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Introduction to Raising Investments

Investment law is a core practice-area of most corporate law firms. For over three years, capital markets and private equity practice have been down, while venture capital investments, that is, investment into companies in their earlier stages of growth are on the rise. Learning about the legal issues in startup investments presents a great opportunity for young lawyers and consultants who want to differentiate themselves. For entrepreneurs, raising investment needs no introduction - investment is the lifeblood of a startup. An entrepreneur can raise investment throught the followig modes:

This is an introductory document about raising investment – it explains the broad categories of investment transactions and the stages in an investment transaction, right from the time of approaching investors till receipt of the investment amount. 

Learning Objectives

  • What are the different categories of investors? How is this difference relevant for an entrepreneur/ businessman or a lawyer?
  • What is thecommercial intent of an investor at the time of making the investment?
  • What is the process of raising investment for a company?
  • What are the different stages in an investment transaction?
  • Which legal documents are executed at each stage of the transaction?
  • Is a term-sheet or a letter of intent binding?
  • What is the purpose served by a due diligence in an investment transaction? What are the corrective measures that a company should take to remedy the findings of a due diligence?
  • At what stage is an investor obliged to invest into the company? On what pre-conditions does the investor’s obligation depend?

A. Introduction
Raising investment is an important part of modern enterprise. Businesses need capital to start operations as well as expand, and raising finance from various sources is an inseparable part of doing business. While some businesses start with meagre capital, sometimes financed by the founders themselves, and thereafter expansion is financed by internal cash flows of the business, most businesses require concerted capital raising efforts. Capital can be obtained primarily in two forms - firstly, equity which is also termed as investment and secondly, debt
In this chapter, the focus of the discussion will be on equity investment in companies. Notably, it is difficult to raise any significant investment, especially from institutional investors, if a business is organized in any form other than a company. LLP may be considered suitable for some kinds of investments in future, but at present, it is not considered to be suitable for investment by investors, who feel more comfortable with investing into companies. Further, raising investment from a foreigner is more cumbersome for an LLP, as compared to a company. The other issues and concerns applicable to and measures adopted for investment in companies will apply to LLPs as well with minimal modification in most cases.

To begin with, let us understand the different kinds of investments that are made into a company and the commercial intent of each kind of investor.

Understanding commercial intent is critical as it significantly changes the manner in which the preliminary stages of an investment transaction are carried out, the way in which different clauses in the investment documentation are drafted and the negotiation process. It also changes the manner in which the business of the company will be conducted post the investment (which is also captured in binding legal documents pertaining to the investment). You will realize which clauses specifically differ after reading about the different clauses in investment agreements (discussed separately in the study material).
Based on the intent of the investor, investments can be divided broadly into two categories - strategic investments and financial investments.
  1. Financial Investments
Financial investments are made with the expectation of making only financial returns in terms of cash flow from the company in which investment is being made. For instance, if a private equity investor buys a stake in a mobile manufacturing company, the intention behind this will be to financially profit from the dividend paid out by the investee company, and/or appreciation of the stake the investor is now buying over time. This is a financial investment as opposed to a strategic investment where the investor looks forward to much more. For this reason, strategic investors usually offer a much higher price than financial investors.

VCs, angel investors and private equity investors are financial investors and their sole intent behind making investments is earning profit through dividend and appreciation of the value of their shareholding over the years.

In case of a financial investment:
  1. The investor will not be interested in running the business - at least as long as the company is profitable and he is earning the expected returns on his investments. If a financial investor finds the promoters to be ineffective or incompetent, then the investor may seek to appoint different managers to run the company.
  2. The investor relies to a greater extent on the existing management. They may also replace the existing management and hire professional managers, but they are not very likely to take over the management themselves, unlike strategic investors.
  3. For the above reason, they also want continued presence of the existing management in the company. They usually do not provide an exit to the founders or existing management. They also would not be interested in a controlling stake (above 50% stake) normally.
  4. Usually, they do not purchase shares from existing shareholders, but buy shares which are freshly allotted - thereby injecting funds into the company as growth capital rather than providing exits to existing shareholders which does little good to the health of the company. Most financial investors will want to put the money in the Company as a priority rather than pay of existing shareholders.
  5. Financial investors have a specific number of years within which they would like to recover their investment amount (plus a portion of profits made by the company as dividend in some cases) and exit the company. It is important to know the investment horizon of the financial investor, since they are likely to demand profitable exits at the end of such horizon from the company. Usually, such claims are embodied in the exit clauses put into an investment agreement (more on this later). For instance, most VCs want an exit in a matter of 5 to 6 years.
  6. Financial investors desire that your business should eventually get acquired by a strategic investor or it should make a public issue of its shares (through an initial public offer).
  7. Financial investors invest in a number of companies knowing that some of the investments will go bad, while the others may do extremely well. Keeping this in mind, at the investment stage financial investors try to protect themselves against loss as far as possible through investment agreements, and ask for various rights and protections from the company and the founders/ promoters. They also try to ask for certain rights (such as the right to pre-emption and right of first refusal over shares to be issued or sold in the future) which will ensure that they can buy bigger stakes in the company if the company performs well.
  1. Strategic Investments
Strategic investments are usually made by cash rich giant corporations into comparatively smaller/ younger companies in order to benefit from business synergies. However, sometimes smaller companies end up buying bigger companies for strategic reasons as well. One well known example is that of Porsche trying to buy Volkswagen.

For instance, if a mobile phone company can buy out a chain of retail electronic stores, it may profit from the synergy of these two businesses by positioning itself closer to the consumer in the consumption chain. It may be able to ensure better visibility for your brand as well as reduce commission paid for selling. Similarly, Google bought Motorola as Google can significantly benefit from having its own mobile phone hardware company which can leverage on Google's existing software empire and user base.

Here, as it would be evident, the intention is not to benefit merely from profits earned by the investee company, but by using the investee company to increase profits of the investor company itself or sometimes by using the resources of the investor company to increase the profits of the investee company significantly.

Facebook's investment in Instagram is another major example of a strategic investment. Facebook intends to benefit from the synergy of Instagram and Facebook, and at the same time Facebook didn't want Twitter to buy Instagram.
Strategic investments might be undertaken even to pre-empt competitors from achieving higher efficiency or synergy by buying the target company.
In case of strategic investments:
  1. Investor wants to exert control and may want to take over the management. Even if it does not take over management immediately, it may want to have certain amount of indirect control.
  2. Strategic investors usually aim to acquire controlling stake or merge the target company.
  3. Existing management may be kept in place, absorbed, phased out, or even fired.
  4. Strategic investors usually pay a premium price, and this is possible because they reap rich benefits compared to financial investors.
  5. Strategic investors may bring in crucial expertise, relationships, tie-ups, market share, etc. that may provide the business a significant competitive advantage.
  6. Strategic investments usually provide significant exit to founders and other shareholders from the company. Strategic acquisitions are lucrative and sought after.


Strategic investments often, but not always made as share acquisitions. In a share acquisition, although one company may substantially own or control another, the businesses of the two companies are legally distinct.

Two other major forms of strategic investment are mergers and joint ventures. In a merger, one of the two companies either merges into the other, or both the companies combine into a third company. This leads to the businesses of both getting combined into one. In India, merger of companies is undertaken through a court-approved process.

In a joint venture, the strategic investor and the target will both jointly incorporate a third entity to carry out the proposed business. This keeps the original business of the two companies separate. Also, the strategic investor doesn’t control the investee’s business, it may only control (jointly or alone) the business of the independent joint venture company.


Stages in an investment transaction


The stages in a commercial transaction and legal documents executed at each stage are mentioned below.



  1. Approaching potential investors

To start with, an entrepreneur will have to approach potential investors. In larger deals, investment banks often help in connecting fast-growing early stage companies with potential investors, as they have already have a huge network of clients who are interested in making high-growth investments. The first stage in an investment is the ‘pitch’ and the presentation of a ‘business plan’ by the company to an investor, which is followed by further rounds of discussions on the key financial elements of the deal. A pitch exclusively comprises the commercial aspects of the business.

Interested investors who are interested in proceeding further with the transaction typically execute a ‘term-sheet’ with the company.

At this stage, it is extremely important for the entrepreneur to enter into a non-disclosure agreement (NDA) with the investor, to ensure that his business plan, business model and any other details of his business are not disclosed to any other entity by the investor.

  1. Expression of interest by investors

a)      Term sheet:

Term sheet is usually a non-binding document addressing important commercial and legal issues of a transaction briefly in bullet-points. It is possible for both parties to specify if any clauses are binding. Usually certain clauses are indicated as binding by parties


Every term sheet has a confidentiality clause requiring both parties to keep discussions relating to the transaction confidential. Investors may also insist on an ‘exclusivity’ period (also called a ‘no-shop’ clause), which usually prohibits the promoters from approaching other investors for the duration of the period. When parties are not yet ready to close the deal but will negotiate on price, investor rights and other aspects, the exclusivity period provides room for negotiation.

Some investors may insert a provision requiring the company to pay a fee (called a ‘break fee’) or to incur certain costs which were borne by the investor in the negotiation process (such as legal fees and expenses). For the promoters, there is ample scope to completely water-down such provisions (or significantly mitigate the effects) of such clauses through effective negotiation.

With respect to the remaining clauses of the term sheet, it may be essential for an entrepreneur to specify that it is non-binding for him unless he has decided that he has received the best deal possible under the given circumstances.

In addition, the Term Sheet also outlines the in-principle agreement of parties over material terms and conditions, which acts as a basis for preparation of definitive legal agreements such as Share Purchase Agreement and Shareholder's Agreement during later stages of a transaction. Usually a term sheet leaves a lot of room for negotiation, at the time when the definitive agreements are drafted, but it should from the very beginning give a clear picture of the commercial proposal of the investor – such as the price, stake to be purchased, parties involved etc.

b)      Letter of Intent

Letter of intent (LoI) is issued to achieve the same end as a Term Sheet – laying down the basic commercial proposal, recording common understanding of parties on certain key issues and usually providing for an exclusive negotiation for advanced level of deal striking. LoI is more often used in merger and acquisition transactions – while the term ‘Term Sheet’ is used in VC and PE deals. Just like a Term Sheet, most provisions of LoI are usually non-binding.

A major difference between Term Sheet and Letter of Intent is their drafting style – a Term Sheet is usually in bullet points or a table format while a Letter of Intent is always written in the narrative letter-writing style with well-worded paragraphs.

c)      Function of Term sheet or LOI

A term sheet/ LoI serves the following purposes:

Ø  to set out the general intent of the parties, especially the initial commercial proposal;

Ø  to set out the key points of a complex transaction;

Ø  to create a documentary basis for soliciting finance/ loan/ investment;

Ø  to provide safeguards in case the business deal collapses during negotiations (some term sheets/ LoI can specify a break fee – to be payable by one party to the other if after negotiation they decide not to go ahead with the deal).

Ø  Negotiations

After the investor has presented a term sheet, the promoters and the investor usually negotiate over its key terms. Negotiations are governed by the commercial intent of the venture capitalist and the startup founder. There may be several rounds of negotiations. Once negotiations over the term sheet are complete, the first round of investment documentation is circulated (typically by the lawyers on the investor’s side).

Next, lawyers from both sides (sometimes the investor and the entrepreneur may also be directly involved) negotiate on the wording of the investment documents, since they contain critical legal provisions as well, apart from the commercial provisions in the term sheet.

  1. Due diligence

In case of an acquisition and merger, the new owners assume all responsibility for the business - which includes all existing liabilities of the business, such as pending tax claims, liabilities due to non-compliance, product liability and so on.

If the business has been releasing toxic substances in the environment which are yet to be discovered or brought to public notice, the new owners will be liable for failures of the old management to contain such toxic substances when the problem will be detected post-merger/acquisition and can pose very damaging consequences.

This is a significant risk that acquirers/ investors face. To identify and minimize these risks, a due diligence exercise is carried out, once the term sheet has been executed. If, after the due diligence, serious non-compliance with applicable law is discovered or if there is a possibility of significant liability (due to pending litigations or proceedings by departments, etc.), the investor may decide to not go ahead with the transaction, or he may ask offer a reduced price.

However, more often the investors/acquirers ask for a specific indemnity, representations and warranties. In case of product liability, environmental risk and such other risks, the acquirers may ask the management to take insurance of appropriate amount to cover such liabilities.


Any actions required to be taken in order to rectify or regularize any irregularities discovered pursuant to the due diligence are sometimes added to the ‘conditions precedent’ (called CPs) to a particular transaction, which must be fulfilled as a pre-condition to the investor’s bringing in the investment. For example, an entity may be required to obtain certain key insurances, or make any pending applications for license / approval/ regulatory filings as part of the CPs in the investment documentation.

Sometimes, the due diligence exercise may continue even after the finalization of the investment agreement, so the obligation on the VC to invest is conditional upon satisfactory completion of the due diligence and resolution of all issues discovered.

Due diligence can be of different types, legal due diligence, financial due diligence, environmental due diligence, labour due diligence, factory due diligence, technology due diligence, tax due diligence and so on. Depending on the transaction, some of these due diligences may be carried out. For a business in which the factories are very important assets, a factory due diligence may be necessary. 

 For example, if anyone plans to invest in or acquire the arm of Maruti which holds the factory in Manesar that is troubled by labour unrest, a thorough labour due diligence will be must.

a)      Materiality threshold and the extent of due diligence

Every due diligence exercise needs to have a materiality threshold, to determine which risks/ deficiencies identified in the due diligence exercise are serious enough to merit action/ attention. The materiality threshold changes with businesses, size of transaction and nature of investment. In big transactions this threshold is determined by the parties, and sometimes by investment bankers. In other cases, the lawyers need to exercise their judgment.

The thrust of due diligence is different in different kind of investment transactions. In case of a purely financial investment (e.g. by VCs or private equity investors), a limited due diligence is carried out and materiality threshold remains comparatively high.

It is understood in these cases that the management and majority shareholders will face the same risks as the financial investor and while the investors would still like to obtain warranties and indemnity from the company and the promoters while investing, it is understood that the management and majority shareholders usually stand to lose from any debacle much more than the financial investor, and that they will take adequate measures to avoid materialization of those risks.

However, in case of strategic investment the due diligence exercise is usually carried out in greater detail (it is often called a comprehensive due diligence) and the materiality threshold is kept low. In case of a joint venture, if a new joint venture partner is coming into an existing business, due diligence is important - but in case of a new business being formed for the joint venture, there is very little scope of due diligence.

b)      Time period for due diligence

The length of the time period over which you will ‘look back’ at records while conducting a due diligence is very important. For example, United Breweries was originally incorporated (in another name) around 100 years ago. If you are conducting a legal due diligence on the company for an investor, will you examine records for 100 years? Company law compliance of the company can be examined for last 3 years, while tax and environmental records of last 7 years are usually examined.

  1. Execution of necessary investment documents
Stages in an investment transaction​

Inexperienced businessmen tend to think that signing a Term Sheet or LoI seals the deal. This is absolutely wrong – a deal is not final until ‘definitive investment agreements’ have been signed (as explained below).

An investment transaction typically comprises two components – subscription to fresh shares issued by the company, and a purchase of shares from existing shareholders. Subscription to fresh shares is what infuses the company with requisite funds. Purchase of shares from existing shareholders only affords them an opportunity to partially or completely exit from the company (and make a profit by selling their shares). However, note that in the earliest rounds of investment, there may be no purchase of shares as the company is too small and not profitable, and an investor may prefer all pre-existing shareholders to stay invested into the company.

The most common definitive investment documents are a Share Purchase Agreement, a Share Subscription Agreement and a Shareholders’ Agreement, which serve the following purposes:

1) Share Purchase Agreement – A share purchase agreement is executed between the investor and shareholders to document the sale of existing shares of by the shareholders to investors. Since the investor must be reasonably certain that the shares, the selling shareholders typically give warranties as to the ownership of the shares and absence of claims against their shares. They also provide indemnity to the investor in case any loss is caused to the investor after purchase of shares due to any claims that were in existence before the time of sale.

2) Share Subscription Agreement – The share subscription agreement (SSA) is the legal document which contains the obligation for an investor to subscribing to the company’s shares, if certain conditions are fulfilled by the company. These conditions are called conditions precedent. Often, the obligation on the investors is not very tightly worded, and they may have the opportunity to back out of the investment at the last moment. The agreement also imposes restrictions on the company so that it does not take any actions that are not in the ordinary course of its business.

Usually the share subscription and shareholders agreement are combined into one document (called a Share Subscription and Shareholders Agreement or SSSHA).

3) Shareholders Agreement – The rights of the investors as shareholders kick-in only after the subscription is complete. The Shareholders Agreement (SHA) contains the key terms of investment, rights over the shares issued to the investor, governance provisions, other rights for investors to protect their investment and certain exit-related rights (which will be explained in a separate discussion later).

Sometimes, the same document may include all of the above agreements, although that is usually done only when the parties from whom shares are being bought also constitute the shareholders who will enter into the Shareholders’ Agreement, that is, when there is only a partial exit by the existing shareholders. If the parties in the share purchase transaction and the shareholders’ agreement are different, that is, when some parties have sold their shares completely and have no relation with the company after the sale – a share purchase agreement (SPA) is executed separately from a Share Subscription and a Share Holders Agreement (SSSHA).

  1. Satisfaction of conditions precedent

After signing the investment agreements, the company is required to fulfil the various conditions precedent or CPs, as specified under the investment agreements, and take any actions to rectify irregularities identified in the due diligence. Once the actions have been completed, a director of the company may have to also issue a certificate to the investor indicating that all necessary approvals that are required for the investment have been taken usually called a CP completion or CP satisfaction certificate.

  1. Inflow of money and other compliance requirements

After the issue of the CP completion/ satisfaction certificate, the investors and the company appoint a date within the time period specified in the investment agreement (which should be very near the date of issue of the certificate) for ‘completion’ or ‘closing actions’, that is, receiving money from investors, issue of shares to investors, appointment of investor’s directors to the board, adoption of amended articles of association of the company, etc. Now, the money has flowed in, and the investor has become a shareholder of the company, with due representation on the board and governance rights. The company is then required to file the amended articles with the Registrar of Companies (ROC).

Is an SHA legally binding on the company? Steps that must be taken


Types of securities that investors can acquire


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