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Raising investment is an important part of the modern enterprise. Businesses need capital to start operations as well as expand, and raising finance from various sources if an inseparable part of doing business. Work on corporate finance (raising investments or loans) constitutes the bread and butter of the country’s biggest law firms, new professional firms and independent business advisors (company secretaries, lawyer, and accountants). While some businesses start with a capital, sometimes financed by the founders themselves, and thereafter expansion is financed by internal cash flows of the business, most businesses require a capital raising efforts. Capital can be obtained primarily in two forms- firstly, equity which is also termed as a financial investment and secondly, debt.
Equity can be raised either from the public through stock exchanges in case of listed companies or can be raised from the private investors (such as private equity or venture capital funds, high net-worth individuals or HNIs, corporates, or even sovereign wealth funds). The cheapest source of capital is to raise money from the public, as this money can be raised without any onerous contractual conditions (unlike a VC or PE funds or even strategic investor will impose) and there is no legal necessity to pay back such money to the investor or provide a profitable exit as is essential for a VC. Investors who buy stocks on a stock exchange only expect to get dividends or make a profit if the value of the company’s shares itself increases. For the business owner, dilution of ownership or control is also a cost of raising equity- but for large corporations, there is hardly a significant change in ownership percentage if they raise equity from the public.
For others, the cost of losing control by giving put equity may be too much and hence they may prefer issuing debt. While debt is usually a cheaper source of capital than VC, PE or private investor money (in the sense that you don’t have to share profits if you make money and your outflow is limited to interest payment), there is always a pressure on the company to pay interest regularly and repay the principal after a fixed amount of time. Failure to do so can result in recovery actions and bankruptcy of the company.
First, let us take a look at investment raised at different points by a company. Notably, it is difficult to raise any significant financial investment, especially from institutional investors, if a business is organized in any form other than the company. The diagram below does not capture loans and debts.
As the company grows, it will raise multiple rounds of financial investment, until it is ready to go public. In all cases (except for the IPO), a similar process will be followed for raising investment (although the actual terms of the commercial document may be different).
Note that every company does not necessarily need to go through this stage. Instead of reaching the IPO stage, a company may itself be acquired by another company (instance being when YouTube was acquired by Google or Skype was acquired by Microsoft), or it may not succeed and have to be shut down. Even f the business fails and has to be shut down, investors may need an exit.
An investment transaction is legally binding when the ‘definitive investment agreements’ have been signed. It usually comprises subscription to fresh shares issued by the company- this infuses the company with requisite funds that can be used for growth and scaling up the operations.
It can also include the purchase of shares from the existing shareholders, which affords them an opportunity to partially or completely exit the company (and make profits by selling off their shares). However in the earlier rounds of financial investment, there may be no purchase of shares as the company is too small to be profitable, and an investor may prefer all the pre-existing Shareholders to stay invested in the company. In such cases, only share subscription will occur.
More often than not, the same document may include all of the above agreements, although that is usually done only when the parties from whom the shares are being bought also constitute the shareholders who will enter into the Shareholder’s Agreement that is when there is only a partial exit by the existing shareholders. If the parties in the share purchase transaction and the Shareholders’ Agreement are different, that is, when some parties have sold their shares completely and have no relation with the company after the sale- a Share Purchase Agreement (SPA) is executed separately from a Share Subscription and Shareholders’ Agreement (SASHA).
A Share Subscription and Shareholders’ Agreement contains certain ‘conditions precedent’ or CP which must be fulfilled for the shares to be issued and money to be invested. Once all the conditions are satisfied, ‘closing’ takes place- the investors and the company determines a ‘closing date’ when the following action takes place:
Once the money has flowed in and the investor becomes a shareholder of the company, he has representation on the board and governance rights. The company is then required to file the amended AoA with the ROC post-closing and a return of allotment indicating issuance of shares to the new shareholders in e-Form PAS-3.
The affairs of the company shall then be carried out as per the amended articles of association and Companies Act.