Startups: “A startup is a company working to solve a problem where the solution is not obvious and success is not guaranteed,” says Neil Blumenthal, cofounder and co-CEO of Warby Parker. And while looking for such solutions and exploring new fields of business, they often need investments. While investing in a start-up is highly risky, as the valuation of the company is not available during the early stages, angel investors, and often joint venture funds show willingness to take that risk. But in return, they often require a startup to cease investment discussions with anyone else as long as the transaction documents are signed.
Flipkart – reversing the way: The exclusivity covenants in investment agreements can also be stressed upon by the investee company in cases where it wants to restrict the potential investors from discussing the investment prospects with any other rival company. This practice has widely been used by Flipkart in recent times. Flipkart is becoming an industry giant whose valuation is growing day by day and instead of investors choosing Flipkart, Flipkart is choosing investors. Flipkart, being the most sought after e-commerce website of India, is entering with non-disclosure and non-compete agreements with the potential investors to restrict them from discussing investment with any other e-commerce companies for a stipulated period of time, ranging from six months to a year.
Changing Trend: The market trend which usually restricted the startups is now reversed. Flipkart’s non-disclosure and non-compete clauses are not only protecting the confidential information of the company, they are also making the investors choose between Flipkart and other e-commerce companies. The non-compete clause is also limiting the investors from investing in the rival companies for the stipulated time period. The investors are negotiating with Flipkart on the period of restriction and the companies that are listed as rivals.
Sample Clause: Such a non-compete clause may be constructed as below:
1.1 Each Investor agrees that till the execution of the Transaction Documents and for a period of 6 (six) months thereafter, in any capacity, directly or indirectly, shall not invest in, have discussions about investment with or have any communication which can potentially lead to investing in (whether directly or indirectly), any company which is engaged in the business of the similar nature as the business of the Company, within India;
1.2 The Parties acknowledge that: (i) the type and periods of restriction imposed in the provisions of this Clause are fair and reasonable and are reasonably required in order to protect and maintain the legitimate business interests of the Company; and (b) the time, scope, geographic area and other provisions of this Clause have been specifically negotiated by sophisticated commercial parties.
To construct a more specific non-compete clause, the name of the companies carrying on similar business as the Company, may be listed specifically.
When can a Startup Demand Exclusivity: The practice of Flipkart and the willing investors is certainly changing the age old trend of limiting the company or its promoters through non-compete and business exclusivity clauses. Now, even the startups can restrict the investors with similar non-compete and non-disclosure clauses. To be able to negotiate on such clause, a startup must be in a position of strength, even if not like Flipkart, it must show a steady growth, increase its valuation or envisage such ideas and show management powers to such an extent that many investors would be willing to invest in it.
Checkpoint: The non-compete clause, binding either the investors or the company or its promoters, must be limited to a stipulated time period. While entering into such arrangements, the startups must keep in mind the provisions of Indian competition law and other applicable laws and draft them accordingly. It cannot restrict the investment options for the rival parties by violating any such law. But all in all, the trend started by Flipkart is no doubt a welcome change for those startups that have the potential to grow into industrial giants in a short while.