Modes of Funding/Capital Infusion for Startups

A successful business requires investment of time, effort and MONEY for its long term growth and prosperity.  Infusion of funds is an essential pre-requirement, especially for Startups if they want to scale up and make their brand popular and visible.

Innovative and promising Startups or businesses always attract enterprising investors who are ready to stake their money and a get a good return out of the same. The difficult part arrives when the decision on the mode of funding has to be evaluated.

There are a lot of factors which determine the mode of funds infusion. Whether the funds are to be given in exchange of Shares or to be treated as Debt or Convertible instrument depends upon the expectation of return and repayment by the investor and relationship with the Company.

This article will give you a brief about different modes of funds infusion and their applicability:

SHARE CAPITAL

One of the most common methods of raising funds is by issue of shares of the Company.

Share capital is a long-term source of finance. In return for their investment, shareholders gain a share of ownership in the company, access to voting rights and right to participate in the management.  Shareholders are not entitled to any interest on their investment. They can be paid dividend on their investment depending on the profits of the company which is subject to the provisions of The Companies Act 2013.

The purpose of investing in Share Capital is to reap the benefit or gain through increase in value of shares. For example – Angel Investors who invest at early stages intend to exit by disposing off their shares in next bigger round of investment at a higher valuation.

Share capital is generally of two types: Preference Share Capital and Equity Share Capital.

The major difference between Preference and Equity Shares is that the former does not enjoy voting rights and have a preferred right to dividend as well as return of capital at the time of liquidation.

 

Most of the investors prefer to invest in Preference Shares to avoid the risk of loss of initial investment in case of liquidation or bankruptcy of the Company. This goes well with the Company also, as Preference Shareholders do not have management and voting rights and hence, there is no interference in the working of the business.

DEBENTURES/BONDS

Bonds and Debentures are debt securities. They have an implicit level of safety simply because they ensure that the principal investment is returned to the lender at the maturity date with interest or upon the sale of the security.

Generally, a legal agreement is executed between the Company and the Investor at the time of issue of debentures specifying in detail, the term and conditions of repayment and interest.

Also, the Debenture-holders are creditors of the Company who get preference in repayment of liability over the shareholders, at the time of liquidation.

Debentures are further classified as Convertible or Non-convertible.

Convertible debentures can be converted into equity after a specific period of time. You can read about these under the section “Convertibles”.

Non-convertible debentures do not have the option of equity conversion but are generally coupled with a higher interest rate.

CONVERTIBLES

The most commonly used instrument for raising Capital by Early Stage Startups is Convertibles.

Preference Shares, Debentures and Loans – all can come with a convertible option. These instruments provide the benefit of deferring the valuation of the Company to a later stage when the conversion to equity actually takes place.

Convertibles are particularly attractive to those investors who want to participate in the rise of hot growth companies while being insulated from a drop in price should the stocks not live up to expectations.

Convertible Preference Shares or Debentures have the advantage of being fixed-income securities that the investor can choose to turn into a certain number of shares of the company’s common stock after a predetermined time span or on a specific date. The fixed-income component offers a steady income stream and some protection of the investors’ capital. However, the option to convert these securities into stock gives the investor the opportunity to gain from a rise in the share price.

The conversion into Equity Stock takes place through a pre-determined conversion price or conversion ratio which represents the number of equity shares, investors may receive for every convertible preferred share or debenture.

UNSECURED LOAN

A loan is when you receive money from any person, bank or financial institution in exchange for future repayment of the principal, plus interest. Loans can be either secured or unsecured.

A secured loan involves pledging an asset (such as a car, house) as collateral for the loan. If the borrower defaults, or doesn’t pay back the loan, the lender takes possession of the asset. These loans enjoy a level of safety because of the collateral attached to them.

An unsecured loan is the one which doesn’t have any security attached to it and supported only by the borrower’s creditworthiness. Though there is a risk of non-repayment of money attached to it, but it is easy and less time taking for a company to raise an unsecured loan. The process does not generally require too much paper works and is easy to execute.

A Private Company can take unsecured loan from its Directors or his relatives ONLY. “Relatives” include the ascendants and descendants of the director and their spouses.

CONVERTIBLE NOTES

The concept of Convertible Notes was recently introduced by the Companies Act making this option exclusively available to Startup Companies.

Convertible notes can be defined as a type of loan or debt security issued in the form of some document or certificate to the investor in return of the money lent to the Company. The amount raised in exchange of Convertible Notes has to be repaid or be converted into equity shares of such startup company at the option of the holder. It should be repaid or converted within a period not exceeding 5 years from the date of issue of the Note. It can also be repaid or converted on occurrence of specified events as per the terms and conditions agreed upon between the parties.

These notes can also be issued to NRIs subject to conditions mandated by RBI in this regard. The minimum amount that has to be raised against issue of Convertible Notes is Rs. 25 lakhs or more in one tranche.

A company can enter into a legal agreement with the Investor at the time of issue of these notes specifying the details of the issue and the terms and conditions of repayment.

Choosing an appropriate mode of funding:

Before choosing an appropriate mode of funding, the pros and cons of each of the methods have to be carefully evaluated. Following points can be kept in mind while choosing the appropriate mode-

  • Whether the company wants to dilute the ownership of the promoters in the Company.
  • Whether the company can afford to include the investors in the management of the entity.
  • Whether the company can afford to pay a fixed sum as interest on debt or loan.
  • Conditions relating to compliances required under different Laws and the cost for the same.
  • Tax benefits available- Interest paid on debt financing is allowed as deduction from profit whereas dividends are paid out of the profits earned and dividend distribution tax is to be paid.

Penalty for Non-filing of LLP annual returns – Can winding up save penalty?

Although Limited Liability Partnership is one of the most popular forms of starting a business, there are various compliances which are required to be followed annually once the business is incorporated.

The Annual Compliances of LLP primarily include:

  • Filing of Annual Return of the LLP in Form 8 – Due date 30th October of the succeeding FY
  • Filing of Financial Statements of the LLP in Form 11 – Due date 30th May of the succeeding FY

Penalty for Non-filing

Late Filing of Form 8 and Form 11 attracts a late fee of Rs.100 per day each per form immediately after the due date till the date the form is actually filed.

In view of the above, one can understand the huge of penalty that can be imposed if there is a substantial delay in filing the annual forms. One should note that these are online forms and cannot be filed without making the fee payment, in any case.

We get numerous queries from many people who formed their LLP but did not carry out any business since the date of incorporation. The most common questions that arise at this point are:

Is it compulsory to complete the annual filings even if the business has not commenced or not been conducted throughout the year?

Yes, it is absolutely compulsory to complete the Annual Filings even if your business has not commenced or not been conducted throughout the year. There is no exemption to annual filings.

Can the LLP be closed without completing the Annual Filings?

No, it is important to complete the Annual Filings before closing down or winding up the LLP.

Many partners of LLP’s are under the impression that if they wind up the LLP, they can avoid the Penalty on non-filing. But unfortunately, this is not the case.  An LLP cannot be wound up without completing the pending compliances as the process of Annual Filings and Winding up is inter-connected. The LLP can be wound up only when all the ROC compliances are up to date and MCA records are updated in this regard.

Conclusion:

Partners of LLP’s should understand that winding up of the business is not the solution to escape the imposition of penalties.  Rather they have to comply with all pending filings and update the ROC with the status of affairs, may it be for continuing the business or discontinuance.

In view of the above it is utmost important to get your LLP incorporated from experienced and responsible professionals who could guide you in complying with the ROC Compliances.

Consequences of Non-Filing of Annual Return and Financial Statements

The consequences of Non-Filing of Annual Return and Financial Statements are severe and one must be aware as well as cautious in this regard. Companies Act 2013 require every Company to file its Annual Return and Financial Statements with the Registrar of Companies, containing information as prescribed in this regard, within 60 days from the date of holding the Annual General Meeting.

Annual return and Financial Statements is mandatory to be filed by all companies, whether it has commenced its business or not, or even if it is a defunct or non-functioning company. In case the Annual Return and Financial Statements are not filed within the specified time period, the same can filed thereafter on payment of requisite late fees. The late fee is of a substantial amount depending upon the period of delay and it should be better avoided.

However, when the Annual Filings are not completed within a period of 270 Days from the date on which it should be have been actually submitted, then the Company and its Officers are imposed with severe consequences.

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Non-Filing of Annual Return

CONSEQUENCES

1. Imposition of Penalty: The company shall be punishable with fine which shall not be less than 50,000 but which may extend to 5,00,000.

2. Penalty imposed on directors/officers: Every officer or Director of the company who is in default shall be punishable with imprisonment for a term which may extend to 6 months or with fine which shall not be less than 50,000 but which may extend to 5, 00,000, or with both.

3. Inactive Company: If the Company has not filed its Annual Return for last two financial years consecutively, it will be termed as “Inactive Company”. Thereafter, the Registrar shall issue a notice to the Company and enter its name in the Register of Dormant Companies.

4. Disqualification of Directors: If a company has not filed its Annual Return for continuous period of three financial years then;

  • Every person who is or has been a director of that company shall not be eligible for reappointment as a Director of that company or any other Company for a period of 5 years (5 years from the date on which the company becomes defaulting)
  • The director of a defaulting company would not be eligible to sign e-forms for any other company, until the default of the defaulting company is made good.

In view of the above, it is highly recommended for every Company to file its Annual Return and Financial Statements without any delay.

What is Statutory Audit

Audits are primarily aimed at protecting a company’s shareholders. They help investors gain confidence in a company and reflect the company’s true business health and performance.

A fast-paced business environment combined with the need to be in sync with the global standards has raised the performance bar for companies and brought in high-quality statutory requirements in the country.

The demand for accurately audited accounts has put more weight on the shoulders of a statutory auditor, usually a chartered accountant. As a result, in recent times, statutory audit has magnified in terms of complexity.

Statutory: Let’s understand the word Statutory means anything regulated by laws of the state. Statutory audit is the official inspection of a company’s accounts typically by an independent body. More elaborately put, it is the audit of books of accounts of a company, according to the requirements of a statute, to ensure fair and accurate representation of its financial records. There are many types of audits in India prescribed by different regulatory bodies. However, commonly, the term ‘statutory audit’ deals with the requirements of the Companies Act, 2013.

The right approach

Even though it happens year after year, the microanalysis and the constant questioning can take a toll on a company and its employees. No matter what the business is, or how big it is, the audit process essentially remains the same. Here is a step-by-step guide to help you understand and prepare for this complex annual routine.

  • Step 1 Plan it well: This is the most important part that most people forget. It is important to understand how well the auditor knows your company and business. A detailed study can help you deal with potential issues and problems early. The more the auditor understands your company, the easier it gets for you. So, to help the auditor know you better, you may have to provide the following details. – The corporate structure including the history, locations, and the market share of your company. – Operations comprising services, products, marketing, and processing – Financial statements, accounts, liquidity, stocks and shares, etc.
  • Step 2 Draw up a schedule: Keep a checklist of the tasks and the assignments along with names of the people who are responsible. Working around a timetable makes it easy to review paperwork and identify any misses, and decide on actions to be taken. The auditors too, usually, obtain the management representation letters beforehand.
  • Step 3 The Audit: The whole audit process works around four main areas. a) Cash b) Stocks c) Receivables d) Payables, e) Statutory requirements and records. The audit analysis may be clubbed under broad subheadings based on statutory requirements and records.
Balance sheet Profit and Loss account
Share capital Secured and unsecured loans Current liabilities and provisions Statutory payments and returns Fixed assets Inventories Investments Current assets: sundry, cash and bank balance, deposit Sales and other income Purchase and other direct expenses Manufacturing expenses Administrative expenses Charges

A good auditor will compile previous years’ (PY) working papers for reference. The team will thoroughly examine the company’s accounting systems and financial statements. The depth of inspection depends on the internal control assessment. If the control report is satisfactory, further testing is limited and if not, a more in-depth analysis is carried out. In the initial phase, auditors examine the Previous year’s copy of audited balance sheet, P&L statements, schedules, and the audit report.

  • Step 4 Verification of various registers and files:The auditors will also physically verify the stock-in trade, if any. The important files to be presented include:- Purchase bill – Sales Register – VAT payments and returns – Salary and wages – Fixed assets purchased – Trade license – Property Tax paid challans – E S I paid challan outstanding – Payment of advance tax – TDS certificates – Investment papers – Bank reconciliation statement. The audit team may put a company’s controls to test not only to see their effectiveness but also to verify that everything is actually present and not just on paper. Effectively, every asset and transaction will go through an audit trail to prove its legitimacy.
  • Step 5 Discussion and feedback: Ideally, there is a discussion at the end of each step of the audit. These informal dialogues offer an opportunity for mutual feedback regarding the analysis of the controls, the documents, and the areas that require improvement or prompt action.
  • Step 6 The Audit report: The final audit report is made after complete analysis and understanding of the financial statements and after all areas of concern have been satisfactorily addressed. The audit team then presents its report to the company’s board or audit committee.

The arrival of the annual statutory audit should not serve as a warning signal. It should rather become a part and parcel of a company’s systematic function. Scientologists use the term ‘auditing’ synonymously with counselling. A hassle-free audit can be ensured with knowledge of the process, proper organization, and preparedness.

VenturEasy can support companies with Statutory Audit through Registered Auditors on panel. Get in touch with us at [email protected]

The importance of a Website Privacy Policy

With the development of technology and e-commerce, the related problems are also on the rise. While websites are growing more interactive and user-friendly, the need for a privacy policy in place that ensures the data security is also becoming essential.

Web users have the right to know that the personal details that many business websites, blogs and online shopping sites ask them to fill out are in safe hands. It is not just to fulfill legal demands, but also an effective tool of transparency towards customers. It is a global norm that such a legal document be exhibited online wherever collection or sharing of personal information is involved.

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Importance of a Website Privacy Policy
The India context

India is the biggest platform of data outsourcing and has, in the recent past, faced a lot of cyber crime, data theft, etc. Therefore, there is a need for a regulating mechanism to deal with these crimes effectively and ensure highest security of internet databases.

The Information Technology Act of 2000 is the consolidated document that lays down guidelines for the development and maintenance of websites, electronic records and digital signatures. The Act defines cyber crimes such as hacking, infusion of virus, unauthorized copying of, tampering with information and also prescribes penalties for them.

An amendment to the Act, in 2008, brought such activities as circulation of offensive or obscene content, identity theft, impersonation, cyber terrorism, voyeurism and child pornography into the criminal domain.

A further amendment in 2009 states that any negligence while handling sensitive personal information is likely to pay penalty and is liable for punishment. This includes disclosure of sensitive personal information without consent of the person.

What is a Privacy Policy?

A privacy policy is a legal document, aimed at protecting online consumers against many unlawful activities and misuse of personal data. It is a very important document and must be crafted in simple terms so as to be easily understood by anyone without any obscurity.

A website privacy policy would consist of the following sections: – Introduction: A brief about the organization, the business and any other specifics about the website.

– The Information: The users need to be clearly told what information is being collected, e.g. forms to purchase, subscribe and sign up. Other information such as hostnames and IP addresses should be mentioned here.

How the data is collected: Here, the method of collection of information is to be described. Is it automated? Is the user asked to fill forms or refer other names, addresses, etc.

– Storage of data: The location of the database and any country or region specific laws that apply are to be mentioned.

– Third party sharing: Almost all websites share the information in their databases with others, such as courier services, or banks. The user needs to be informed that their information maybe shared within the legal domain.

– Website contact details: Email addresses, postal addresses, phone numbers, etc. have to be mentioned so as to allow users to get in touch in case of queries or grievances.

Sensitive Personal Information According to The Information technology Rules, 2011 sensitive information includes the following.

• Passwords

• Financial information such as bank account, credit card or debit card details.

• Information describing physical, physiological or mental health condition of a person

• Sexual relationship and orientation

• Medical records

• Biometric data.

Creating, updating, monitoring or managing privacy policies also involves certain best practices. For those who are responsible, whether it’s part of your job because you’re an entrepreneur and everything is your responsibility, or you’re hoping to add this area to your book of knowledge, there are certain best practices to keep in mind. Some of the points are given below:

1) The policy must be written in plain English. If a lawyer is drafting the policy then you must ask it to be written in simple language which will be understood by the consumer or visitor.

2) Something found free on the Internet should not be just cut and pasted as your own. The risk of penalties is very real and therefore your policy should be your own and reflect the unique circumstances of your site.

3) The privacy policy should be updated regularly to reflect changes in the online environment, what your company actually does with that information, and clarify areas that may be vague. This updation must of course also be communicated to the visitor.

4) Follow the policy! Do not deceive the consumers by not following the policy. What is written should be followed.

5) Consumers, readers, forum visitors, or others should have the right to opt out of having their personal information retained.

6) A privacy policy should be easy to find and accessible.

7) The information that you take from consumers should be secure too. The potential disclosure or sale of private information can be devastating.

8) Try and get a well-respected privacy certification program for credibility.

9) You should never ask for intrusive or excessively personal information through a privacy policy unless absolutely necessary.

Consumers are becoming increasingly intuitive and will refuse to provide information that they feel is not required. If you do ask for extremely personal information, be clear on why you need it and how secure it will be.

What we post on Facebook, Twitter or other online social media all constitute personal information and we cannot imagine how this kind of data can be used or misused. Privacy policies are often not given the attention they deserve. A company may dish out a policy without even realizing its actual merit.

We must make an effort to read these policies as consumers and these policies also say a lot about what the company stands for and what it wants to achieve. Information is key to future growth and it gives insights of what cannot be replicated any other way. We all want our information to be safe and secure and a well-written privacy policy is the first step to doing just that!

Get in touch with us at [email protected] if you would like us to draft a Privacy Policy for your startup.