For any entrepreneur to become successful, it’s necessary to define the scope of success for the founder. Every founder hopes that their company becomes a monopoly but raising funds even for a successful business can be a long journey. Founders' mindset, clarity on structures and processes, and knowledge about apt due diligence, valuation reports, and other investment-related documents are essential.
The process of raising funds may take as long as a year, and is contingent on various conditions set after commitment. This may include revenue targets, market conditions, and other regulatory compliances. Hence, it is worthwhile to spend time structuring the round to remain reasoned with your ‘ask’ for the company. For an investor, if an entrepreneur is unable to justify the amount of funds sought, it is a big red flag. While, some businesses need more capital than others in the early stage, and some need more in later stages, but seasoned investors will sniff out the inane quickly. So make sure you know why you are raising funds and why you need it on a particular timeline, and what they will be utilised for.
Startups’ nature and associated instability carry risk makes it impossible to avail debt financing. In recent years, though, equity financing has gone through a major change, and it has managed to balance the interests of startup entrepreneurs as well as investors. An angel investor or venture capitalist can now invest in the company by way of subscribing to the equity share capital or by subscribing to Compulsory Convertible Preference Shares (CCPS) or Compulsory Convertible Debentures (CCD). Equity shareholding does not ensure a fixed return on investment and it doesn’t come with any special rights or preferences. However, the last two options—CCPS and CCD—are hybrid options that are favorable to an angel investor or venture capitalist as well as the founders. Founders can effectively control the management and retain decision-making rights in the venture by issuing convertible instruments. Another form of instrument is I-SAFE - India Simple Agreement for Future Equity. This is a hybrid of all the instruments mentioned above and it can be converted into equity on the occurrence of specified events, which are agreed upon by both investor and founder. Being alert to proposals and their impact on the business is crucial.
Legal insight is required for all of the above-mentioned scenarios, especially when it comes to communicating the same to investors and other founders with lucidity. A competent CA, secretary, and lawyer will ensure structuring is done with compliance and in a meticulous manner. These professionals also prove consequential with regards to the valuation of a company, or in other words, how much stake the founders give out.
The company’s valuation report made by an accredited valuer, will set a benchmark for the threshold of company stocks. Both investors and founders will have a fair idea of how much stake should be given out at what price. This smoothens the process of raising funds, and gives an objective framework to validate the discussion.
Partnerships can make or break a business. Some strategic partners may not always bring monetary investment, but, for example, can enable the company to reach out to potential stakeholders. To extract maximum benefit from this kind of association, founders must be careful about the terms of association and do their due diligence in order to justify this partnership to the other involved parties.
The founders must be cognisant of the fact that shareholding patterns might change post-investment. They must spend time understanding the nuances of the shareholder agreement, and other legal documents to make sure that everything is in order. The founders are directly aligned with the incentives of the company, and hence they are the best parties to make sure the paperwork reflects the ideal deal for the business.
The point of fundraising is to actually have money to spend on your business. In 99 percent of cases, investors commit money subject to due diligence—the process of vetting as described above. However, this also means that the founders must conduct their own due diligence on the parties with whom they engage. The conception that an entity is trustworthy just because they are willing to put money into a business is false and can be detrimental in the long run.
Lastly, entrepreneurs must realise that even after the commitment of funds, the process of due diligence, and extensive documentation, a deal may fall through. This can be disheartening but is a part and parcel of fundraising. One must not be discouraged and must appreciate the legal insight and learning derived from a failed deal, which will definitely add value to the business when it finally succeeds.
The author is founding partner at Vis Legis Law Practice, Advocates.
The thoughts and opinions shared here are of the author.
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