Written while pursuing the WBNUJS bussiness law diploma
STAGES OF RAISING INVESTMENT
The establishment and running of a new business or startup
requires investments and this need no introduction , in other words if we
consider the entire startup to be the cell , initial investment is the
mitochondria i.e the powerhouse of the cell , the power generating unit .
Raising investments is one of the primary concerns of an enterprise . Startups
require sufficient amount of capital to initiate their operations as well as to
expand their business . most of the businesses depend on concentrated efforts
in raising capital but it should also be noted that this isnt a hard and fast
rule and sometimes capital may even come from internal sources . Sometimes a
startup may start with meager capital , or the initial investment is done by
the founders themselves and thereafter the fund needed for expansion is
generated by the cash flows in the business . The two main sources of raising
capital are i) by raising funds i.e equity and ; ii) by debt . Keeping the
present scenario in mind it may be said that it is notably difficult to raise
investment for a business organized in any form other than a company from
institutional investors . raising
investments from foreigners also become difficult particularly for
business other than a company such as LLPs . Foreigners are more comfortable in
investing in companies than any other business forms .
The word commercial intent plays an important part in the
investment . \The manner in which investment transaction will be carried out , the
investment drafting and negotiation process is carried out , keeping in mind
the commercial intent of the investment .
Now based on the intent of the investor , investment can be
broadly divided into two categories :-
i)
FINANCIAL INVESTMENTS and
ii)
STRATEGIC INVESTMENTS
WHAT ARE FINANCIAL INVESTMENTS ??
The investments made with the sole intention of making
profit through dividend and appreciation of the value of their share holding
over the years , is called financial investment . A financial investor be it
private equity investors or angel investors invest with the expectation of
making only financial returns in the form of cash flow . Financial investors
generally have time boundations and they try to recover their invested amounts
within that specific time ( a few years) and then exit the company . Now let us get a brief
concept about strategic investment .
STRATEGIC INVESTMENT
Strategic investments are the investments usually made by
cash rich giants to smaller business starups in order to benefit from their
business synergies . The main aim in strategic investment is to exert control
over the smaller company and ultimately acquire controlling stake and merge the
company with the investor company .
As discussed earlier the primary concern of any enterprise
is raising investments . It should be mentioned here that there are certain
stages of raising the investment . Let us discuss those stages in details .
Investment transaction basically takes place through six
different stages , namely –
i)
Approaching potential investors
ii)
Expression of interest by investors
iii)
Due diligence
iv)
Execution of necessary investment document
v)
Satisfaction of conditions precedent
vi)
Inflow of money and compliance requirements
Now lets discuss each of the above mentioned points in detail
..
i)
Approaching investors :-
This can be termed as the first stage of investment
transaction where entrepreneurs are required to approach the potential
investors to persuade them to invest in their startups . Investment banks often
help in creating a vridge between fast growing early stage companies and potential investors as they have huge number of high profit
seeking clients . The first stage in an investment transaction is the
presention of the business plan and the commercial aspects of the company seeking an investment to the potential
investor . The next step what interested investors do is that , the execute a
term sheet .
ii) Expression of interest by investors
Now as soon as the potential investor intends to invest in
the entrepreneur’s business , it executes a typical term sheet or letter of
intent . Now what is a term sheet ???
Term sheet – term sheet is a kind of non binding document
dealing with theimportant commercial and legal issues of transaction in bullet
points . Any of the clauses of term sheet may have binding effect but it has to
be specifically mentioned by the concerned party as binding such as any kind of
confidentiality cause relating to any business plan where the parties will be
under an obligation not to disclose the business plan or commercial intent of
the company or business with any other third party . Investors may also
persuade the promoter to observe an exclusivity period i.e a period during
which the promoter wont be able to approach other potential investors . This
gives time to the investor party to rethink the deal and imposing an
exclusivity period also gives thm room to negotiate the particular deal if it had not been closed . Investors may also propose to insert a “break
fee” clause requiring the promoter company to incur certain costs borne by the
investor . The term sheet also deals with the agreement of the parties over material terms and conditions which form
the basis of creation of the definitive legal agreements such as share purchase
agreements , share holders agreement etc . A term sheet should from its very
inception clearly indicate the commercial proposals of the investor .
LETTER OF INTENT
The term letter of
intent as it sounds is actually self explanatory . In simple words it
means a document containing words that clearly declare the intention of the
writer . It is synonymous with the expression term sheet . From a legal sense a
letter of intent lays down the basic commercial proposals , mutual
understanding between the parties on key issues , any special clause mentioned
by any party. A letter of intent generally provides for an exclusive
negotiation . Most provisions of Letter of intent is non binding i.e same as
that of term sheet . A major difference between term sheet and letter of intent
is that a term sheet is written in bullet points whereas a letter of intent is
written in paragraphs in a detailed manner .
Now what are the exact functions of a term sheet / letter of intent ???
Both term sheet and letter of intent –
ð
Mentions the understandings between the parties
on key issues
ð
Mentions the intents of the parties and the
commercial proposals of the investor
ð
Provides a basis for negotiations
ð
Mentions any kind of special clause mentioned by
any of the parties be in confidentiality clause or break fee clause i.e paying of a specific fee
by the promoter to the investor
ð
Creates a documentary basis for soliciting loans
/ finance etc\
It must be noted here again that a term sheet is supposed to
be prepared by the investor . It is an investor ‘s thing . After presentation
of the term sheet / letter of intent by the investor the deal becomes open for
negotiation and both the parties negotiate over key issues relating to the
investment keeping in mind the
commercial intent of the startup founder i.e the commercial intent of the
promoter . After the negotiations are complete the first round of investment
documention is circulated . The next step includes negotiation of the wordings
of the investment documents by the lawyers of both sides or even entrepreneur
and investor from their respective sides .
iii) Due diligence
The terms due diligence literally means a vivid research
done to evaluate the commercial potential of the business or to avoid any
burden of any trouble / loss in future , it may also be said to be identifying
of the potential negativities (by conducting a vivid research) and
renegotiating the deal . Due diligence can be of different types depending on
the situation namely financial due diligence , environmental due diligence
,legal due diligence , factory due diligence , etc . If the investor discovers some preexisting /potential threatsor
risks relating to the deal , he may
order the carrying out a due diligence to identify and minimize these already
present / potential risks. If after the due diligence serious non compliance
with the existing laws are found then the investor may opt not to proceed with
transaction further or ask for specific indemnity , warranties . Sometimes the
irregularities discover as a result of due diligence is placed in condition
precedent and the promoter must rectify those before proceeding further with
the deal . Now there are time boundations in the process of conducting due
diligence . As per the company law , past records of a company can be examined
to a maximum of past 3yrs whereas in case of environmental records past 7years
of records are usually taken into account .
iv) Satisfaction of condition precedent
After signing of the investment condition the promoter has
to fulfill all the condition precedents specified in the investment agreement
and also take necessary steps to regularize the risks mentioned in the due
diligence report .
v) Inflow of cash
After the issuance of completion
certificate by the director of the company once the necessary actions have been
taken the investor and the company appoint a date specified within the time
period mentioned in the agreement for
receiving money from investor , issue of shares to investor , adoption of amended
articles .
