5 BRUTAL POINTS TO TAKE CARE OFF WHILE RAISING INVESTMENT

By Paras Mehra

www.Quickcompany.in

Aakash Saxena (changed name), a former technical head of a

very famous travelling website, quits a 1cr package for a startup

which he feels worth millions. He, with his other partner, founded

a venture, a platform for hotels to start their own websites. In 3

months, there venture started to pick up and hence they decided

to form a company. They want a less regulated country, so they

decided to form a company in Singapore instead of India. In the

mean time, they look for venture capitalists to raise investment

and they did find some but they declined because offer wasn’t

lucrative.

Amit, the other partner and the holder of 75% share capital of the

company, decided to have a shareholder agreement between him

and Asheesh. Asheesh has no knowledge about the legal, so he

went to Quickcompany.in for help. If investment is to be raised,

then this shareholder agreement plays a very important role,

because whatever is written in the agreement is binding on both

the shareholders and can sometimes proven very harmful if not

drafted carefully.

When we vetted the shareholder agreement, we find 5 clauses

which can steal the celebration of raising investment from the

shareholders. We pointed out that 5 clauses and told to Asheesh

to either amend or delete the clauses from the agreement.

Since, this era is moving very fast for start ups and millions of

dollars are being invested, so we tried to share our experience

with you all and to caution you from these 5 points which every

founder should look into the shareholding agreement while getting

into it.

1. DRAG ALONG CLAUSE: Drag along clause favors the

major shareholders. This right enables the major

shareholder to compel the other shareholder to sell their

shares even if the other shareholder/s doesn’t wants to.

As the name suggest, it allows the major shareholder to

drag the other shareholders along.

Imagine a scenario, where you hold 49% of the ownership

and other one holds 51%. The major shareholders wants to

sell the ventures as he wants to move forward to another

idea, but the you, because you have putted everything into

the venture don’t want to sell as you believes in this idea. In

this situation, if you have signed the shareholding agreement

which has this DRAG ALONG CLAUSE, then you have no

right to oppose and you will have to sell your shares as well.

Sometimes, this clause may be useful to you. In case you

holds 90% ownership then you don’t want that other 10%

holder should intervene if you wants to sell the ventures,

because VC’s sometimes rejects the funding proposal if you

do not offer 100% ownership shares.

These types of cases happen, so always take care of this

clause while signing the shareholding agreement.

2. TAG ALONG CLAUSE: Now this clause is designed to

protect the minority shareholder from being left behind when

a majority shareholder decides to sell. As the name suggest,

it gives the right to the minority shareholders to join the deal

and sell their stake at the same terms and conditions as

would apply to the majority shareholder.

This clause is very important especially for the minor

shareholder. In order to protect your interest, you need to

look into this clause and always be cautious.

3. PRE EMPTION RIGHT: In business terms, it is a contractual

right to acquire new shares before it can be offered to any

other person or entity. It is also called “first option to buy.”

This right will protect you from stock dilution which is always

a concern for every business founders.

Remember the case of facebook.com, where the shares

of co founder Eduardo Saverin has been reduced from

34% to 0.03%, and the important thing is that he didn’t

even get to know when did his shares were diluted.

However, you can protect yourself by entering this clause

into the shareholder agreement.

4. RIGHT OF FIRST REFUSAL: In business terms, this clause

gives the right to the existing shareholder to claim damages

in case any shareholder sells his shareholding to the third

party without offering them. This right protects the existing

shareholders from intrusion of any unknown person into the

board and ownership of the company which they do not

wants to.

This right might also helps the existing shareholders to

increase their percentage of ownership into the business at

the pre determined price which they can also agree through

this clause.

5. PERMITTED USE: Finance is the lifeline of any business

and hence its use should be optimum. This clause gives the

right to minor shareholders to restrict the use of funds of the

company in any matter or area which they think is prejudicial

to their interest.

Understand this by way of example: suppose Mr.A has

invested around 80 lakh in the business which only worth

20% of the capital, in this case, there is a risk to Mr.A, that

other shareholders might use the funds in area’s which Mr.A

thinks is prejudicial to him, then he can use the power of this

clause to restrict the use of funds in any particular area.

We have tried to use the language as simple as possible to make

the entrepreneurs understand the important aspects while raising

investment. Apart from the above, there are certain other clauses

are also there which also can also prove vital in your business. It

is your business, it is your world, be cautious and go and win the

world.

(Paras Mehra, is a practicing Chartered Accountant, entrepreneur

expert and also a founder of www.Quickcompany.in, a leading

website for registering companies in India.)

Contact Details:

paras@quickcompany.in or +91 9654622792