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11 Jul 2016

Start-up fundraising gets a boost!

By: Rajnish Pal
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The Companies (Acceptance of Deposit) Amendment Rules, 2016 (hereinafter referred as “Amendments”) notified by Government of India on June 29, 2016 (http://www.mca.gov.in/Ministry/pdf/Rules 30062016.pdf) has addressed some key bottlenecks in fundraising by companies in general and  start-ups in particular.

The Companies (Acceptance of Deposit) Rules, 2014 (referred as “Deposit Rules”) had made fund raising through convertible securities very onerous. The stringent requirements allowed companies to raise funds only either through “Secured Bonds or Debentures” or “bonds or debentures compulsorily convertible into shares of the Company within 5 years”.

Given that by and large, start-ups are unlikely to possess significant tangible assets that could be used as security, fund raising through “Secured Bonds or Debentures” was not seen as a credible option. Investors too were left with no choice but to invest either by directly subscribing to equity or at best, by subscribing into Compulsorily Convertible debentures of tenures of up to 5 years. Any investment which was structured as optionally convertible debentures or redeemable debentures was not covered by the list of exclusions for being treated as “Deposits”. As a result, most start-ups and  investors have stayed clear of this path for obvious reasons.

The recent amendments have succeeded in removing this bottleneck besides as well as bring some additional points which should cheer up start-ups/investors alike.

 

  1. Investment through Convertible note:

An amount of INR 25,00,000 received by a Start-up by way of “convertible note” in a single tranche from a person would not be considered as a “Deposit”.

 

The important thing to be kept in mind is that:

  • The Start-up must be a company recognized by Department of Industrial Policy and Promotion (DIPP) under Ministry of Commerce and Industry [as referred in Start-up India Action Plan (startupindia.gov.in)].
  • The Convertible note is either repayable or convertible into equity shares within a period of 5 years;

The redeemability or convertibility is at the option of holder.

b. Amounts received from Alternate Investment Funds, domestic VC Funds and Mutual Funds registered with SEBI

 

Considering that most AIFs, VC Funds, Private Equity Funds and Mutual Funds are structured as “Trusts”, any amount received from such entities which were not in the nature of an equity investment or CCD’s were treated as “Deposits”. This was a bottleneck for any Investor to provide bridge funding or to get into short term arrangement to help start-ups where they have already made investments.

 

Now, since receipt of any amount from AIFs, domestic VC’s, PE Funds and mutual funds registered with SEBI is completely exempted, it will go in a long way to improve investor sentiment towards investing in start-ups/early stage companies. Investors can also explore the opportunity to fund start-ups with loans in the early days that can be later converted into pure equity or a convertible note once they are sure about the potential of the start-up.

c. Private Limited Companies are allowed to accept deposits from their members/shareholders upto 100% of their paid-up capital + free reserves + securities premium account

Earlier the maximum limit was 25% of the paid-up capital + free reserves + securities premium account for any company- including a private limited company.

 The limit has now been enhanced to 35% for other companies, while private limited companies are now allowed to raise deposits upto 100% of their paid-up capital + free reserves + securities premium account. Such acceptance of deposits needs to be reported to Registrar in such manner as may be specified later.

 An additional step that will ease operational bottlenecks is that certain categories of money accepted by a company have been excluded from the definition of “Deposits”.

  1. Advance consideration for warranty or maintenance contracts for periods upto 5 years. Earlier, the maximum tenure of such service contracts was 1 year and amount held against future services for periods beyond 1 year was treated as deposits.
  2. Any amount received in advance for subscription of any publication (both in print and digital media).
  3. Any amount received as subscription in respect of a chit.
  4. Any amount received under collective investment schemes in compliance with SEBI regulations.

This set of Amendments in the Deposit Rules is definitely a timely action to improve India’s ranking towards Ease of doing Business as well as encouraging and boosting investor sentiment towards investment in start-ups/early stage companies as envisaged in Start-up India Action Plan.

Disclaimer:

 

This write-up is meant for general informational purposes only. The views expressed are the author’s personal views and as such, they should not be considered as the firm’s view on the subject.

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