If you are the founder of an early stage startup on course to raising an angel round or seed/pre-seed round, from friends, family, micro/seed VCs this is relevant for you. When raising a small cheque to run your venture, hiring an experienced advisor to ensure that all required legal and statutory compliances might get overlooked. But unfortunately, slipping up on some of these compliances could pose long term, expensive and at times irreversible problems. What are the critical compliances which you don't want to slip up on?
Delay in allotting shares after remittance from Investors:
If you don't allot shares to an investor within 60 days of receiving the investment, you have to refund the investment amount within the next 15 days. Often in rounds with multiple investors remitting at different points of time, the company often waits until all (or a majority) of the investment is received before allotting shares to any of the investors. This exposes you to the risk of tripping this 60 day hard stop. Breaching this 60 day timeline is a high impact non-compliance which will pose hurdles in later round financings.
Investment amount not matching the value of shares allotted:
This can occur in two situations: (a) investor remits in a foreign currency and the company receives a marginally higher or lower amount than the value of the shares allotted; (b) a domestic investor remits a rounded off amount while the exact value of the shares allotted is different (owing to the share price not being a round number). If the company receives a higher amount than value of the shares allotted to the investor, the company should return the excess amount (even if it is a very small amount) within 75 days of receiving the money, or if the company receives a lower amount than the value of shares to be allotted, do not allot shares of a value in excess of the investment received. Any excess amount after this exercise should be refunded within 75 days of the remittance. Any non-compliance with this requirement is likely to put hurdles in future rounds and the investors would want the company to apply to the Ministry of Company Affairs to compound the non-compliance. This compounding can attract significant fines and penalties.
Gaps in complying with specified statutory process:
Issuing shares is fairly process heavy under the law. The company needs to:
- pass board and shareholders' resolutions (if the issue is a private placement or CCPS are being issued on a rights issue basis);
- obtain a valuation report if the issue is a private placement or CCPS are being issued on a rights issue basis;
- pre and post allotment filings with the Ministry of Company Affairs;
- receive the money raised in the round in a zero balance capital account, which the company does not use in its operations, like collecting revenue or paying out expenses (the money in the capital account may be used in operations only after filing of a form (Form PAS-3) with the Ministry of Company Affairs within 15 days of receipt of the money);
- if there are any foreign investors in the round, filings to be made with the RBI as well.
The valuation report in a private placement should be based on company's financials and data which are at least 30 days prior to the date of the shareholders' meeting called to approve the issue. This is only a very high level highlight of the key processes to be followed, and should not be treated as a comprehensive list of processes and compliances required. Non-compliances in issuing shares can lead to questions about the validity of the shares and might require compounding with expensive fines and penalties.
Delay/failure in RBI reporting of allotment of shares to foreign investors:
If you receive any amount from a foreign resident, including NRIs (other than amounts received from an NRI's NRO account) the company is required to make a foreign investment filing with the RBI within 30 days of allotment of shares. This filing is to be made through the company's bank where the investment is received. Failure in making this filing is a serious non-compliance and could place hurdles in the way of the Company raising foreign investment in the future until the non-compliance is corrected.
When the remittance is made, the investor's bank is required to share certain KYC information about the remitter with the company's bank. Similarly, the remitter needs to identify the correct purpose of the remittance. Once the required KYC information is received by the company's bank and the remittance is received with the correct purpose indicated, the company's bank would issue a foreign inward remittance certificate. This certificate is to be attached with the company's RBI filing. Often in angel investments made by foreign resident individuals, we see gaps in KYC information from the investor's bank or wrong purpose of the remittance being indicated by the investor. These mistakes can lead to long delays in the RBI filing, and the founder and the investor spending a disproportionate amount of time to fix the errors. To avoid this, your bank would need to play a proactive role before the wire is initiated by the investor.
We trust that this is helpful. All the very best with your fund raise and the success of your startup!
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.