Small Factories Bill

art-1192793At present, small and medium enterprises are required to comply with multiple labour laws which takes a toll on such generally resource-strapped enterprises. In an attempt to further strengthen the Government’s mission to promote ease of doing business in India, the Labour Ministry is looking to revive the Small Factories (Regulation of Employment and Conditions of Services) Bill in 2014 (“Small Factories Bill”).

What entities are covered by the Small Factories Bill?

Manufacturing companies which have less than 40 employees in a factory fall within the definition of a ‘small factory’, unless the small factory carries on a hazardous manufacturing process. In case of the later, the existing Factories Act will continue to apply.

What are the basic features of the Small Factories Bill?

  • Small factories will not have to comply with 14 legislations, including the Factories Act, ESI Act, EPF Act and the relevant Shops and Establishment Act.
  • Provisions of various labour laws, such as standards for the wages to be paid to employees, working conditions, facilities on the premises, etc will now be covered in this one Bill for small factories.
  • Employers of such small factories can electronically apply for registration of the factory, notify of the closure, and intimate the authorities of any changes in the ownership.

The Valuation Game…What Does It Mean Exactly?

In this blog, we will be explaining the concepts of investment amount and valuations. The most basic of all concepts in an investment process – if you get these basics right then the rest of the process may become relatively easier (not necessarily painless!)

Most investors / VCs and entrepreneurs start the investment game / conversation with a statement that goes something like this:

Entrepreneur: “I am seeking a $1m investment in exchange for a 20% equity stake in my company.”

Or you will hear VC say: “We typically invest $2m (or our “sweet spot” is $2m) and we take a minority stake in the startup – typically in the mid to high-teens”

The Investment Game

Let us break down the terms in the figure:

  1. The investment or Investment Amount is the actual cash amount the investor will put into your company – so it is also called “New Money
  2. The Pre-Money Valuation is the value of the company before the investment happens
  3. The Post-Money Valuation is valuation of the company immediately after the investment happens

The Ownership % is the Investment Amount over the Post-Money Valuation, also referred to as dilution, i.e. we don’t want to give away more than 20% of our company…

Dilution

So, what comes first? Pre-Money, New Money, Post Money or Ownership %?

It is the New Money!

  1. The New Money is the exact investment amount / the actual cash amount the investor will put into your company; it is also the basis for your business plan.
  2. The valuation of the company is calculated based on a funded business plan – different amount of funding means different plan – so, it comes after the New Money coming in, so, it is called Post-Money or Post-Money Valuation.
  3. So, the pre-money valuation – the value of the company before the New Money came in – is the Post Money Valuation less the New Money – it is a derived number and comes last
  4. Here you can see that the promoter ownership got diluted from 100% to 80%, or by 20%. Remember the promoters did not sell any shares, the company issued new shares which diluted the promoters’ ownership

Once the money is in – it is old money, so, now when a new investment comes in the old investor’s shares get the same dilution as the promoter shares. Take a few minutes and work through this next round of investment – $5M new-money for a $25M Post-Money.

  1. Ownership the new investor or New Money gets is 5/25 or 20%
  2. So the older ownership stakes gets diluted by 20% – i.e. reduced by a multiple of 80% or .8 – so, 80% becomes 64% and 20% becomes 16%
  3. Pre-Money is $20M – so with the new round the value of the holders of the old shares went from $10M to $20M – i.e. the value doubled
  4. The Value of the company went from $10M to $25M or 2.5x

That jump in valuation is what each investor is looking for when they invest into their company with an expectation of what the eventual return would be for them and when. All the investment terms that go alongside the valuation and ownership are linked to the differences in yours and their expectations or around the risks or ensuring some minimum returns.

So, how much equity should an investor get for funding a business?

Exactly what his Investment Amount will buy him over the Post-Money Valuation that you can agree that you will create using the funding (Investment Amount)!