Compliance mistakes Founders should avoid while fundraising in India | Qapita

Written By:
Srikanth Prabhu
Calendar
August 9, 2023

Beyond the captivating storytelling and pitch-making aspects, fundraising involves a crucial phase post –signing the term sheet where many potential pitfalls lie. In this live session, we aim to shed light on the numerous compliance mistakes that should be vigilantly avoided. Garima Mitra, co-founder of Treelife, joins host Srikanth Prabhu from Qapita to provide valuable insights on navigating the compliance side of fundraising with precision.

Amidst the fundraising process, a common misconception arises once the term sheet is signed - the assumption that everything is smooth sailing and the funds are guaranteed to arrive. However, it's crucial to recognize that the term sheet serves only as a letter of intent, and there are still significant steps and considerations ahead to secure the funds. There are three processes that usually take place:

1. Finance related Matters

2. Compliance  

3. Legal Documentation (SHA/ SSA)

When all three are completed is when a company will receive its funds. This entire process can take anywhere between 3 to 5 weeks.  

Regulatory Framework related to Equity Fundraising

Garima explains during this conversation that there are three broad regulations involved in any fundraise process. These include:

1. Companies Act, 2013

2. Foreign Exchange Management Act, 1999

3. Income-Tax Act, 1961

Garima introduced us to the perfect pathway that unfolds through three simultaneous processes. The first crucial step involves compliance measures, where signing forms to increase authorized share capital and enable private placement take center stage. Subsequently, as the funds are received, the post-funding compliances come into play, encompassing tasks such as issuing share certificates and other essential procedures. By following this well-structured approach, the fundraising journey becomes more streamlined and successful.  

For legal purposes, it primarily consists of creating and reviewing/ vetting investment agreements and employment paperwork. This is then followed by preparing disclosure letters & competition certificates.  


Regarding finance matters, the focus is on securing tax and producing a valuation report.

They then discuss the various forms that must be filled out along with the purpose of filing. Within pre-funding compliance comes an increase in authorized share capital and an offer letter for private placement, which have the forms SH-7 and MGT-14 respectively. Once the MGT-14 is signed, you send the PAS4 to your investors, asking them for money. It is often forgotten that the valuation report is required for these forms, which will often be in the form of a registered valuer report as well as a merchant banker report.  

Garima reminds us that in case an investor is from outside India, it is important to note that they will need either a Chartered Accountant Valuation report or a merchant banker report. Additionally, if you are issuing shares to Indian investors, they will require a merchant banker report under the Income Tax Act.  

After the pre-funding compliance is completed and the money has been received by the company, one must ensure to fill out PAS 3. This is to proceed with the allotment of securities by the company. During the issuance of shares or securities, one might forget to keep in mind that the share certificates need to get stamped from the state that the company is registered in. This is another common misstep that could occur with new founders. For stamp duty jurisdiction, if the company hypothetically is registered in Mumbai, the company is to look at the Maharashtra Stamp Act. Almost all filings would require stamp duty, even for something as minute as the transfer of shares. So, it is important to keep stamp duty jurisdiction in mind.  

An important step that a lot tend to forget about is that once the SHA or SSA is signed, or the share certificates are distributed, the AOA amendment is overlooked. After conducting a fundraising round, the AOA is subject to modification, as it represents the official chartered document of your company. Therefore, any alterations must be duly incorporated into it.

For RBI reporting, within 30 days of allotment of securities, one must fill out the FC GPR form, which requires a FIRC and KYC from your authorized banker.

Garima and Srikanth then move on to discussing investment instruments, particularly Equity shares, CCPs, CCDs, and CNs (Convertible Notes). CNs have gained popularity in recent times, they allow firms to completely peg their value to the next round of funding, allowing them to have a hybrid instrument with debt and equity. It does not require anything except a shareholder’s resolution. However, the minimum investment amount is the highest, at around 25 Lakhs.  

Validity of valuation is another topic they touch upon, as a common mistake or overstep made by founders. It is vital to keep in mind that three months is set as the validity timeline for valuation reports, as RBI has come up with a rule that any type of issuance or transfer of shares requires a report that is no older than three months.  

The live provided a lot of information on possible downfalls that could occur, especially keeping in mind the compliance required to successfully partake in fundraising for one’s company. They conclude the live with the most common mistakes that Garima has seen be made by founders, in her capacity as the co-founder of TreeLife which includes:  

  • Not involving acompliance professional sooner
  • During incorporation, stamp duty is forgotten about, or during fundraising, the process is not followed correctly
  • Purpose code is incorrect in FEMA procedures
  • Compliance with angel tax exemption rules

Though mistakes are bound to happen in the arduous journey that is the journey of a founder, Qapita hopes to continue providing resources such as this live, to nudge startups in the right direction.  

You can watch the full video here:

Also Read: Things to do Before Raising Funds: How Qapita Can Help

Srikanth Prabhu

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