A must-read for every venture wanting to raise funds

13th Apr 2016
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Every startup has to invest a lot of time and effort to raise money to scale and keep the business going. All the effort and time invested, could be for nought, if, one very important, but oft under-estimated aspect is ignored.

That, is the compliance and regulatory health of any startup. It includes everything from the startup’s incorporation certificate to intellectual property rights.

Every VC/Angel investor, before pumping in their money, will perform a due-diligence process. This process varies in tenure and complexity based on the industry, nature of transaction, and also the stage of investment. Any deal is successfully closed, only after satisfactory-completion of due-diligence, failing which, the deal drops dead. Sometimes, they get a legal opinion, before proceeding.

Image: Shutterstock
Image: Shutterstock

In venture financing, legal opinion is primarily intended to provide the investors with comfort that the records and procedures relating to the company’s formation, corporate governance, continued existence, and capitalisation are not only in order but it also has the legal authority to enter into, the subject investment, without any potential legal issues.

One cannot fault a VC/Angels/PE, for being too finicky about due-diligence, for it is usually the minor details that make or break a deal.

Many startup entrepreneurs moan about how all these rules and regulations are destroying the zeal of running a business. True as that may be, adherence to processes and procedures, not only impresses an investor, but also has a bearing on the valuation of the enterprise, thereby netting the promoter and the company, much more than what they would have spent on compliance and normalising such issues.

Nevertheless, these are very procedural tasks, involving regulatory compliances, and therefore, not to be chanced with. Well, at least if you want your startup to focus on business and not on legal issues.

It is here, where most Indian startups fail to grasp the notion of experts/professionals. Get your infrastructure and compliances in place before hitting the road for fund-raising. Any expansion/scaling up will spectacularly collapse, if basic compliances are not ensured, as it could lead to a vicious circle of legal issues due to non-conformity. All this could result in the promoters spending more time and resources on rectifying this, rather than on core operations.

Understand this. Your pitch is a one-shot opportunity, and it doesn’t make sense when it gets rejected over non-operational issues. Grab the opportunity and deal with the relevant issues accordingly. Accord the respect that these regulations deserve. Even grudgingly, is just fine.

Better to be safe, than sorry.

Here are a few points for startups to focus on when setting their house in order:

  • Incorporation (legalisation): The most basic mistake that most entrepreneurs commit is their failure to corporatise or legalise their entity, and, as a result, lose the advantage of ring-fencing themselves with an artificial-legal entity. Failure to do this, has been the bane and downfall of many a startup. A legal entity not only adds professionalism to the startup, but also provides a sense of confidence to the other transacting party.
  • Revenue registration/dues: The one thing that every person hates is Tax. Yes, that obligation to pay the government whenever due, no matter what. No school-time leave letter – esque excuses allowed.

This also stretches to Provident Fund (PF) Compliance, Service Tax (ST), VAT (Value-Added-Tax), etc. So, naturally, it is prudent that startups get their revenue registrations in place first, as even non-filing/registration, attracts the long arm of the law.

  • Founders’ agreement: If it isn’t complete lack of knowledge of corporate law, that does it in, for startups, then it’s the founders themselves. No one remembers what they have typed in their mail the previous night, let alone verbal agreements that are the norm during the startup phase. Putting things in words is not a reflection of lack of trust, it’s just prudence.

Think of it as a pre-nuptial agreement. You don’t want to be the Winklevoss twins or Divya Narendra, do you?

  • Legal issues: No matter how frivolous, real, or imaginary; all it requires to scare away potential investors is to utter “lawsuit”. Every legal case is unique and a legal advisor is a must; even more vital, in cases, where it involves Intellectual Property and Complex agreements and contracts. It is better to tackle all outstanding issues head on, rather than soft-pedalling, and, inadvertently becoming targets for litigation-sharks.

Let your legal health do the talking, rather than trying to convince someone to put their money in a place, which is replete with legal landmines.

  • Organisation: You have incorporated your startup, your composition is still skeletal and you are the PA, MD, Courier Boy, and what not. Nevertheless, start implementing basic forms of corporate governance. Startup, as a mentality, or, attitude always drives a person; but as a form of working, that is, without organisation, can only drive you nuts. Start striving to put relevant processes, procedures, etc., in place from the moment you set up shop.
  • Accounting: Pull up your socks and start keeping account of all your income and expenditure. Maintain Income and Expenditure statement, P&L Accounts, other Financial statements.

If it is eating too much of your time, and weaning you away from core business-building activities, outsource it to someone who does it professionally. It’s prudent to keep a professional by your side. Don’t crib over the costs involved. Firstly, it is never as expensive as it is made out to be, and you are as important to them, as they are to you. Secondly, you just spent three-grand on that Manchester-United jersey. So, don’t crib.

  • Employee agreements: Every employee who works must be contracted with basic clauses to protect the interests of both the parties. Also, records of past employees to be maintained. Basic compliances like Labour law, PF etc., to be met.

No investor/country, looks kindly at a startup with labour issues. No matter how big or how small the violation might be, the first thing that crops when they hear of any labour violation is something akin to child labour. So don’t take this lightly. You have been warned. Don’t forget, you are an employee too.

  • Intellectual property: Ownership of Intellectual Property, including non-exclusive licenses, infringement, inappropriate use and potential action, have to be dealt and agreed upon.

The only bankable asset in every tech startup is its Intellectual Property. Any minor issues on this front is more than enough to scare off your investors.

  • Third-party agreements: The same rules apply for every third-party that transacts with the enterprise. Vendors, associates, affiliates, contractors, and other partners need to sign proper agreements, with non-disclosures, how the relationship is defined, responsibilities, and IP assignment.
  • Previous fundraising documents:If you have already raised funds, then future investors would like to know the details of fundraising, utilisation, its impact, etc. Put these in order so they can understand them thoroughly.

The above list reflects nothing more than a scratch on the surface, compared to what a deep and thorough due-diligence would encompass. These are some of the issues that you can take care of yourself, or, by roping in some experts, rather than waiting for due-diligence to pick up these issues, and act upon it then. It is better to have all these issues sorted before you pitch, than having all these on the plate, and trying to convince your investors to look past them.

If you are an entrepreneur, it makes sense to de-risk, whenever and wherever possible, right? Then, start it with your venture.

Never forget that the importance of a corporate entity, with its house in order, is never underestimated.

Q.E.D – It means money.

(Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the views of YourStory.)

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