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5 Headaches Investors Want To Avoid When Investing In A Startup

5 Headaches Investors Want To Avoid When Investing In A Startup

Indian startups raised $1.7 Bn from investors in just the first quarter of 2014-15, which is a 300% growth from that of last year. In India, 147 deals were finalized between January to March this year. Moreover, India witnessed 67% more deals than in China in absolute volume, again in the first quarter itself (Courtesy:  Media Reports). Then why is the investment process still considered to be a draconian task? Why there is still a feeling in the air that it is extremely difficult to please “vulture capitalists”?

Investors are normal people with normal psyche. Just like you and me, they want to secure their investment. We have been assisting a number of startups in securing investments for their business. What we have seen is, if you get your basics right, Investment can be a cake walk.

In this article, we have compiled six basis points that investors look for in any startup. If you get this right, half your work is done. The other half? Let you prototype win it!

Internal agreement among co-founders

Last day I came across a discussion in a certain startup group. A young CEO was being criticised because he wanted to document his understanding with his friend and co-founder of his startup. Most of the suggestions were spurts of passion, suggesting him to trust his instincts rather than “mere pieces of paper” with respect to his understanding with his co-founder.

This is THE picture when it comes to starting up in India. Most startups are co-founded by young guys from college who dream to build their own world. Fair enough. Now, what happens when one of them gets a lucrative job and leaves or changes his mind altogether about starting up? Most do not exit formally. That is to say, they remain in the books of the company but they are not practically involved in the business. What would be his share in the company while he exits? Or what would be his share when your business is valued for investment? Your investors do not want to give him a penny because he never did a thing for your business. But legally he is entitled to his 10% stake in the company!

Fiasco! This could have been easily avoided if you had your terms documented with your co-founder. This is exactly what a Founder’s Agreement does. It outlines the rights, duties, responsibilities among co-founders. Clarity related to exit, dilution, participation and vesting of sharers is a must have in your list. This is one of the key points that pave the road for a hassle free funding. Not only does it give the investors a confidence on the soundness of the stability of the company, it also instils a sense of transparency and trust. As they say, an investor invests in “people”.

Day to day tax and regulatory status 

Is your business in compliance with the tax and regulatory authorities of the country? Have you filed your returns? Do you file your reports regularly? Do you comply with statutory deadlines or you often meet the compliances with penalties and additional fees?

These questions are as pertinent as the viability of your product itself. Some of the key areas where start-ups tend to miss out are enumerated below:

Tax Deducted At Source (TDS)

Some common payments on which TDS needs to be deducted

  • When you make payment to your employees as Salaries
  • Payment of Interest on Securities OR other than
  • When you make payment to Contractor and Sub – Contractor
  • Payment for Commission or Brokerage
  • While Paying for Rent
  • Fees for Professional or Technical or Services or Compete Fees

TDS is required to be deducted at the time of payment or at the time of credit to the books of accounts, whichever is earlier.  The same needs to be deposited with the government before the 7th day of the next month, however for the month of March it can be deposited before 30th April.

Requirement to file TDS Returns

TDS returns are to be filed for each quarter, the four returns for a financial year, with no requirement to file annual returns.

Penal Provisions for non -compliance with TDS provisions

The penal provisions attached to TDS are so stringent that, its non-compliance can be enough reason to shut down the start-ups/ business, before it actually gets funded. More fatal than any interest or penalty provisions, non-deductibility of tax at source on certain expenses will not allow you to claim such expenses in computing your business income.

Service Tax

Service tax 14% becomes chargeable on the value of services when the domestic turnover of your start-up reaches Rs. 10, 00, 000.  Besides, Service Tax registration becomes mandatory once the turnover reaches Rs. 900,000.

An interesting element of service tax which is known as reverse charge refers to the slightly strange legal rule where you pay service tax not for providing the service, but for receiving the service. Herein, companies which received or ‘imported’ services, so to speak, would be treated as if they had provided the service. This will apply to your Company as well if you have either your place of business, permanent residence, usual place of residence or fixed establishment here in India.

Annual ROC & Income Tax Filings 

The apex regulatory bodies in India for companies are the Income Tax Department and the Ministry of Corporate Affairs, more commonly christened as RoC (Registrar of Companies). Every company has to file its annual returns and financial solvency report with these two departments annually. You simply cannot miss out on this. Your Income Tax Return Filing acknowledgment and RoC form filing challans are the only proofs that your company is compliant with the laws of the land. This acts like an Insurance cover for the investors that their investment will not be eroded in paying off hefty penalties and rehabilitating sick units.

Secretarial Records 

In the Indian startup scenario, there is a general lack of formality and compliance due to inter-personal relationships among founders. This is why start-ups miss out on one of the most important aspects of compliance- Maintenance of Secretarial Records. Every company has to conduct four Board Meetings and one Annual General Meeting in a year. Accordingly, minutes of every such meeting along with relevant explanatory statements and notice have to be maintained and executed as per standards prescribed by the Companies Act (Amendment) Act, 2015. Further, a company is required to maintain certain statutory registers like the Share Application and Allotment Register, Minutes Book, Membership Registers in its registered office. The secretarial record is a mirror to the compliance health of your company. Hence, missing out any one of these might just ruin your successful pitch to the investors.

Trademark & Intellectual Property Rights

Thanks to social media, now most startups are aware of what Trademark is. It is an intellectual property right by the virtue of which the holder enjoys exclusive rights to the use of the property. What start-ups miss out in this case is that they get the Trademark filed in their own names. This is a big screw up. Investors are interested in the company’s property, not that of the founders.  The trademark registered in your name does not make it the property of the company even if the company is owned by you.

As they say, the devil lies in details. So, let us not ignore the details. A disciplined compliance environment in your startup will not only facilitate it in sailing through the Due Diligence check of investors, but would also help your business grow internally. So, let us act on these, make our base strong and put forth a strong pitch.

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