Information to Include in Director’s Report

The following information must be mandatorily disclosed in the Director’s Report filed by the Board of Directors:

1 Dividend, if declared & amount, if any, carried forwarded to reserves
2 Details of ESOPs:

a. Options granted

b. Options vested

c. Options exercised, and

d. Total number of Options in force, if any

3 Information about the financial performance / financial position and details of the subsidiaries / associates/ JV
4 Details of loans, investments and guarantees by the company
5 Details relating to deposits, covering the following:

Accepted during the year;
Remained unpaid or unclaimed as at the end of the year;
Whether there has been any default in repayment of deposits or payment of interest thereon during the year and if so, number of such cases and the total amount involved (i) at the beginning of the year (ii) maximum during the year and (iii) at the end of the year.
Details of deposits which are not in compliance with the requirements of Chapter V of the Act

6 Website address
7 Disclosures under the Sexual Harassment of Women at Workplace (Prevention, Prohibition & Redressal) Act, 2013
8 Borrowing by the company
9 Details of rent paid
10 Electricity expenses
11 Director remuneration (for each director)
12 Details of transfer of shares during the financia year
13 Break up of related party transaction (1. Name of related party and nature of relationship and 2. Duration of the agreement)

Important Deadline — Form filing for loans and deposits — June 30

If your company has taken loans or deposits, this form filing requirement applies to you!

Every company having outstanding money/loan received shareholders or directors or any other person has to file Form DPT-3 by June 30, 2019 with respect to deposits/exempted deposits accepted by the Company and the amount of loan/money outstanding as on March 31, 2019.

In case, no amount/loan has been received by the Company which can be considered a deposit or exempted deposit, the filing of form DPT-3 with ROC is not applicable.

Also, in case there are deposits accepted by the Company, you also require a certificate from the statutory auditor certifying the details of the same.

In case of default in filing of form, the Company shall be liable to pay a penalty of Rs. 5,000 and Rs. 500 per day in case of a continuing default. If the Company is non-compliant then it shall be chargeable with fine of Rs. 1 Crore to Rs. 10 Crore. Every officer who is in default shall be chargeable with fine of Rs. 25,000 to Rs. 2 Crore and imprisonment up to 7 years.

LexGyaan Series on ESOPs – Part 1: How do Employee Stock Options Plan (ESOPs) work?

CREATING AN ESOP POLICY

In our experience of having assisted several entrepreneurs with execution of ESOPs for their startups, we have observed that most entrepreneurs are under the impression that by just mentioning the number of ESOPs on their cap table, or in offer letters to their employees, the startup has fulfilled its obligation to grant ESOPs to its employees. This is actually incorrect.

Mentioning ESOP pool on your cap table actually just makes your investors happy. Why? Well when an investor invests in your startup, they want to ensure that they do not get diluted for any reason except in case of future rounds of fundraising by your startup (even for that they have the right to maintain valuation aka pre-emptive right). It is important for investors that their shareholding does not get diluted in order to give shares to your employees, mentors or all those well-wishers of yours, whose help and guidance you took in the initial days of starting up and promised equity to. Only you the founder should get diluted to give these promised equity shares to your mentors and advisors, not the investors. This is the reason why investors require a startup to create an ESOP pool/advisory stock option pool, as a condition precedent to their investment in a startup. This is also the reason why investors require you to convert all loans from friends and family, and conversion of convertible notes, if any.

Related reading: Understand how valuations work and how a founder’s shareholding gets diluted when an investor invests in a startup in our blog titled ” The Valuation Game.. What Does It Mean Exactly? , by our co-founder, Karthik Chandrasekar.  

Therefore, all you have achieved by mentioning a “ESOP Pool” on your cap table and inserting a number against it is (a) carving out the maximum number / percentage up to which your investors won’t get diluted, and (b) demonstrating to your investors, your intention to give ESOPs some day to your employees.

At this stage, where your startup’s ESOPs are only on the cap table, your ESOPs are only a virtual pool. How do you convert the ESOPs in to reality? Well, that’s easy, you will just have to create an actual ESOP pool. In order to do that, you will have to take the following steps:

Step 1

Draft an ESOP Policy in compliance with the Indian Companies Act, 2013. The ESOP Policy will have to set out in detail the terms of ESOPs, cliff period, vesting schedule, exercise price/strike price, exercise period, consequences of employee leaving the startup, consequences of the startup getting acquired, etc.

Sign up here to request a free Demo

Step 2

Once the draft ESOP policy has been finalized and if you have investors in your startup, then check your Shareholders’ Agreement and Articles of Association, to verify if the approval of investors for a ESOP policy will be required. Lost? Well, just look for a clause that is titled either as “reserved matter right” or “affirmative voting matter” or  “affirmative voting right” or “investor protection matter”. Once you find this clause, then look through the several items and check if creating a stock option, ESOP etc is listed therein. If it is, then you would have to send an email to your investor alongwith copy of the ESOP policy for your startup, requesting the investor for its approval to the ESOP policy.

LexGyaan: Most VCs get their respective legal team to also review the ESOP policy. Therefore, be prepared for few iterations and discussions.

 Step 3

Where you don’t have any investors in your startup, you can skip step 2 and directly proceed with step 3, i.e., convene a Board Meeting for approval of the ESOP Policy. How to convene a board meeting properly under Companies Act, 2013?

Step 4

Convene a meeting of Shareholders (aka EGM) of your startup, for approval of the ESOP Policy.

Now you have an ESOP policy and can formally start granting ESOPs. Click here to download a free template of a ESOP grant letter!

Click here to read FAQs on ESOPs.

LexStart makes ESOP creation a breeze. Click here to learn more. Request a Demo.

 

LexStart’s LexGyaan Series: Can I grant ESOPs to a Co-Founder?

Granting ESOPs to Promoters/Co-Founders

I often get asked this question – “Can I grant ESOPs to a Co-Founder who I recently brought on board my Startup?”. Well the answer is both yes and no!

The Companies Act, 2013 prohibits grant of ESOPs to the Promoter of a company. The term “Promoter” does not necessarily refer to only a person who is named as a Promoter at the time of incorporation of the company. A Promoter is defined broadly and includes, the following:

  • Any person who has been named as such in a prospectus or is identified by the company in its annual return; or
  • Any person who has control over the affairs of the company, directly or indirectly whether as a shareholder, director or otherwise; or
  • Any person in accordance with whose advice, directions or instructions the Board of Directors of the company is accustomed to act. Provided that such person is not someone who is acting merely in a professional capacity.

Therefore, typically a Co-Founder who you bring on board at a later stage, may not be a Promoter as stated in the Charter Documents (Memorandum and Articles of Association of your Startup) but still can be considered a “Promoter”, thus restricting him from receiving ESOPs in the company.

ESOPs to Promoters/Co-Founders of recognized Startups

The Companies Act, 2013 has made an exception to the above rule, by allowing Startups that are recognized by Govt. of India to grant ESOPs to founders, as long as the grant of such ESOPs is within 5 years from their incorporation. This means if your Startup has a Certificate of Recognition from DPIT, Govt. of India, then you can grant ESOPs to Promoters/Co-founders.

Related Readings : How to Get Startup India Registration

FAQs on ESOPs

 

Issue of Shares with Differential Voting Rights

What is Differential Voting Rights?

Shares with Differential Voting Rights (DVRs) means shares that give the holder differential rights as to voting (either more or less voting right) as against the Ordinary shareholders of the company.

Types of DVR    

  • Shares that have superior voting rights
  • Shares that have inferior voting rights

Eligibility/Condition for issue of shares with DVR*

  • AOA of the Company should authorize issue of DVR;
  • Consistent track record of distributable profits for the last three years;
  • No default in filing annual return for last 3 Financial Years;
  • No default in payment of declared dividend or repayment of deposit or loan borrowed;
  • the shares with differential rights shall not exceed twenty-six percent of the total post-issue paid up equity share capital;
  • No penalty by court or tribunal for any offense for the last 3 Financial Years; and
  • The shares issued with DVR cannot be changed later.

*This provisions shall not apply to private companies in case MOA and AOA of the company provide otherwise.

Procedure for issue of shares with differential voting rights

  • Check AOA of the Company;
  • Obtain valuation certificate from registered valuer;
  • Open a separate bank account;
  • The terms of issue of shares should be finalized;
  • Conduct board meeting for issue of shares with DVR;
  • In case issue of DVR affects the rights of existing class of shares then obtain consent from 3/4th of the shareholders of that class;
  • Filing form MGT-14 with ROC within 30 days of EGM;
  • Circulate offer letter along with the share application form to the investors;
  • Receive share application money along with the application form ;
  • Conduct board meeting for allotment of shares;
  • File form PAS-3 within 15 days of allotment of shares;
  • Pay stamp duty and issue share certificates; and
  • Make entry in register of members.

Difference between DVR shares and Ordinary Shares

DVR shares
  • Provide few or higher voting right to shareholders.
  • Rate of dividend is low or higher.
  • DVR shares are ideal for small shareholders or promoters.
  • Issued at a discount in comparison with ordinary shares.
Ordinary Shares
  • One share One Vote.
  • Rate of dividend is fixed for class of shareholders.
  • Ideal for large shareholders.
  • Issue at FMV.

Advantages of Issuing shares with DVR

From Issuer Perspective
  • To raise more capital without diluting its ownership structure.
  • Get control in decision making process.
  • A tool to avoid hostile take over.
  • To fund large Project.
From Investor Perspective
  • Benefit to investors since share are issued at discount & also for incremental dividend.
  • Better for investors who are looking for good quick return rather than voting rights.
  • Institutional Investors can invest in private companies without any limit and making it a subsidiary.

Dis-advantages of DVR

From companies Perspective
  • Lack of investor awareness about such issue of shares.
  • Issue shares at discount.
  • Minority shareholders can lose faith in the Company.
From investor Perspective
  • Lack of investor awareness about such issue of shares.
  • Possible misuse of voting power
  • by the promoters & hence act
  • against the interest of the shareholders.
  • Lack of liquidity may hamper return.
  • Not beneficial for Institutional
  • Investors as they are
  • interested in voting rights and long term capital gains both.

Case of Tata Motors

  • In 2008, issued DVR shares.
  • It was the first company in India to issue DVR shares and amongst the very few in Asia.
  • Issued at Rs 305 a share which was about 10% lower than the issue of normal rights at Rs.340.
  • Will offer 5% of more dividends.
  • Gives an additional 10.3% discount.
  • But carry one-tenth the voting rights of ordinary shares. This means 10 DVR shares = 1 ordinary share as far as voting rights is concerned.

Amazon caps voting rights in Witzig Advisory Services at 17%

  • Amazon has bought 17% stake in the company through Class A shares and the rest 32% through Class B shares having differential voting rights (DVR).
  • Each Class A share shall have one vote, while the Class B shares shall not carry any voting rights. This effectively caps Amazon’s voting rights in Witzig at 17%.
  • Amazon appears to have made use of DVR shares to comply with the new ecommerce FDI norms that came into force from February 1, and also to ensure that More can continue selling on its Indian marketplace.
  • The new ecommerce FDI guidelines had forced Amazon to reduce its stake from 49% to 24% in Cloudtail and Appario, the two top sellers on its marketplace. The American etailer had also evaluated the idea of limiting its holding in Witzig to less than 26%, and not acquiring 49% in the company as was originally planned.
  • By capping its voting rights in Witzig at less than 17%, Amazon will be able to continue with More as a seller. Samara Capital will hold 51% in Witzig, making the latter an Indian owned-and-controlled company.

Conclusion

  • For an investor, who wants to be in the company’s decision processes, DVR  shares is not an attractive proposition due to limited voting rights.
  • But if an investor isn’t concerned much with voting rights, then investing in the DVR would certainly be an attractive option.

Disclosure of Significant Beneficial Ownership

The Ministry of Corporate Affairs (MCA) on June 13, 2018 notified Section 90 of the Companies Act, 2013 (Act); and notified Companies (Significant Beneficial Owners) Rules 2013. This rule came into effect on June 14, 2018. These provisions require certain compliances to be followed by a Significant Beneficial Owner and a company.

Who is a “Significant Beneficial Owner”?

“Significant Beneficial Owner” means an individual who acting alone or together, or through one or more persons or trust, including a trust and persons resident outside India, holds ultimate beneficial interest of not less than 10% in shares of a company or the right to exercise, or the actual exercising of significant influence or control in a company.

This applies to the (i) individual who is acting alone or together with one or more persons (includes partnerships) (ii) includes a trust (iii) person resident in India or outside India.

 Sr. No. Where Shareholder of a company is a Who is Significant Beneficial Owner?
A. Company Significant Beneficial Owner is the natural person, who, whether acting alone or together with other natural persons, or through one or more other persons or trust holds atleast 10% of share capital of the Company or exercise significant influence or control in the company.
B. Partnership Firm Significant Beneficial Owner is the natural person, who, whether acting alone or together with other natural persons, or through one or more other persons or trust holds atleast 10% of capital or is entitled of not less than 10% of profits of the partnership firm.
C. Trust The Significant Beneficial Owner shall be- the author of the trust, and the trustee and the beneficiaries with not less than 10% interest in the trust and any other natural person exercising ultimate effective control over the trust through a chain of control or ownership.

Where no natural person is identified in point no. A and B in the table above, the Significant Beneficial Owner is the relevant natural person who holds the position of senior managing official.

What is the obligation of Significant Beneficial Owner?

  • Every existing Significant Beneficial Owner is obligated to file a declaration in Form No. BEN-1 with the respective company. This declaration is to be made by September 10, 2018.
  • Every Significant Beneficial Owner shall file any change in his significant beneficial ownership within 30 days to the company.
  • Every individual, who acquires significant beneficial ownership in a Company, shall file a declaration in Form No.BEN-1 to the Company within 30 days of acquiring such significant beneficial ownership.

What are the obligations of the Company?

  • The company receiving the declaration has to maintain a register of Significant Beneficial Owners.
  • The company has to file a return in Form No. BEN-2of significant beneficial owners of the company and changes therein with the Registrar within 30 days from the date of receipt of the declaration.
  • Maintain a register of significant beneficial owner in Form No. BEN – 3.
  • Also, if the Company knows or has reason to believe that someone is s Significant Beneficial Owner (or has been a Significant Beneficial Owner in last 3 years) and is not registered with the company as a Significant Beneficial Owner then, the company is required to give notice to such person seeking information in Form No.BEN-4.

Consequences of non-disclosure by Significant Beneficial Owner

  • Shares may be made subject to the restriction on transfer.
  • All rights in shares held by such Significant Beneficial Owner shall be suspended, including, voting rights, dividend etc.
  • The MCA may impose penalty of up to INR 1,00,000/- and INR 1,000 per day the default continues.
  • Such Significant Beneficial Owner can be charged with fraud under Section 447 of Companies Act, 2013.

Consequences of non-compliance by a company?

Fine ranging from INR 10,00,000/- to INR 50,00,000/- for company and INR 1,000 per day the default continues.

Who is exempted from definition of Significant Beneficial Owner?

  • Mutual Funds;
  • Alterative Investment Funds (AIFs); and
  • Real Estate Investment Trusts (REITs) and Infrastructure Investment Trusts (lnvlTs).

Startup India Series: Raising money from Angel Investors: How to take money from friends and family ? (Part 2) (Raising money by issuance of equity shares)

Fundraising 2 (1)

In Part 1 of this series we looked at debt as a means of raising money for a startup.

In Part 2 we look at raising money through issuance of equity shares.

A company can raise money by issuing shares to existing shareholders or new investors, and this process is fairly simple as long as all investors are Indian residents.

Pros: Since the investment is being made in the shares of your company and is not being provided as a personal debt to you or as a loan to your company, there is no question of returning the investment at a later date and in most cases there is no requirement to provide dividends.

Cons: With third party capital you are bound to give up certain amount of control (Term Sheet), and always remember that the third party investor is looking for an exit, whether it is short term or long term. You should be very careful while negotiating exit clauses and try to avoid any form of excruciating promoter buybacks, where the promoter will end up having to buy back the shares of the investors mandatorily after a certain time period (and usually at a certain profit margin) in case they fail to provide an exit.

The biggest challenge when raising equity capital in the early stage is valuation. How do you agree how much dilution is ok? Wondering what we are talking about? Read our blog on the Valuation Game and how it affects your shareholding as a promoter in your startup.

Compliance check: While issuing shares always ensure that you obtain a valuation report for the shares from a merchant banker and do not undervalue them during issuance, since there can be severe tax implications in case you decide to issue shares at a price lower or higher (in case of angel investors) than the fair value.

Things to look out for: Do think about the dilution that the founding team will be facing. Considering that at an early stage the valuation of the company will be quite low, you may end up becoming a minority shareholder in your own company in case you raise too much money through the equity route at early stages. Also have a shareholders agreement in place which clearly identifies the rights of each party and ensures that there is no room for confusion at a later date. Equity investment in a private company can be uncharted territory for friends and family and make sure that you educate them on the risks involved prior to the investment.

With the Startup India series we plan to answer the ten most commonly asked common legal questions which we get asked. In the next part we answer “Raising money by issuing convertible instruments”

At LexStart we advise startups at various stages of growth on disclosure related compliances and non-disclosure arrangements. You can reach out to [email protected] with any specific queries that you may have.


Disclaimer: Please note that the article above is for information purposes only and represents the views of the author and should not be construed as legal advice.

Private Limited Company or Limited Liability Partnership. Which one to choose?

Many Entrepreneurs starting a new business are curious about the comparison between a Private Limited Company vs LLP. Both entities offer many similar features required to run a small to large sized business, while also differing starkly on certain aspects.

In this article, we will decode for you the comparison between Private Limited Company vs LLP from the viewpoint of an Entrepreneur starting a new business.

Registration Process

The Private limited company registration process and the LLP registration process are very similar with some differences in the documents and forms being filed for incorporation. The steps for incorporation of a Private Limited Company are:

  1. Obtaining Digital Signature Certificate (DSC) for the proposed Directors,
  2. Obtaining Director Identification Number (DIN) for the proposed Directors,
  3. Obtaining name approval from MCA and 4. Filing for incorporation.

LLP registration also has a similar process:

  1. Obtaining Digital Signature Certificate (DSC) for the proposed Partners,
  2. Obtaining Director Identification Number (DIN) / Designated Partner Identification Number (DPIN) for the proposed Partners,
  3. Obtaining name approval from MCA and 4. Filing for incorporation.

Both Private Limited Company and LLP are registered with the Ministry of Corporate Affairs and are issued a Certificate of Incorporation. The processing time for incorporation of a private limited company and LLP are also comparable with both entities taking on average about 20 days to incorporate.

Registration Cost

The Government fee for incorporation of an LLP is significantly cheaper when compared to the Government fee for incorporation of a Private Limited Company. LLPs have been introduced to meet the needs of small businesses and hence LLP enjoy lower government fee for incorporation. Also, the number of documents that have to be printed on Non-Judicial Stamp Paper and Notarized is lesser for LLP registration when compared to that of a Private Limited Company registration.

Features

Both LLP and Private Limited Company offer many of the same features. LLP and Private Limited Company are both separate legal entities and have assets and liabilities that are separate from that of the promoters. LLP and Private Limited Company are both transferable, though a Private Limited Company offers more flexibility when it comes to transferring or sharing of ownership. LLP and Private Limited Company both have perennial life, unless and otherwise closed by the promoters or a competent authority.

Ownership

Private Limited Company offers more flexibility for the promoters when it comes to ownership and ownership sharing. The ownership of a Private Limited Company is determined by its shareholding and a private limited company can have up to 200 shareholders. Further, since the shareholders do not directly participate in the management of the company, there is a clear distinction in a private limited company between the owners of share and the management. Hence, a private limited company is advantageous when it comes to ownership and management features.

In a LLP, there is not a clear distinction between the owners and management. In a LLP, the LLP Partners hold ownership of the LLP and also hold powers to manage the LLP. Therefore, a Partner in an LLP will be both an owner and a manager, whereas, in a Private Limited Company, the shareholders (owners) do not necessarily have to have management powers.

A private limited company is recommended for any business that is considering FDI or Employee Stock Options or Equity funding or Venture Capital funding.

Compliance

Tax compliances are similar for both private limited company and LLP. However, when it comes to compliance relating to the Ministry of Corporate Affairs, LLP enjoys significant advantages. An LLP does not have to have its accounts audited if the annual turnover of the LLP is less than Rs.40 lakhs and the capital contribution is less than Rs.25 lakhs. An LLP would, however, have to file LLP FORM 8 and LLP FORM 11.

A private limited company, on the other hand, would have to file annual return audited financial statements with the Ministry of Corporate Affairs each year.

Fines and Penalties

The penalty for non-compliance or late filing of documents with the Ministry of Corporate Affairs are most of the times higher for an LLP as a flat fee of Rs.100 per day is levied when the non-compliance continues with no cap on the liability. Therefore, LLPs could incur larger penalty or fines from MCA due to non-compliance. Therefore, it is important for the promoters of an LLP to be aware of the due dates and file the required documents with the registrar on time.

Other Factors

Private limited companies have been in existence for longer than LLPs and enjoy widespread recognition in India and the world. Therefore, there are well-established processes and procedures for Private Limited Companies. LLPs, on the other hand, is a recently introduced entity in India. Therefore, some of the rules, regulations, and procedures are continuing to evolve. LLPs are also not as recognized in India as a private limited company since it is a relatively new concept.

Private limited company offers its promoters a better image or standing than that of an LLP. Private limited company also enjoys better access to funding from banks and foreign direct investment.

Foreign Ownership

Foreigners are allowed to invest in an LLP only with prior approval of Reserve Bank of India and Foreign Investment Promotion Board (FIPB) approval, whereas in Private Limited Company Foreigners are allowed to invest in a Private Limited Company under the Automatic Approval route in most sectors.

Existence or Survivability

Existence of a Partnership business is dependent on the Partners. Could be up for dissolution due to death of a Partner.

In LLP, existence is not dependent on the Partners. Could be dissolved only voluntarily or by an Order of the Company Law Board, however in a Private Limited Company existence of a Private Limited Company is not dependent on the Directors or Shareholders. Could be dissolved only voluntarily or by Regulatory Authorities.

Registering the right type of company is crucial to the success of your business as it will help you avoid any complications later on. Every entrepreneur needs to closely consider his/her needs before even thinking of registering a company because every business is unique and the type of company you choose can go a long way in ensuring its success!

Contributed by: Vashvi Panwar