Blog Article

An agreement is a legally binding arrangement between two or more parties. Several agreements are used throughout the process of funding between an investor that wants to fund a business and a company that requires funding. Some of the agreements required are non-disclosure agreement, term sheet, subscription agreement, loan agreement, shareholders agreement, etc. among other formalities a company must complete before availing of funding. This article also shows an investor how to fund and the taxation on such funding as well.

Though registration it isn’t an agreement nor is it a compulsion, investors usually require businesses to be registered so that a business can enter into formal agreements. If a business is not registered, then agreements executed in the name of the business will be considered void. Registration also legitimizes a business in the eyes of the investor as it has been approved by certified Government authority. 

Non-Disclosure Agreement (NDA)

When a company proposes their business ideas to several investors, it is important to protect the interests of business by signing an NDA between the parties. During the pitch, important information, key metrics, business proposition/idea, innovation, content, software, etc that is shared with potential investors, needs to be secured against misuse or theft, knowingly or unknowingly. After signing an NDA, the parties are bound by the terms of the contract and must maintain the confidentiality of the business proposition. As an investor, more often than not he will be required to sign an NDA agreement before being able to access company information and to provide funding.

Valuation By Chartered Accountant

The shares need to be valued by a certified Chartered Accountant (CA) and the manner of valuation in order to ascertain the equity value of the company. Once the value is determined, the price for which a company will issue shares will be at par, at a discount or at a premium. For a startup, the entire investment amount will be exempt from tax and in other cases of unregistered startups and companies, vide Notification 1 dated June 14, 2016 (CBDT Notification) had made the required changes in Section 56(2)(viib) of the Income- Tax Act, 1961, the tax rate varies based on the profit or loss (if any) from capital gains.

Term Sheet

A term sheet covers the key terms of investment. A term sheet covers the structure of the transaction and the valuation of the company. Other minor points included in the term sheet would be relating to board membership, voting rights, additional funding, exit strategy, etc. Once both the parties have an agreement on all the terms on the term sheet, the investor and the company sign a non-binding term sheet.  

To Buy Or Lend Funding

I. Buy Shares In A Company

Subscription Agreement

A subscription agreement is a customizable document that has no fixed template but share similar characteristics. It states an investor’s intent to buy shares and the investor’s qualification to buy such shares. It contains the names of the parties involved, the price of the shares, the number of shares, and the responsibility and roles assigned to each party in the agreement. Startups and small businesses employ this form of an agreement because these businesses do not meet the criteria that Venture Capitalist (VC) firms require nor do these businesses have enough resources to cater to the general public.

Any verbal agreement executed earlier with the investor is ratified and solidified with the help of a subscription agreement. To establish credibility, the subscription agreement generally requires a large amount of detailed information about the investor. A subscription agreement reveals the financial history and current status of an investor and in a way serves as a screening process for the investor. It enables a company to gauge if the investor can provide the funding amount as previously agreed upon. A lawyer or specialized legal services should be availed to draft a personalized subscription agreement.

II. Lend Money To A Company

Loan Agreement

A loan agreement is a document executed between an investor and a startup where each party makes mutual promises (in the form of debentures or other debt instruments). An investor can choose to loan money to a company (instead of exchange for equity) in return for the principal amount and interest by executing a loan agreement. The loan can be either paid back to the investor or be exchanged for shares at a later date as specified in the agreement. Since there is no exchange of shares initially, the investor would want to secure collateral against his loan. An investor should check the cash flow, creditworthiness, character, etc of the business before lending money. The paperwork involved in executing a loan agreement involves the recording of commitment letters sent between parties, a promissory note and a collateral agreement executed between the parties.

It is important to note that investors often select a combination or mixture of equity and debt to fund a company.

Due Diligence

Due diligence in the areas of finance, business and technology are an important and essential step in the process of funding. After both the parties have come to an agreement, the buyer, creditor or investor makes an evaluation of the liabilities and assets of a business along with its future market potential before giving any funding or loan. Different investors look at different metrics to evaluate the value of a business and negotiate the terms of the same with the business being invested in. Due diligence applies to the sale of companies, mergers and acquisitions, investing, funding, loan approval, auditing, etc. Third-party services or professionals are appointed by the investor to conduct due diligence.

Shareholders Agreement

A shareholders agreement covers all the terms of the term sheet. This agreement certifies that the investor is a shareholder in the company and the transaction has been recorded in an official document.  It is executed by the lawyers from both parties after both the parties have come to an agreement post due diligence. Funds can only be transferred to the company after both the parties have executed an official shareholders agreement. A shareholders agreement is binding on the company itself and the shareholders of the company. The enforceability of shareholders agreements in Indian law is based on previous case decisions, and clauses incorporated in the shareholders agreement should already exist in the Articles of Association. The new ownership of equity also needs to be mentioned in the company’s articles.

How To Fund?

If the funding is received from a foreign investor in foreign currency, then a Forward Remittance Inward Certificate (FRIC) is required by the company. The FRIC serves as an official document to record all transactions received by individuals/companies in India from outside the country. Non-Residential Indians (NRI) and Foreign Institutional Investors (FII) can invest in India through the Portfolio Investment Scheme (PIS).

The Foreign Exchange Management Act (FEMA) is an Act enacted by the Parliament of India relating to trade and payments relating to foreign exchange with respect to Foreign Policy.

The Securities Exchange Board Of India (SEBI) sets rules and guidelines for investments made and received by any individual or group of individuals to any company. The SEBI also enacted the Foreign Portfolio Investor Regulations, 2014 for regulating the process of foreign investment.

If funding is received from an Indian investor or an Indian company, then the investor can fund up to any amount as agreed upon with the company. An upper or lower limit does not exist yet and is at the discretion of the investor and the company.

Taxation On Funding

For a company to be considered a startup, some of the conditions to be met are the firm under Notification 2 of the Government of India, Ministry of Commerce and Industry, Department of Industrial Policy and Promotion (“DIPP”), number G.S.R. 180(E), dated the 17th February, 2016, published in the Gazette of India, Extraordinary, part II, section 3, sub-section (i), dated the 18th February, 2016: be driven by intellectual property and/or technology , work towards commercialisation and innovation of novel products (which is extremely difficult to quantify and measure), be less than 5 years since incorporation and also, have a turnover of less than INR 25 Crore. A start-up can bring in an Investor and the investor would be exempt from paying tax if the investor is an Indian angel investor or if domestic funds (INR) are used for making an investment.

Funds raised by an unregistered startup (a company that does not fulfill the conditions for being considered a startup under the initiative) by issuing equity will be taxed at over 30% of angel tax investment, for the amount of investment over and above the fair value of a startup. This was previously applicable to all startups, but the government has exempted all startups that have a startup stamp from paying tax on investment or funding acquired.

How To Get Your Agreements?

Availing the help of a legal professional or legal services will ensure a smooth transition from wanting to invest, to becoming a shareholder. LegalDesk.com enables a company to bring in an investor by providing services in conjunction with registration and Legal agreements/contracts (Term sheet, Shareholders Agreement, Non-disclosure Agreement, Founders Agreement) as the case may be. So ensure you safeguard your company’s position before accepting investments in your company.