Compulsory convertible preference shares are corporate fixed-income securities that the investor can choose to turn into a certain number of shares of the company’s common stock after a predetermined time span or on a specific date. The fixed income component offers a steady income stream and some protection of the invested capital. It is shown in the shareholder’s equity in the balance sheet of the start-up.
Compulsory Convertible Debentures are the instruments which are recognized as debt initially till they are converted mandatorily in equity shares of the company. CCD also carries a coupon rate. It is shown as debt until converted into shares in the balance sheet of the start-up.
A coupon rate (interest in case of CCDs and dividend in case of CCPS) is a fixed income stream attached to a security. Coupon rates are decided based on the risk matrix and expected free cash flow of the start-ups of each investment (i.e., riskier the investment, higher the coupon rate). Coupon rate can be accrued and converted into shares at a future point in time at the prevailing valuation.
An option pool consists of shares of stock reserved for employees of a company. The option pool is a way of attracting talented employees to a start-up company—if the employees help the company do well enough to go public, they will be compensated with stock. We recommend start-ups to have a minimum of 10% as stock option pools.
“Tag Along” Rights enable the investor to sell its shares at the same price when there is a change of ownership in the company. When a majority shareholder/founder sells their shares, a tag along right will entitle the minority shareholder to participate in the sale at the same time for the same price for the shares.
“Tag Along” clauses is designed to protect the minority shareholders from being left behind when a majority shareholder decides to sell their shares.
“Drag Along” rights enable investor to sell the total shares of the company if an exit is not provided to the investor in the stipulated time or the investor is not able to sell its stake in the company independently.
“Drag Along” rights are required to ensure that the investor is able to get an exit as each fund has its own life cycle to which it has to adhere.
They are a set of conditions that are to be fulfilled by the start-up before the investor puts in the money. They are related to compliances related to companies act and other regulations.
They are a set of conditions that are to be fulfilled by the start-up after the investor puts in the money. They can be related to regulations, compliances, media announcements, etc.
Founder vesting is a process by which founders “earn” their stock over a period of time depending on the performance and commitment to the start-up. The company gets the right to buy back the stock if one or more of the co-founders leave.
The core idea of the vesting is to incentivize the co-founders to stay; and protect the company in case one of the founders leaves.
In an early-stage start-up, the investor puts up money majorly on the basis of the founder’s capabilities and commitment towards the start-up with little or no revenue. Hence, if the founder sells some portion of his holdings, it depletes the commitment of the founder towards the start-up and an investor would like to avoid that.
Bad Leaver: is a founder whose professional relationship is terminated by the start-up for any of the following reasons: material and willful breach of his obligations towards the company, fraud, deceit, embezzlement or any other serious criminal offence, gross negligence and any other act which would justify a dismissal for urgent cause. In this case the founder forfeits the vested and unvested part of his shareholding.
Good Leaver: is a founder who does not fall within the Bad Leaver definition, e.g., because of death, permanent disablement or upon termination by the start-up for reasons other than the Bad Leaver grounds of termination. In this case the founder gets to keep the vested part of his shareholding.
In case of material and willful breach, fraud, deceit, embezzlement, or non-submission of audited financials/metrics as per agreed on timelines the investor will have a right to appoint an external auditor. The cost of the external auditor will be borne by the start-up.
As every investor as timeline for the fund life cycle a timely exit is required for each investment. Under this clause if a start-up is not able to provide exit in the stipulated time through the means of further investment round/merger or acquisition or IPO then the investor will be provided an exit through buyback of shares by the start-up if permitted by the cash flows of the start-up.
If all of the above options fail to provide an exit to the investor then, the investor has the right to invoke the drag along clause of required.
Anti-dilution provisions are clauses built into convertible preferred stocks to help shield investors from their investment potentially losing value. It aims to discourage start-ups to raise further money at lower valuation at which the investor has invested.
If the start-up raises money at a lower valuation, then the start-up will have to compensate by the means of additional shares to investor to ensure the worth of the shares of the investor does not deplete.
The reserved matter rights are present to ensure that all the corporate finance decision along with decisions that require significant capital of the start-up should be done with consultation with the investor. While ensuring that the day-to-day operations of start-ups are not hindered in any way.
The fund manager will decide on case-to-case basis. Board member/ observer is generally appointed in the start-ups where extra care is required to be taken with regard to the operations, extra guidance is required to be given to the founders, startup is at an inflection point and the board member/ observer can help the start-up, etc.
Founders are expected to adhere to the agreements signed and provide timely reports to the investor regarding the performance and heath of the start-up.
Founders are required to be full time committed to the business.
Investor shall appoint the auditors/ compliance consultants in consultation with the founders. The intention is to let the founders be involved in the regular operations of the start-ups with the companies being fully compliant with the regulatory requirements.
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