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Raising funds, tapping talent may get easier for start-ups

But there are some pitfalls in Companies Law Committee recommendations

Taking the Start-up India drive a step ahead, the Companies Law Committee has laid out a bunch of recommendations that specifically address issues relating to start-ups, in its draft recommendations submitted on Monday.

At present, the fund raising limits for start-ups during the initial five years of their incorporation is capped at 100 per cent of paid-up capital and reserves. The committee has recommended doing away with such limits. “This is a good move that gives start-ups sufficient headroom to raise deposits without any upper limits. But, it could be subject to misuse,” observed Mehul Modi, Senior Director of Deloitte in India.

There do seem to be some pitfalls. Start-ups often raise funds as deposits from friends, relatives and high networth individuals (HNIs).

Removing caps could do away with embedded safeguards provided in the company law for such investors, experts feel.

The committee also recommended excluding convertible notes (those convertible into equity or repayable within five years) from the definition of deposits.

“The ability to issue refundable instruments (without limits) gives flexibility to the promoter to manage equity dilution better as well as to raise short-term finance,” said Ajay Jindal, Partner at Wisdomsmith Advisors.

Convertible notes

However, the committee suggested fixing a minimum individual threshold limit of ₹25 lakh — to restrict the issuances to sophisticated and informed investors such as HNIs. Convertible notes, which are essentially promissory notes, are a popular form of fund raising among domestic start-ups.

Besides, the limit for sweat equity issuances should be raised from 25 per cent to 50 per cent of paid-up equity capital, said the committee. “This is a positive move for start-ups, giving its owners a chance to draw benefits from providing know-how or making available rights such as intellectual property rights and other value additions,” said Yogesh Sharma, Partner, Grant Thornton India.

Sweat equity shares are issued by a company to its directors and employees. These are different from ESOPS, which can be issued only to employees (and not promoters).

Popular mode

Globally, sweat equity is a popular mode of building equity for cash-strapped entrepreneurs in their start-up ventures. However, it hasn’t caught on in India, thanks to complex rules governing its issuances.

To attract better talent, the committee has also suggested relaxing recruitment norms, allowing start-ups to hire foreign nationals as managing and whole-time directors. According to Grant Thornton India’s Sharma, “Start-ups funded by global private equity funds would welcome this move”.

Foreign nationals with expertise and experience of working in developed markets, where many start-ups have successfully metamorphosed into larger companies, can now be roped in.

The committee has also recommended simplifying the procedure to convert an LLP into a company, while allowing innovative names to be registered.

This article was published in the Hindu Business Line, to read please click here.