With the Startup India series, we plan to answer the ten most common legal questions which we get asked. This week we answer your queries on raising funds from angel investors.
Once you have got that killer idea, found the team, worked out your business plan (and planned on how you will spend the billions that you make from the business !), one consideration hits you in the face: Money or rather the lack of it ?
Although terms like “lean” and “bootstrapped” are now in vogue, every startup will have a certain burn rate in its initial years and unless you plan to fund yourself, it may be a good idea to get incorporated and start looking to raise money.
The first round of investments that a startup raises is generally from friends and family and under Indian laws, a startup can look forward to raising money by means of a loan or by issuing shares.
While issuing shares is a fairly simple process (as long as issuances are being made to Indian residents), taking loans by a startup maybe a bit more complicated, considering that a company incorporated in India, can accept loans from only certain people. There is a third option of issuing a convertible instrument, where the money received will be treated as a loan on the books of the company, till the loan converts into shares of the company.
In this 3 series article, we take a detailed look at all the possible options, i.e.:
(iii) Convertible Debt
(i) Debt: Debt can be raised in form of a simple loan or a secured loan (where the property of the founders or the company acts as security for the loan). The catch is that under Indian laws companies can accept loans only from certain specified persons. Therefore before your company accepts a loan from friends or family make sure to check that you are allowed to do so under the Companies Act and the Deposit Rules.
As per Indian law, loans can be taken by a company from persons who were at the time of giving such loan, a director or a relative a director the company, provided the lender in this case gives a declaration that the loan being given is not out of borrowed funds. “Relatives” under Indian company law include Father (including step-father), Mother (including step-mother), Son (including step-son), Son’s wife, Daughter, Daughter’s husband, Brother, (including the step-brother), and Sister.
In case your company is planning to accept any loans from any other relatives (Uncles and Aunties!), and they are not directors in your company, such loan will be treated as a deposit and will require complex compliance.
Things to look out for: Typically loan agreements with institutional lenders (e.g. Banks, NBFC’s) give the lender the option to convert their debt into equity in case there is a default on the part of the startup. Also a lender typically has the option to recall the loan immediately incase there is an “event of default” i.e. any event which makes the lender feel that there might be a risk of non-payment by the startup. Also, in case you as a founder give a personal guarantee, please understand that you will end up repaying the loan from your pocket in case there is a default on the part of the company.