part becomes as good as redeemable debenture which is repaid after the expiry of the agreed period.

Security

Debentures are secured in two ways. One when the debenture is secured by the charge on some asset or set of assets which is known as secured or mortgage debenture and another when it is issued solely on the credibility of the issuer is known as the naked or unsecured debenture. A trustee is appointed for holding the secured asset which is quite obvious as the title cannot be assigned to each and every debenture holder.


First Mortgaged and second mortgaged debentures

Secured/Mortgaged debentures are further classified into two types – first and second mortgaged debentures. There is no restriction on issuing different types of debentures provided there is clarity on claims of those debenture holders on the profits and assets of the company at the time of liquidation. First mortgaged debentures have the first charge over the assets of the company whereas the second mortgage has the secondary charge which means the realization of the assets will first fulfill the obligation of first mortgage debentures and then will do for second ones.

 

Transferability / Registration

 

In the case of registered debentures, the name, address, and other holding details are registered with the issuing company and whenever such debenture is transferred by the holder; it has to be informed to the issuing company for updating in its records. Otherwise, the interest and principal will go the previous holder because the company will pay to the one who is registered. Whereas, the unregistered commonly known as bearer debenture can be transferred by mere delivery to the new holder. They are considered as good as currency notes due to their easy transfer-ability. The interest and principal are paid to the person who produces the coupons, which are attached to the debenture certificate and the certificate respectively.


Type of Interest Rates

FIXED AND FLOATING RATE DEBENTURES

Fixed rate debentures have fixed interest rate over the life of the debentures. Contrarily, the floating rate debentures have the floating rate of interest which is dependent on some benchmark rate say LIBOR etc.

No Coupon Rate

ZERO COUPON AND SPECIFIC RATE DEBENTURES

Zero coupon debentures do not carry any coupon rate or we can say that there is zero coupon rate. The debenture holder will not get any interest on these types of debentures. Need not get surprised, for compensating against no interest, companies issue them at a discounted price which is very less compared to the face value of it. The implicit interest or benefit is the difference between the issue price and the face value of that debenture. These are also known as ‘Deep Discount Bonds’. All other debentures with specified rate of interest are specific rate debentures which are just like a normal debenture.

SECURED PREMIUM NOTES / DEBENTURES

These are secured debentures which are redeemed at a premium over the face value of the debentures. They are similar to zero coupon bonds. The only difference is that the discount and premium. Zero coupon bonds are issued at the discount and redeemed at par whereas the secured premium notes are issued at par and redeemed at the premium.


Mode of Redemption

CALLABLE AND PUTTABLE DEBENTURES / BONDS

Callable debentures have an option for the company to buyback and repay to the investors whereas, in the case of puttable debentures, the option lies with the investors. Puttable debenture holders can ask the company to redeem their debenture and ask for principal repayment.

SUBORDINATED DEBENTURE

In these types of debentures, the debenture is given priority after other debts when company goes into liquidation. They are also known as subordinated loan, subordinated bonds, subordinated debt or junior debt

 

PROCEDURE TO ISSUE DEBENTURES UNDER THE COMPANIES ACT, 2013

Section 56, 72, of the Companies Act, 2013 read with Rule 18 and 19 of the Companies (Share Capital and Debentures) Rules, 2014

  1. Call and hold Board meeting and decide which types of the debenture will be issued by the Company.
  2. If the Company decides to issue secured debenture the company has to comply with the condition prescribed in the Rule 18 of the Companies (Share Capital & Debentures) Rules, 2014.
  3. In case appointment of Debenture Trustee, consent shall be obtained from a SEBI registered Debenture Trustee, who is proposed to be appointed. If debentures to be issued are Secured Debentures, a Debenture Trust Deed in Form No. SH – 12 or as near thereto as possible shall be executed by the Company in favour of Debenture Trusteeswithin sixty days of allotment of Debentures.
  4. In the Board meeting pass resolutions for
i)Approval of Offer letter for private placement in Form No. PAS – 4 and Application Forms (In case of private placement of debentures);
ii)Approval of Form No. PAS – 5 (In case of private placement of debentures);
iii)Approval of Debenture Trustee Agreement and appointment of a Debenture Trustee (In case of Secured Debentures only)
iv)Appointment of an expert for valuation (In case of private placement of debentures);
v)Approval of increase of borrowing powers, if required;
vi)To authorize for creation of charge on the assets of the company;
vii)Approve the Debenture Subscription Agreement;
viii)To fix day, date and time for the extraordinary general meeting of shareholders
   
    5. Prepare the draft of
i)Debenture Subscription Agreement;
ii)Offer Letter for private placement in Form No. PAS – 4 and Application Forms;
iii) Records of a private placement offer in Form No. PAS – 5;
iv)Debenture Trustee Agreement;
v)Mortgage Agreement for creation of charge on assets of the company.
  • Issue notices of extraordinary general meeting along with the explanatory statement.
  • Hold extraordinary general meeting and pass special resolution to issue convertible secured debentures and increase borrowing powers of the company and to authorize the Board to create charge on the assets of the company.
  • File Form No. PAS – 4 and PAS – 5 in Form No. GNL – 2 with the Registrar of Companies.
  • File Offer Letter in Form No. MGT – 14 with the Registrar of the Companies.
  • File copy of Board resolutions, Special Resolution, Debenture Subscription Agreement, Debenture Trustee Agreement etc in Form No. MGT – 14 with the Registrar of Companies.
  • File Form No. PAS – 3 (Return of allotment) with the Registrar of Companies after making allotment of debentures.
  • File Form No CHG – 9 for creation of charge on assets of the Company(in case debenture are secured)

Issue of Debentures, whether redeemable or convertible involves compliance with the substantive and procedural aspects of law, therefore, documentation becomes very important


DOCUMENTS REQUIRED:

Form

Description

Time line

Documents Required

MGT-14

Filling of resolutions and agreements to the registrar

Within 30 days,

from the date of passing of the special resolution for allotment of securities on private placement in general meeting

–       Certified true copy of special resolution

–       Offer letter issue to the shareholders

GNL-2

Form for submission of documents with the Registrar of Companies

within 30 days,

from the issue of offer letter to the recorded person

–       PAS 4 (Offer Letter)

–       PAS 5 (Record of Private Placement)

PAS-3

Return of allotment

Within 30 days,

from the date of passing of the board resolution for allotment and issue of securities

–       Certified true copy of Board minute

–       List of allottees.

 


We at Wazzeer will be glad to help you in this matter, from drafting agreements to issuing share certificates, all funding compliance matter we are equipped to take care of.

 

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Funding Compliance, Healthcare Startup

The growth of the IT sector in India has led to the emergence of Healthcare Tech sector in India. And, as a part of this immense development, to scale up, entrepreneurs look forward to raising funding for healthcare startup from an external source. This article is dedicated to founders in this sector finding answers to ” How can I raise funding for my healthcare startup?”

You can raise funds through 3 routes:

  1. FDI
  2. Venture Capital investment
  3. Borrow money

FDI Route:

  • Foreign investment into India is governed by the Foreign Exchange Management Act, 1999 (“FEMA”), the rules and regulations made by the RBI, and the Industrial Policy and DIPP.
  • 100 percent FDI is permitted in most sectors under the automatic route (no approval of FIPB”)
  • Hospital sector and in the manufacture of medical devices – 100 percent FDI allowed under automatic route
  • Pharmaceutical sector – Under the automatic route, FDI is permitted up to 100 % in Greenfield projects and 74% in Brownfield projects and FDI beyond 74% in Brownfield projects requires FIPB approval.
  • The cap on FDI in the insurance sector has been increased from 26 percent to 49 with the directive that the ownership of the insurance company be retained in Indian hands.

 

Venture Capital Investment Route:

 

  • All venture capital investment by entities registered with the Securities Exchange Board of India (“SEBI”) as foreign venture capital investors.
  • It is not mandatory for a private equity investor to register as a Foreign Venture Capital Investor (“FVCI”) under the FVCI regulations 11, there are some significant advantages to be gained by registering as an FVCI.
  • Registered FVCIs benefit from free entry and exit pricing and are not bound by the pricing restrictions.
  • FVCI can opt for both QIP route and QIB route in IPOs.
  • FVCI can opt for Lock-in options in case of IPOs.

 

Borrow Money Route:

Before entering the lending process, analyze the situation first:

  • When money lender is a foreigner:  These guidelines issued by the Reserve Bank of India (the RBI), regulate not only the returns (prescribed all-in-cost ceilings pegged to 6 month LIBOR cover fees, interest fees etc. except pre-payment fee, commitment fee and fees payable in Indian Rupees) but also the tenure and amount of the loan, the sectors and purposes for which loan can be availed, the type of security and so on. Sometimes approval of the authorized dealers and in some cases that of the RBI may be required.
  • Transaction costs: Stamp duty (and sometimes registration duty) plays a significant part in the choice of security, properties (immovable or movable and location of immovable property) and place of execution. It differs across states in India and can be very significant.
  • Money advanced against the provisions of Contract Act and Existing Laws: any contract drafted to lend money should be in accordance with Provisions of Contract Act, sometimes due to Ignorance, money is loaned to a minor or for purposes barred by Indian Law. Recovery of money in cases is extremely difficult.
  • Taxation Issues: Loan money received has no tax availed on them but when interest is charged, the interest is liable to tax.

     To Ensure Recovery of Your Money:

  • There are three easy steps to ensure the recovery of your Money-
  • Promise Note: A promissory note is an acknowledgment to pay back debt (on demand or otherwise) and may include some simple terms and conditions. If the aim is to include specific or detailed clauses, it is advisable to enter into a loan agreement.
  • Loan Agreement: Unlike a promissory note, a loan agreement can be modified. An amendment clause needs to be incorporated in the agreement. It enables the parties to amend the document on mutually-agreed terms and conditions. Thus, when more Complications are Involved
  • Money Lender License: If Money Lending is your Business and major part of your Income comes through it you need to get Money Lenders Registration from Local Authorities. Constitution grants power to State Governments to draft Legislations as to Money Lending. Some of them also impose restrictions as for rate of interest, and procedure to be followed and such licenses provide security in legal disputes.

 Enforcement Remedies: Given the overstretched judicial system in India where recovery proceedings are typically time-consuming, you can approach the Debt Recovery Tribunal under the Recovery of Debts Due to Banks and Financial Institutions Act, 1993, this represents a significant advantage. Some have tried to work around this through inter- creditor arrangements.


Wazzeer is vouched by Entrepreneurs as the most reliable Legal and Accounting Partner. We would be super excited to help you. Let’s Connect! 🙂

BTW, This blog might interest you Every Venture Wanting to Raise Funds, things you need to know


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