Funding compliances for startups

Funding is key for any startup to expand its horizon of products and resources. Pitching for investments and getting a deal is one aspect, but the legal side is something that founders find complicated. I experienced this when I saw some of my clients panicking about how to go about funding compliances, once they received confirmation of funds from investors in India or abroad.

Below are the pre- and post- funding compliances that a private limited company has to adhere to while receiving funds from investors:

Compliance with the Registrar of Companies (RoC) When a company receives funding, it has to a give a piece of equity to its investors in exchange, by allotment of shares. As per the guidelines of the Companies Act, 2013, a private limited company can issue shares to raise money (from within and outside India) by making a Preferential Allotment of Shares.

Preferential allotments are made to people who wish to take a strategic stake in the company, like angel investors, seed investors and venture capitalists. The issuing of shares on a preferential basis should be authorized by the articles of association of the company.

Allotment of shares should also be authorized by a special resolution, and the price of such shares should be determined by the company valuation report. There are five steps for allotment of shares on a preferential basis:

Step 1: Conducting a Board Meeting: A meeting of the Board of Directors of the company should be called for making a proposal for Preferential Allotment.

Step 2: Conducting an Extra Ordinary General Meeting: An Extra Ordinary General meeting of shareholders should be held for approving the Preferential Allotment by passing a Special Resolution (i.e. 75% of votes should be in favor of the resolution). This special resolution is valid for a period of 12 months, and the Preferential Allotment can take place anytime during this validity period.

Step 3: Issue of Offer Letters: Once the proposal has been approved by the majority, the company can go ahead and issue Offer Letters in specified formats to investors. A complete record of Preferential Allotment is to be filed with the Registrar of Companies (RoC), within 30 days of issuing the Offer Letters. After filing this record with the RoC, the company is free to receive money from the investors.

Step 4: Allotment of shares: The company has to allot securities to the investors within 60 days of receiving the funds, by passing a resolution in a Board Meeting, and filing a return of allotment with the Registrar within 30 days of such allotment. The Return of Allotment contains a list of all shareholders, with their full names, addresses, percentage of shareholding allotted and other such relevant information.

Step 5: Issue Share Certificates: On completion of the allotment, the company can finally issue share certificates to the investors that are now the “shareholders” of the company. All the above steps always apply, whether the private company is receiving funds from domestic or foreign investors. At this point, it is prudent to mention that raising funds from foreign investors entails some additional compliance, according to the guidelines issued by Reserve Bank of India (RBI), summarized as under:

RBI Compliance on raising funds from Foreign Investors A two-stage reporting procedure is to be followed when a company is raising funds from a foreign investor: On receipt of funds: The company has to provide details in an “Advance Reporting Form” to the RBI, within 30 days of receiving funds from foreign investor(s). This form should contain the following:

  1. Name and address of the foreign investors;
  2. Date of receiving funds and the amount equivalent in rupees;
  3. Name and address of the bank/authorized dealer through whom the funds have been received;
  4. Details of the government approval, if any; and
  5. KYC report on the non-resident investor from the overseas bank, remitting the amount of consideration.

Also, the company has to issue shares within 180 days from the date of receiving funds. Otherwise, it would lead to violation of the Foreign Exchange Management Act (FEMA) regulations. On issue of shares to foreign investors: The company has to report in specified form (FC-GPR) to the RBI, within 30 days from the date of issue of shares along with: A) A Certificate from the Company Secretary certifying that

  • the company has complied with the procedure for the issue of shares, as laid down under the Foreign Direct Investment (FDI) Scheme, and,
  • the investment is below the ceiling permissible under the Automatic Route of the Reserve Bank, and/or in terms of the approval of the government, as the case may be, and that all the requirements of the Companies Act have been complied with

B) A certificate from a Chartered Accountant indicating the manner of arriving at the price of the shares issued to the foreign investors. Although the procedures stated above are lengthy, it is very important for companies raising capital to be aware and ensure compliance for a smooth business.

This article was originally published at YourStory

Nikita Bhatia
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