Most of the times all the discussions and agreements for funding of the business is complete and the investor is ready to wire the money but still funding is delayed…why? Because some of the legal requirements are not met yet.
This is very common scenario in many a times when the start-ups go for funding. This delay in getting the money in to the bank account and set the ball rolling can be avoided if the entrepreneurs are little pro-active in having in place some of the legal things well in advance.
What are the things that the entrepreneurs should be taking care of?
Legal documentation wise all funding activities usually start with investors sending a term Sheet to the investing company. The term sheet, though not a legally binding agreement, contains all the terms of investment for clear understanding of both the parties. One of the terms of investment shall be investee company obtaining a clean certificate from the due diligence team of the investor who does legal, financial and accounting due diligence of the investee company for detecting any hidden legal or financial risks.
If the Due Diligence team finds any deficiencies in legal documentation, all corrective measures for rectifying such deficiencies shall get in to Investment Agreement as Conditions Precedent for investment. This is where the delay begins as you need to approach your CA/Company secretary to get these documentations done before investment can happen and the documentations take time.
So, lesser the findings at the time of due diligence, faster will be further steps. After conducting due diligence for hundreds of start-ups, this writer has observed that, there are certain grey areas, in which most of the start-ups will have issues. Hence an effort is made to list out many of the legally mandatory stuffs which the start-ups might have ignored during the course of their initial business operations, but are very important at the time of investment.
- Issue of share certificates to founders and initial angel investors.
Usually after the incorporation of the company or further allotment of shares to angel investors, issue of share certificates to the shareholders will gets missed out. This is because, unlike many other legal documents (like MoA, AoA, return of allotment etc), the share certificates doesn’t needs to be filed with any statutory authorities. Consequently legal consultants may not have given much of a heed for issue of share certificates to the shareholders. But, in fact share certificates are very important corporate legal documents to prove the ownership of shares and as per the provisions of Section 56 (4) of the Companies Act, 2013 every company is obliged to issue share certificates within 2 months of allotment of shares. If your company has not yet issued share certificates, share certificates should be issued before due diligence starts.
- Loan Agreements with promoters/founders
Usually promoters do spend their personal money for company during its initial days of operation. This money is in fact a loan given by the promoter to the company which will be usually formally not documented through a loan agreement. So a formal loan agreement should be made between the company and the promoters for any amount of personal money spent by the promoters which they wish to get back in future from company.
- Employment agreements with executive Directors
The founders, who will also be working for the company might have issued employment contract to all their employees but usually miss to make one for themselves with the company. But contract with all the employees including founders is very much required to clearly lay down the terms of employment and the compensation for the employment.
- Authorized capital
For every company to issue any shares, first the company should have the authorization from the Government to issue so many number of shares. The number of shares the company is authorized to issue is called authorized shares. Usually while incorporating the company, authorized capital is always blindly kept at a minimum of one lakh which would have been fully subscribed. But it would be prudent to have more authorized capital (depending upon the expected capital requirement) in advance and the authorization to issue both preference and equity shares should be made. If the company do not have authorized shares, at the time of investment discussions itself, its better to initiate the process of increasing the authorized equity as well as preference shares. This process will usually take around a week to be completed.
Once the company starts its operations and the founders try to get some key employees in the organization, always ESOP promises are made. But actual paper work for legally creating and issuing the ESOPs to employees would have never been done by the company. This should be taken care well in advance before investment talks begin.
- Shops & Establishment License
In most of the states in India, a license called Shops & Establishment license needs to be obtained under the labor regulations. Usually most of the start-ups ignore this license and minimum of 1 to 2 weeks is required to obtain this license. This can really make you frustrated if at the final moment of investment you run for this license.
- Minutes of the meeting
Every company is supposed to hold a minimum of four Board meetings in every financial year and minutes of Board meetings should be kept signed by the Chairman. Since in most of the private limited companies, these meeting will never be formally held or even if it is held, no formal written minutes are kept. There are certain statutory agenda’s to be dealt in these Board meetings and consequently same should get reflect in minutes of the Board meetings. All these documents should be properly maintained in advance well before you receive a term sheet as these are some of the rudimentary documents for a company.
- Trade Mark registration
Most of the companies will be using one or more trademarks or trade words. However would have never made a formal application for registration of these trademarks. These trade names are very crucial for the business and trade mark registration should be applied for. To obtain a trade mark registration certificate, usually more than a year’s time is required. However, trade mark application acknowledgment will serve the purpose for due diligence.
Above are some of the very basic legal documentations without which no investor can invest in any company. To get all these documents prepared from scratch, a minimum of two weeks of time is required and if you start the process after investment deal is through, you should be unnecessarily making the investor wait for transferring the money which in some cases even jeopardize the whole deal itself. None of these documentations will cost much. With better prudence and advance planning, company can sail though the investment process seamlessly.
[The author is a legal and financial expert for start-ups and SMEs. He consults through his firm G.P.S & Co. (www.gpsconsulting.in) and can be reached at firstname.lastname@example.org]