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Accounting and Financial Agreements

Apart from legal provisions, there may be contractual arrangements which can govern and affect accounting in a business. In case funding is raised from financial investors (including VC or PE investors), or significant amount of money is borrowed from an institutional lender or a bank, the agreements governing these transactions will have clauses which addresses accounting. Investors and lenders to a business consider proper accounting to be very crucial.

To begin with, they rely on various financial statements to decide whether the business is creditworthy or investment worthy. If these statements are manipulated and do not reflect the correct financial situation of the business, this may result in misrepresentation or fraud on part of the founders/ promoters/ officers / directors.

Also financial agreements as described above always require the company and the management of the company to make specific representations to the effect that the financial statements provided are correct in all respects. For any discrepancy the promoters and the company usually have to provide indemnity – which stipulates that in case the lender or the investor suffers any loss due to negligent or false accounting, all such loss will be made good by the company (or even the promoters, jointly with the company), as required.

For example, a company and promoters will have to make good a decrease in value of the investment, or failure of the company to return borrowed money if it is realized that there have been misrepresentations in accounting statements at the time the company sought investment or took a loan.  Founders need to be especially careful about this matter as such agreements impose personal liability on them, and the investor or lender may recover losses from the personal properties and assets of the founder/ promoter.     

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