This article is written by Nimish Dhagarra who is pursuing a Diploma in M&A, Institutional Finance and Investment Laws (PE and VC transactions) from LawSikho.
Indian economy with its boom and market opportunities has presented investors all around the world a place to get higher return on their investment, that is what it means being a developing country. India has now come to a point where it needs businesses, especially homegrown businesses to excel in our market as we have been getting competition from the foreign companies resulting in a narrative which has become a reality that a Indian customer prefers a product of a foriegn brand rather than a home grown product by our own businesses.
When liberation opened doors to the outside world for us, these foreign companies invested their brand in Indian environment in the early stages such that they are now enjoying fruits of such investment in the form of huge market share from tech industry to food industry, you name it. But this narrative has slowly started to change from last decade as India has started to see a surge in its investment in its own homegrown Indian businesses in the form of start-ups, small and medium sized enterprises.
This is where venture capital transactions have picked up its pace where venture capital firms/venture capitalists have started to pick out such businesses and started seeing the potential of such businesses. It is important for a startup who has potential to grow to get the adequate and needed round of funding in its early stages so as to provide structure to their businesses and tap in to the market in such a way that it creates for them a sound basis to grow their brand and to help them establish such sound structure In-House counsels are hired who works with VC firms and startup/small and medium enterprise to help them push through the investment process- from negotiating the term sheet to the signing of the final investment documents.
In India, Venture Capital is regulated by SEBI (Venture Capital Funds) Regulation, 1996 under which section 2(m) defines venture capital funds –
“venture capital fund” means a fund established in the form of a trust or a company including a body corporate and registered under these regulation which—
(i) has a dedicated pool of capital;
(ii) raised in a manner specified in the regulations; and
(iii) invests 5 [* * *] in accordance with the regulations;”
And section 2(n) defines venture capital undertaking
“ venture capital undertaking” means a domestic company—
(i) whose shares are not listed on a recognized stock exchange in India;
(ii) which is engaged in the business for providing services, production or manufacture of articles or things or does not include such activities or sectors which are specified in the negative list by the Board with the approval of the Central Government by notification in the Official Gazette on this behalf.]
Source- Zider, R. 1998. How Venture Capital Works, Harvard Business Review, November-December, 131-139 , ttps://hbr.org/1998/11/how-venture-capital-works
SEBI published a report on the venture capital market in India highlighting the opportunities threat, need for regulating the venture market and what needs to be done for critical success of the venture capital industry in India.
In-House Counsel and its perspective in Indian Legal System
According to the definition mentioned in the Merriam Webster Dictionary, house council means-
“a lawyer employed by a business to work in-house on its legal matters”
The legal profession in India is governed and regulated by the Advocates Act 1961. Section 29 of the act says that, subject to rules of the act, only advocates are entitled to practice the profession of law and under Section 2 clause 1(a) of the act – advocate is a person who is registered under any roll under the provision of the act. Rules and Regulation are framed by Bar Council of India. Bar Council of India Rules under the Advocates Act 1961 provides some parameters which highlights in which cases an advocate can do or participate in business related activities.
These rules to summarize say that an advocate appearing before the court cannot be engaged in any full-time business or be employed by an entity to do such so. Based on this rule the role of in-house counsel in India is limited to setting out policies and legal directive with businesses as they cannot appear before the courts so their duty end leading up to court appearances as a legal advisor, therefore people say one of the disadvantages of hiring in-house counsel is that in case of dispute you have to engage outside counsel to represent a party before the court of law as an advocate.
That’s why the perspective of people in India about in-house counsel is undermining, from advocates to people engaged in legal profession they are skeptical about the such career move and looks down at the practice of being in-house counsel, which is very wrong provided the help they provide in structuring deals in day to day business activities and helping companies comply with respective laws by making the job easier for outside counsels, advocates and parties when a matter goes to the court for dispute due to so and so reason.
But again as homegrown businesses have started growing up in India, In- House counsels have been engaged in almost all the deals and transactions acting as a legal advisor helping the management make quick decisions while navigating through the legal implication and helping companies manage the internal documents of the company.
Stages of Venture Capital Financing and typical document required
As we are talking about venture capital transactions, it is important to understand the chronology, the stages in which such investments are given to startup and businesses and during those process which document are dealt and complied with-
1. Early Stage Financing- As the name suggests in these stages depending on the status a startup is at, they are given a certain small amount of investment to kickstart their business. It again can be divided into 3 sub-stages namely-
a. Seed Financing in which a startup is eligible for startup loan and receives a small amount to payment.
b. Startup Financing in which startups are given investment to finish the development of their final products and services.
c. First Stage Financing in which startups are well positioned and need funds to start its business operations on large scale.
2. Second Stage Financing- Also known as the expansion stage, in this stage businesses are provided funds for expansion of businesses. This head also includes Bridge financing in which is given for short-term interest only financial and helps the company get assistance for initial public offers as business strategy. If a business is at an advanced stage later than bridge financing that they are given large funds for major expansion of business operations.
3. Acquisition and Buyout Financing- This is the last stage in which a company is now enjoying stable return and is well-positioned in the market and needs funds to acquire another company to expand its portfolio and business operation into new areas and sectors. In buyout, a company looks to acquire another company’s product or services to expand it market share either in the same sector or wishes to enter a new sector of business to expand it variety of the product offered by the company.
Typical Documents Involving in these stages-
- Term Sheet
- Every VC transaction starts with a term sheet which is a non-binding document which outlines the basic financial structure of the deal. A consensus must be reached between the startup and investor meaning terms must be agreed in the same sense in the same meaning.
- Letter of Intent
- It is an instrument that lists out the terms of the deals in a specified greater detailed manner. It ensures and shows evidence that the parties to the transaction are serious about the transaction and are allowed to investigate each other for background check-up meaning the process of due diligence can be started.
- Subscription Agreement and Subscription Letter
- Subscription agreement provides the details of the term of investment so that the parties to the transaction make the investment binding and lock in the amount through which an investor will buy a certain amount of shares of the company.
- Subscription letter will confirm the investment amount per investor.
- Shareholder Agreement
- One of the key documents in venture capital financing, this is a formal document which sets out the rights/obligations as to shares, voting, restriction on transfer, lockup period, exit strategy of the investors, outlining the structure and nature of the relationship between business and investors as well as governing such relationships.
- Amended and Restated Certificate of Incorporation
- It is filed immediately after the completion of the venture capital deal which formulizes any structural changes to the business structure and corporate governance the parties have agreed to.
- Other documents include in VC transaction- Stock purchase agreement, asset purchase agreement, Confidentiality agreement, Merger and Acquisition agreement, Convertible notes, filling with appropriate authorities, Investors right agreements etc.
In 2012, SEBI notified SEBI ( Alternative Investment Funds) Regulations which repealed the VCF regulation with the aim to extend the perimeter of the regulation of unregulated funds for the sake of market stability and efficiency, consumer protection and encouraging formation of new capital. Now the status is that venture capital funds that are registered under the VCF Regulations would continue to be governed by the VCF Regulations; however, they have been subject to some prohibitions. Also, these funds are permitted to migrate to the AIF Regulations by re-registering under these regulations after receiving an approval of two-thirds of their investors (by value).
Role of In-House Counsel in VC Transactions
In-house counsels in a normal venture capital transaction have to keep in mind variety of laws from securities laws to contract to company to taxation etc, you name it, bust the most important this is to hold the essence of the interest of the party, therefore their role varies in number of ways-
- To balance the interest of the investor and owners/founders of the business, to ensure that both the parties reach a desired contract and it is up to their expectations and plan, as most of the dispute arise on the financing aspect and equity ownership aspect front in which the interest of the parties get deviated most of the time.
- Overseeing ongoing legal and regulatory compliance with regulators like Reserve Bank of India, Security Exchange Boards of India, the Forign Investment Facilitation Portal, with regards to operation of business and investing activities as to investors right, liabilities and exit strategy.
- To help parties make quick business decisions while navigating through the legal issues and implication by formulating negotiation strategies and roadmaps.
- To avoid conflict and provide valuable inputs from the time term sheet is made to negotiate and documentation of investment transactions, laying down the rights and obligations of the parties to the contract.
- Helps venture firms evaluate the investment opportunities and helps the firm perform the process of due diligence to check for any potential liabilities. This includes assessment of documents, records and procedures of the company and vice versa for startups, identifying possible investors and conducting corporate due diligence processes.
- Drafting and negotiating important agreement to transactions such as term sheet shareholders agreement, investors right agreement, share purchase agreement, amendment to certificate of incorporation, joint venture agreements, ESOP policies, Advisory stock, Convertible notes, Confidentiality agreement, M&A agreements, asset purchase agreement and others.
- Drafting and negotiating a broad range of IP and technology related agreements to ensure that there is no infringement of such rights by any party, manage outside counsel and ensure internal approvals and compliances are made.
- Risk management- helps business identify, evaluate and mitigate risk with implementation and promotion of good corporate governance practices.
- Formulation of policies with compliance with laws and providing training on policies, practices, business models and current legal issues.
- Help the parties in formulating the best investment structure which is feasible to both of them in terms of capital resulting in a tax-efficient deal execution with no complications.
In the case of V.B. Rangaraj vs. V.B. Gopalakrishnan, The investors’ rights were in question as to conflict between shareholders agreement and AOA, the SC court held that the provision of shareholders agreement imposing restriction on transfer of shares which are consistent with the companies act can only be authorized to do so if they are incorporated in the articles of the company. But this view was overturned by the apex court in case of Vodafone International Holdings vs. Union of India., but was again held in the case of World Phone Pvt. Ltd. and Ors vs WPI Group Inc by Delhi High Court.
It is evident that a company cannot comply with so many documents on their own, that’s why they hire in-house legal teams who carry out all the documentation and formalities process from negotiating the terms, to drafting the contract to signing the contract. It is the job of in-house counsels to educate the parties of their rights, liabilities, duties and obligations so that they are aware what they are getting into. So at the end of the day in-house counsels make sure that parties do not accidentally violate securities law and all your paperwork is complied with. In-house counsel have a strong grip on the laws related to such transactions who help VC firms and startups prevent being tangled up in legal details and negotiation.
These counsels helps both the parties in smoothening of the transaction in such a way that it streamlines the relationship of venture investors and law firms meaning it helps such parties to the transaction optimize the work by providing structure to their deals by spacing out the risk-minimizing them, highlighting and solving legal implication, helping with paperworks and formalities.
One of the best features of in-house counsel is that they help the party prepare a mechanism beforehand in case of future dispute adjudication. In-house counsel plays a vital role as they provide sound structure to companies deals in their early stages on financing of funds, help them execute such deals in no time by helping them make quick business decision covering all the basis and contingencies and assist such parties in ensuring that they get what they wished for and expected from each other. It is important that the interest of investors, as well as founders/owners of the business, is not undermined.
- Report of K.B. Chandrasekhar Committee on Venture Capital, Security Exchange Board of India, Jan 08 2000 https://www.sebi.gov.in/sebi_data/commondocs/oct-2017/Venture_p.pdf\
- House counsel.” Merriam-Webster.com Legal Dictionary, Merriam-Webster, https://www.merriam-webster.com/legal/house%20counsel. Accessed 21 Apr. 2021
- Advocates Act, 1961, http://www.barcouncilofindia.org/wp-content/uploads/2010/05/Advocates-Act1961.pdf
- Bar Council of India Rules under the Advocates Act 1961, http://www.barcouncilofindia.org/wp-content/uploads/2010/05/BCIRulesPartItoIII.pdf
- Maulik Vyaas, Indian companies are expanding in- house legal teams, Mint, Updated: 22 Oct 201https://www.livemint.com/Companies/H1xJboVvIOK6Nq3UUyXEcM/Indian-companies-are-expanding-inhouse-legal-teams.html.
- Nishith Desai Associates, Private Equity Investment in Indian Companies, April 2013, http://www.nishithdesai.com/fileadmin/user_upload/pdfs/Research%20Papers/Private_Equity_Investments_In_Indian_Companies.pdf
- V.B. Rangaraj vs. V.B. Gopalakrishnan, (1992) 1 SCC 160 (India).
- Vodafone International Holdings vs. Union of India, (2012) 6 SCC 613 (India).
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