What happens if an employee leaves the company before the shares have vested?

This depends on the ESOP policy of the company. The norm is for the unvested ESOPs to lapse upon cessation of employment. This means that the employee will not be able to exercise and avail ESOP benefits from those ESOPs any more.

However, in case an employee suffers a permanent incapacity while in employment, all the ESOPs granted to him as on the date of permanent incapacitation, shall vest in him on that day and in the event of the death of an employee while in employment, all the ESOPs granted to him till such date shall vest in the legal heirs or nominees of the deceased employee.

Below are the typical scenarios:

Company Friendly
Event Vested Unvested
Termination with Cause Lapse Lapse
Termination without Cause Exercise within the notice period Lapse
Resignation Exercise within the notice period Lapse
Death or Disability Exercise within 3 months of the event Exercise within 3 months of the event
Retirement Exercise on or before the last working day Lapse

 

Employee Friendly
Event Vested Unvested
Termination with Cause Exercise immediately Lapse
Termination without Cause Exercise immediately Lapse
Resignation Exercise immediately Lapse
Death or Disability Exercise within 6 months of the event Exercise within 6 months of the event
Retirement Exercise within 6 months of the event Exercise within 6 months of the event

What does Cause in the above scenario mean?

 If your employment agreement has a definition of cause, you could consider including that. If not, then we would recommend the following definition:

“Cause” shall include:

  • Wilful insubordination or disobedience, whether or not in combination with another, of any lawful and reasonable order of a superior.
  • Theft, fraud, misappropriation, embezzlement, moral turpitude or dishonesty in connection with the employer’s business or property.
  • Habitual absence without leave, overstaying the sanctioned leave without sufficient grounds, or proper and satisfactory explanation, or habitual late attendance.
  • Commission of any act subversive of discipline or good behavior on the premises of the Company, such as, drunkenness, riotous, disorderly or indecent behavior, gambling or taking or giving bribes or any illegal gratification whatsoever.
  • Disregard of the rules of the Company.
  • Disclosing to any unauthorized person any confidential information with respect to the Company and/or its business and/or its operation, including but not limited to trade secrets, intellectual property etc.
  • Commission or attempt to commit any cyber-crime.
  • Proven instance of sexual harassment.
  • Any other grounds that results in the Board of Directors of the Company to conclude that the act or omission by the concerned person may result in loss, damage or injury to the Company.

 

 

Applying for Trademark? Here is how you can get a proprietor code

Before creating a Proprietor Code you need to ensure that you have a valid Class III Digital Signature Certificate and the same is installed on your computer.

Proprietor Code can be created online on the Trademarks Registry’s Website. To create a Proprietor Code you need follow the below steps.

  1. Go to http://www.ipindia.nic.in/
  2. Click on Trademarks;
  3. On the next page, click on Comprehensive eFiling Services for Trade Marks;
  4. On the next page, click on No Account? Sign Up;
  5. On the page, click on Proceed for Registration;
  6. The Next Page will display the New User Registration Form; on this page, select “Proprietor” in the type of Applicant and in the Enter Code box, type your (applicant’s) name and click on Search;
  7. On the next page, type your (applicant’s) name in the box and click on Submit;
  8. On the next page, click on Add New;
  9. On the next page, select the Proprietor Category and fill up the form, the form requires basic details like:
    • Name;
    • Address;
    • Nationality;
    • Service Address (where you want all notices to be served);
    • Telephone:
    • Fax;
    • E-mail;
    • Trade Description (Brief description of your business);
    • Trading As (Business Name);
    • Legal Status (Company, LLP, Partnership Firm, Trust, etc.).
  10. Once you have filled the form, click on Submit and a Proprietor Code will be generated.

You need to mention the same Proprietor Code, for all applications made under the same name.

What happens if an employee leaves the company before the shares have vested?

This depends on the ESOP policy of the company. The norm is for the unvested ESOPs to lapse upon cessation of employment.

However, in case an employee suffers a permanent incapacity while in employment, all the ESOPs granted to him as on the date of permanent incapacitation, shall vest in him on that day and in the event of the death of an employee while in employment, all the ESOPs granted to him till such date shall vest in the legal heirs or nominees of the deceased employee.

Below are the typical scenarios:

Company Friendly
Event Vested Unvested
Termination with Cause Lapse Lapse
Termination without Cause Exercise within the notice period Lapse
Resignation Exercise within the notice period Lapse
Death or Disability Exercise within 3 months of the event Exercise within 3 months of the event
Retirement Exercise on or before the last working day Lapse
Employee Friendly
Event Vested Unvested
Termination with Cause Exercise immediately Lapse
Termination without Cause Exercise immediately Lapse
Resignation Exercise immediately Lapse
Death or Disability Exercise within 6 months of the event Exercise within 6 months of the event
Retirement Exercise within 6 months of the event Exercise within 6 months of the event

What does Cause in the above scenario mean?

If your employment agreement has a definition of cause, you could consider including that. If not, then we would recommend the following definition:

“Cause” shall include:

  • Wilful insubordination or disobedience, whether or not in combination with another, of any lawful and reasonable order of a superior.
  • Theft, fraud, misappropriation, embezzlement, moral turpitude or dishonesty in connection with the employer’s business or property.
  • Habitual absence without leave, overstaying the sanctioned leave without sufficient grounds, or proper and satisfactory explanation, or habitual late attendance.
  • Commission of any act subversive of discipline or good behavior on the premises of the Company, such as, drunkenness, riotous, disorderly or indecent behavior, gambling or taking or giving bribes or any illegal gratification whatsoever.
  • Disregard of the rules of the Company.
  • Disclosing to any unauthorized person any confidential information with respect to the Company and/or its business and/or its operation, including but not limited to trade secrets, intellectual property etc.
  • Commission or attempt to commit any cyber-crime.
  • Proven instance of sexual harassment.
  • Any other grounds that results in the Board of Directors of the Company to conclude that the act or omission by the concerned person may result in loss, damage or injury to the Company.

Is Your ESOP Grant Really an ESOP Grant or Just an Offer?

I was talking to a startup founder about ESOPs and he very proudly informed me that he has given ESOPs to his employees. I must say I was impressed! The reason being, this friend of mine had incorporated his start-up only 6 months back and although he had been hiring aggressively, I didn’t think he had the bandwidth to set up a ESOP Policy to give the employees the ESOP benefits. On further probing, he very innocently explained to me that he had indicated the no. of ESOPs for each employee and other details of the ESOP grant in their respective offer letters. Therefore in his opinion, he had completed the daunting task of “granting” ESOPs.

Well, he is not the only one! Most entrepreneurs think they have granted ESOPs just because they have mentioned the same in the offer letter or employment agreement of their employees, without realizing that under the Indian laws (more specifically, the Companies Act, 2013), for a company to grant ESOPs to its employees, the company has to first create a ESOP Policy, which has to be approved by the Board of Directors and Shareholders of such company.

EMPLOYEE STOCK OPTIONS – LIFECYCLE

ESOP POLICY – HOW IT WORKS

The law has a very specific ESOP definition and prescribes all the terms that need to be included in a ESOP Policy. You should therefore ensure that you include the following terms in a ESOP Policy:

  1. Total number of ESOPs to be granted
  2. Identification of classes of employees entitled to participate in the ESOP Policy
  3. Requirements of vesting and period of vesting
  4. Maximum period within which the ESOPs shall be vested
  5. Exercise price
  6. Exercise period and process of exercise
  7. Lock-in period, if any (lock-in period means the period during which the employee is not entitled to transfer the shares issued to him upon exercise of the vested options)
  8. Conditions under which option vested in employees may lapse e.g. in case of termination of employment for misconduct
  9. Specified time period within which the employee shall exercise the vested options in the event of a proposed termination of employment or resignation of employee.

OFFER LETTER = ESOP GRANT?

Sorry for the digression. Coming back to my friend’s example. He had not created a ESOP Policy, but had just mentioned ESOPs as part of the compensation package for his employees, in their offer letter. This did not mean that the employee had been given or “granted” ESOPs. An employee officially gets ESOPs only when the company, after creating a ESOP Policy (duly approved by Board and Shareholders) issues a letter to the employee indicating the exact no. of ESOPs being given to the employee and the terms of such ESOPs. Till the time you, as a company have completed these formalities, you have only promised ESOPs to employees and not granted them ESOPs!

Also remember, delay in granting ESOPs would result in delay in vesting of ESOPs to employees, as there is a mandatory 1 year cliff on ESOPs under the Companies Act, 2013. So, a delayed ESOP grant means a delay in ESOP benefits accruing to the employees.

 It is therefore important for every startup to create ESOP Policy at the earliest and actually grant ESOPs to their employees! #StartRight_RightNow! 

Tax Implications of Stock Incentives

EVENT TAX IMPLICATION ON EMPLOYER TAX IMPLICATION ON EMPLOYEE
Granting of ESOPs, i.e., when the company/startup issues a grant letter to the employee setting out details of ESOPs granted to the employee. NIL

 

(This is because there is no monetary transaction being conducted at this stage. Additionally the employee only gets an option to buy shares at the time of grant)

Vesting of ESOPs, i.e., when employee fulfills the conditions stated in the grant letter and becomes eligible to purchase shares of the company) NIL

 

(This is because there is no monetary transaction being conducted at this stage. Additionally the employee only gets the right to buy shares at this point)

Exercise of ESOPs, i.e., when the employee actually purchases shares in the company/startup Employer may have to deduct TDS (withhold tax) on the additional perquisite value, in accordance with Section 192 of the Income Tax Act, 1961. Difference between the Fair Market Value (“FMV”) of shares on the date of exercise of option and amount paid by employee, shall be taxable as ‘perquisite’ under Section 17(2)(vi) of the Income Tax Act, 1961.
Sale of shares (where shares were held for less than 36 months by the employee), i.e., when the employee sells shares held by him NIL Difference between the sale price and the FMV of shares on the date of exercise would be treated as short-term capital gains. Gains would be taxable as per the ‘normal slab rate’ applicable to an individual under the Income Tax Act, 1961.
Sale of shares (where shares were held for more than 36 months by the employee)  i.e., when the employee sells shares held by him NIL Difference between the sale price and the FMV of shares, on the date of exercise would be treated as long-term capital gains.

 

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 or holds equity in 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 the DIPP, Government of India to grant ESOPs to Promoters, 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 DIPP, Government of India, then you can grant ESOPs to Promoters/Co-founders.

 

Designing your Stationary? Ensure you include these.

Under the Companies Act in India, every company is required to mention certain items on its letterhead and visiting cards. It is therefore pertinent that you include these items while designing your startup’s letterhead and visiting card.

Dormant Company – What does it mean? And how to go about it?

Foreward by Anisha Patnaik, Co-Founder

When one decides to discontinue their business operations, the first option that comes to the mind is shutting down the company. This almost always seems to be the way out, because, one doesn’t want to get into the hassle of maintaining compliances for an inactive entity. However shutting down or “winding up” as is referred to in the legal parlance, can be a long process involving paperwork. Moreover, what if you change your mind and want to restart operations again? If you have gone down the long winded route of “winding up”, you will have to incorporate a fresh company all over again.    

It is for such situations, that the Indian law has provided for changing the status of a company from “Active” to “Dormant”. It is almost like putting a company in a deep freezer for some time, till you are ready to bring it out and start running again. The advantage of keeping a company dormant is that you do not have to comply with all the requirements under the Companies Act. The compliance requirement is minimal and hence the cost of running or keeping operational an otherwise unoperational company is low. And, you can almost immediately change the status of the company back to “Active” if you decide to revive it.  Of course, one cannot keep a company in “dormant” state forever. The law prescribes 5 years as the maximum period for “dormant status” of a company, post which, if the company is not revived, the Registrar of Companies (Ministry of Corporate Affairs) will automatically strike off the company’s name from its records!

Read more, in detail about the “Dormant Status” in the below article, by our Compliance LexStar, Hamza Boxwala.     

What is a dormant company?

Dormant Company is a company which is not carrying on any business or operation. As per Section 455 of the Companies Act, 2013 (“Act”), where a company is formed and registered under this Act for a future project or to hold an asset or intellectual property and has no significant accounting transaction, such a company or an inactive company may make an application to the Registrar of Companies (“RoC”) for changing it’s status to that of a dormant company.

When can a company be called “Inactive”?

“Inactive” means the company has not been carrying on any business or operation, or has not made any significant accounting transaction during the last 2 financial years or has not filed financial statements and annual returns during the last 2 financial years.

“Significant accounting transaction” means any transaction other than 

  1. Payment of fees to the Registrar.
  2. Payments made by it to fulfill the regulatory requirements.
  3. Allotment of shares.
  4. Payments made for maintenance of office and records.

When a voluntary application is filed with the RoC for dormant status or when a Company defaults in statutory annual filings for a consecutive period of 3 years, the RoC changes the status of the company from “Active” to “Dormant”.

Dormant status can be obtained for all type of companies. This includes private limited, public limited and OPC.

What are the conditions to be fulfilled before applying for dormant status?

  1. The company should not have been carrying on any business or operation, or not made any significant accounting transaction during the last two financial years or has not filed financial statements and annual returns during the last two financial years
  2. In case there is any unsecured loan in the Company then consent of the lender should be obtained.
  3. Statement of Assets and Liabilities should be obtained from Statutory Auditors of the Company.
  4. No dispute certificate should be obtained from the management or promoters of the Company.

Are there instances when a company may fulfill the above conditions, and yet be ineligible to apply for dormant status?

Set out below are few instances, when a company can be disqualified from converting to a “dormant” status, inspite of fulfilling the conditions prescribed under the Act:

  1. Where any inspection, inquiry or investigation has been ordered or taken up against the company or prosecution has been initiated against the company and pending under any court.
  2. Where it has any public deposit or interest thereon outstanding for payment.
  3. Where there is any secured creditors in the Company.
  4. Where the company has any outstanding tax dues either to central or state government or local authorities and has defaulted in payment of workmen dues.
  5. Where the company is listed in stock exchange.

Does a dormant company also have to comply with any filing requirements?

 Yes, a dormant company will have to comply with certain compliance requirements, although these are very minimal. Listed below are the compliance requirements:

  1. A dormant company should file ”Return of Dormant Company” every year indicating the Company financial position duly audited by Chartered accountant in practice in Form MSC-3.
  2. A dormant company is required to convene at least one Board meeting in every six months.

What are the benefits of having dormant status?

  1. To revive and operate a company you intend to use in future.
  2. To protect your interest and reputation as a sole trader.
  3. To hold a fixed asset such as a property.
  4. Less compliance.

What is the procedure for conversion of status from dormant to active company?

If company that has been declared as “dormant” starts carrying out significant transactions, then within 7 days from the date of undertaking such transaction, the company will have to file an application with the RoC in form MSC-4 accompanied by a return in Form MSC-3 to get back the status active from the earlier status of dormant.

After considering the application, the RoC will issue a certificate in Form MSC-5 approving the change of status of the dormant company to active company.

For how long can a company continue in “dormant status”?

A company can continue in dormant status for a maximum period of 5 years. Before the expiry of 5 years, the company will have to apply for changing the status to “Active”, otherwise the name of Company shall be struck off by the RoC.

How long does it take to change the status of a company from “active” to “dormant”?

It takes around 1-2 months to complete the whole process of obtaining dormant status subject to the satisfaction of queries if any of the RoC.

P2P Lending Regulations – Important Provisions You Should Know

The Reserve Bank of India, in its recent notification, has brought in platforms carrying out the business of P2P lending under the purview of NBFC. Below are the key provisions:  

  1. Any business proposing to carry out business of Peer to Peer (“P2P”) Lending will be required to register with the Reserve Bank of India (“RBI”).
  2. Existing entities carrying out the P2P business will have to register within 3 months of the notification
  3. Dos and Don’ts
    1. What can a registered P2P entity do?
      • Act as an intermediary providing an online marketplace or platform for P2P lending.
      • Ensure adherence to legal requirements applicable to the participants.
      • Store and process all data relating to its activities and participants on hardware located within India.
      • Undertake due diligence on the participants and undertake credit assessment and risk profiling of the borrowers and disclose the same to their prospective lenders.
    2. What are the restrictions on a registered P2P entity?
      • Cannot raise deposits.
      • Cannot lend on its own.
      • Cannot provide or arrange any credit enhancement/credit guarantee.
      • Cannot facilitate or permit any secured lending linked to its platform.
      • Cannot hold, on its own balance sheet, funds received from lenders for lending, or funds received from borrowers for servicing loans.
      • Cannot cross sell any product except for loan specific insurance products.
      • Cannot permit international flow of funds.
  4. Prudential Norms
    • A P2P entity shall maintain a Leverage Ratio not exceeding 2.
    • The aggregate exposure of a lender to all borrowers at any point of time, across all P2Ps, shall be subject to a cap of INR 10,00,000/-.
    • The aggregate loans taken by a borrower at any point of time, across all P2Ps, shall be subject to a cap of INR 10,00,000/-.
    • The exposure of a single lender to the same borrower, across all P2Ps, shall not exceed INR 50,000/-.
    • The maturity of the loans shall not exceed 36 months.
    • P2Ps shall obtain a certificate from the borrower or lender, as applicable, that the limits prescribed above are being adhered to.
  5. Mode of Transfer of Funds
    • Fund transfer between the participants on the P2P lending platform shall be through escrow account mechanism, which will be operated by a trustee.
    • The P2P entity needs to set up at least 2 escrow accounts – 1 for funds received from lenders and pending disbursal, and the other for collections from borrowers.
    • The trustee shall mandatorily be promoted by the bank maintaining the escrow accounts.
  6. Prior written permission of the Bank shall be required for:
    • Any allotment of shares which will take the aggregate holding of an individual or group to equivalent of 26% and more of the paid up capital of the P2P entity.
    • Any takeover or acquisition of control of a P2P entity, which may or may not result in change of management.
    • Any change in the shareholding of a P2P entity, including progressive increases over time, which would result in acquisition by/ transfer of shareholding to, any entity, of 26% or more of the paid up equity capital of the P2P entity.
    • Any change in the management of the P2P entity which would result in change in more than 30% of the Directors, excluding Independent Directors.
    • Any change in shareholding that will give the acquirer a right to nominate a Director.
  7. Public Notice about Change in Control/ Management
    • A public notice of at least 30 days shall be given before effecting the sale of, or transfer of the ownership by sale of shares, or transfer of control, whether with or without sale of shares. Such public notice shall be given by the P2P entity and also by the other party or jointly by the parties concerned, after obtaining the prior permission of the Bank.
  8. Intimation Requirements – Change of address, directors, auditors, etc. RBI needs to be intimated about any of the following changes, within 30 days from the change:
    • The complete postal address, telephone number/s and fax number/s of the registered / corporate office.
    • The residential addresses of the Directors of the company.
    • The names and office address of the auditors of the company.
    • The specimen signatures of the officers authorised to sign on behalf of the NBFC-P2P to the Regional Office of the Department of Non-Banking Supervision of the Bank within whose jurisdiction the Registered Office of the P2P entity is located.
  9. Reporting Requirements 

The following quarterly statements are required to be submitted to the RBI within 15 days of the end of each quarter:

  • A statement, showing the number and amount in respect of loans (quarterly).
  • The amount of funds held in the Escrow Account.
  • Number of complaints outstanding at beginning and at end of quarter, and disposed of during the quarter.
  • The Leverage Ratio, with details of its numerator and denominator.

Convertible Note- The Simpler Form of Fundraising

Anyone who has gone through the process of fundraising in India, will tell you how cumbersome and tedious the process can be! Right from haggling over valuation for a startup that is still in the process of building a product or testing the waters to having to procure a valuation certificate and a string of board and shareholders’ resolution – the entire process can sometimes leave you in need for a break even before you have started out!

“Why can’t we simply do a Convertible Note?” was a common question we got asked often. For most of you familiar with the Silicon Valley style convertible note – this was not an option in India till very recently. A “Convertible Note” structure in India till recently, still required you to go through the process of allotment of instruments like “Compulsorily Convertible Preference Shares” (CCPS) or “Compulsorily Convertible Debentures” (CCD) which involve several compliance related paperwork but most importantly still required you to assign a valuation to the startup, either a current valuation or for a potential future conversion value.

In yet another step to ease doing business in India, the Ministry of Commerce and Industry, Government of India, has permitted recognized  “Startups” to raise funding through the convertible note route.  What does this mean? If you are a company that has received a Certificate recognizing you as a “Startup” from the Government of India, you can accept funds in the form of a debt from investors,  which can convert into equity at a future date. Of course everything comes with conditions. In order for a recognized Startup to receive funding through Convertible Note, the following additional conditions will have to be complied with:

  • The amount of investment will have to be atleast INR 25 lakhs in a single tranche
  • The amount will have to be converted within 5 years
  • The terms of conversion will have to be determined upfront

Take this quick 2 minute test to find out if you can raise or invest in Convertible Notes!

For those who haven’t fundraised and are wondering what the brouhaha is about, well the below graphic should answer your questions:

The VC view. Here is what Karthik Chandrasekar, our Co-Founder and also Founder & CEO of Sangam Ventures has to say about Convertible Notes:

I’m one of those that keeps whining to Anisha about how painful it is to do seed investments without the ability to do true Convertible Notes. When we (@ Sangam Ventures) had a chance to do a SAFE investment in Inficold, Inc. in the US, we jumped on it. So, when the awesome folks at Startup India gave recognized startups the ability to issue Convertible Notes, we had to jump on it and make good use of it!

Most startups need to raise funds soon after incorporation to fund hiring and operations, and the Convertible Note can be a vehicle for investors to fund companies at this very early stage.  Most of the value is in the idea and vision of the founders and the founding team. Unlike the sale of equity in traditional priced rounds of financing, a company can issue a Convertible Note quickly and efficiently, without multiple documents and the necessity of amendment to the charter documents.  As a flexible, one-document security, without numerous terms to negotiate, the Convertible Note should save companies and investors money and time.

In the simplest terms the Convertible Note is an IOU as in “I owe you money!” and can be linked to the expected return rather than a valuation and percentage of ownership getting away from the valuation quagmire for a seed stage investment.

A Convertible Note is typically set up like a debt instrument with an interest rate and maturity date along with a discount on the next significant round of investment which values the startup. If the Convertible Note hasn’t converted by the maturity date it converts to equity in the startup, again requiring to set a valuation for this potential conversion today. But, thankfully the convertible note unlike a CCD does not require filing a valuation certificate on the issue date.

We took the Convertible Note opportunity given by the folks at Startup India a bit further by moving to what Y-Combinator developed for its investments, the SAFE. As defined by Y-Combinator, “A SAFE is a Simple Agreement for Future Equity. An investor makes a cash investment in a company, but gets company stock at a later date, in connection with a specific event.  A safe is not a debt instrument, but is intended to be an alternative to convertible notes that is beneficial for both companies and investors.” The key difference is that the SAFE does not have a maturity date, for our case, we ignore the maturity date provision of 5 years in the regulatory requirements because in 5 years we are all dead in the startup universe – i.e. we expect to use SAFEs / Convertible Notes when investing in very early stage startups that we expect will raise money within 12-18 months or die! I will speak a bit later on our preference and different options one can have under the SAFE.

So, when does a Convertible Note / SAFE make sense? [at least for us]

  1. When the value of the startup cannot be determined easily
  2. When the value of the startup cannot be agreed upon between the founders and the investor within meaningful bounds
  3. When the focus for both the investor and founders is to be very efficient with their time and the investment is for very short time horizons – seed round to get to a fund raise or bridge round to get to the Series-A

 

When does it not make sense to do a Convertible Note / SAFE?

  1. The investor is looking for a lot of protective provisions or a complicated set of terms for the conversion
  2. There is no urgency in closing the round and with some effort a value for the startup can be determined by the investor
  3. There has been a recent investment where another investor has valued the startup or there are already multiple investors in the startup
  4. What the startup is looking for is a loan or other non-dilutive forms of financing

On the SAFE option

The preferred options in a SAFE instrument for the Y-Combinator (this might be a good time to give the SAFE Primer a read) is one with a Valuation Cap i.e. the investment amount will convert to equity at the lower of the next round valuation and the Valuation Cap. In India, we have found this to be problematic where the next round investors are always looking into what the previous round investor set as a potential future valuation – also our pet peeve with the CCDS. So, we dropped the Valuation Cap – exposes us to not getting the upside if our startups get some absurdly high valuation, we will rethink it when a few of our startups do that 🙂 For now, we are going with a discount on the next round of investment which builds up and gets capped at the end of a 12-18-month period by which we expect our investees to fund raise. For investors who want to be super safe with value coming back to you can always take the option of doing both. The last one that is used in the SAFE which we like is the MFN or Most Favored Nation provision – where if the startup issues a SAFE or Convertible Note before getting to a valued financing round, the SAFE investor has the option of converting to the new instrument at which point the SAFE and the MFN provision ceases to exist.

Many thanks to the LexStart team for templating the Convertible Note (in the form of a SAFE) which we used for our investment in Delectrik Systems Pvt. Ltd. The same can be downloaded here along with a primer for you to review and use for yourselves. Would recommend reaching out to the LexStart team if you have any questions or using their services for the first time you do a Convertible Note investment, they can also help your startups with the process of getting the Startup India recognition.

Here is hoping this really opens up the seed stage investment eco-system for FDI investors and we see the Convertible Note becoming the instrument of choice for seed investing in India.

Happy Investing!