Private Placement – A Practitioner’s Guide

There are a lot of questions about funding and the right way to work with them. Considering the changes in the Companies Act, 2013 which has changed some of the basic fundamentals and imposed some restrictions for investor protection, the challenges faced by startups have increased.

So we thought that putting these thoughts together in an instructional FAQ would help as part of our ‘Practitioners Guide’ series.

Disclaimer: Please note that these are our answers  based on our experience in being advisors on various Seed/ VC/ PE/ Technology collaboration transactions. They are for the limited purpose of educating founders. The facts and the procedure to be followed can vary significantly based on the exact nature of the transaction and the stage of the business. 

How can I receive
funding into my venture?

There are primarily only 2 ways in which money enters and rewards leave the business.

 

Debt

(Loans, Debentures, Guarantees, LCs, Convertible Debentures)

 

§  Harder to access for most start-ups

§  Usually taken when business is likely to generate cash flows in the near future

§  Expensive in the short term, Cheaper in the long term

§  Utilization is primarily for shorter gestation based purposes – marketing of a B2B product, new factory premises, new equipment, working capital

§  Usually comes with covenants on how the funds need to be put to use

 

 

Equity
(Common Stock, Equity shares, Preferential shares, Convertible Debentures)

§  Easier to access for most start-ups (as cash required is not in relation to their asset base but their ability to generate future value)

§  Usually taken when expenditures are in longer gestation activities such as product R&D, customer acquisition, content development, platform development

§  No outflow in short term, Really expensive in the long term

§  Occasionally comes with covenants on how the funds need to be put to use

 

 

Where do start-ups go wrong?

Roopa’s Notes: As a start-up, one of the things Founders fail to understand is that Equity carries a rate of interest of between 20-30% (sometimes as high as 40%). Businesses tend to think that the fact that they are saving current cash flow and pushing repayment liability is the only consideration. Equity on an average costs the Founders 2.5x to 3x more than debt does.

Nag’s Notes: What is important is the long term value that this person/ institution brings to you. If the value is as short-lived as the cash brought in, you need to reconsider parting with Equity. For a great VC, we have seen Founders chose lower valuations. Further, Equity does not mean that you don’t need to repay a VC/ PE. They are a business just like you. Just that they need to see viable ways to access returns from investing in you.

For the purpose of this document, we will delve a little deeper into the second one – EQUITY, where most start-ups/ mid-sized companies wish to have more clarity.

 

 

 

Ok. For Equity,
what options do I have for my raise?

2 ways provided by Companies Act, 2013 –

  • Private placements
  • Rights and Bonus issues

 

Where do start-ups go wrong?

Dilip’s Notes: A private placement is when an offer at a certain valuation is made to potential investors. Investors need to bring in the required capital for the valuation fixed in the offer for private placement. Investor discussions are usually the first activity that happens in such cases and term sheets get signed. The offer is then made and noted in the respective places. A rights issue on the other hand is made to investors who are already shareholders of the company. An offer is made to all the existing shareholders to subscribe at a certain value and every shareholder has a right to offer his interest to subscribe.

Nag’s Notes: There is a logical reason that the 2 routes of placement have been provided. Private placement is the right route for a new investor who is coming in at an agreed upon valuation. During our consulting of start-ups, we have encountered several circumstances where the minimum capital requirement of INR 20,000 (as explained in the table to follow) of face value cannot be fulfilled especially at the seed stage. Founders tend to take a shortcut method here at times to comply. This might not always be the right way  in the long term scheme of things.

 

What is a
Private Placement really?

Private Placement is a term that is often heard of but rarely understood in its entirety. Let’s look at a few pertinent questions.

When you are making an offer to issue new equity shares (to less than 200 persons/ institutions), you need to comply with certain provisions of Companies Act, 2013.

Ref: Section 42(2) of the Companies Act, 2013

Where do start-ups go wrong?

Roopa’s Notes: A common problem that persists in the system is a lack of understanding of Private Placement. There have been many instances where companies have resorted to other ways of structuring an investment which are perceived to be less cumbersome. They may issue shares to investors through the rights issue channel since it does not require a Valuation Certificate by a registered valuer or a requirement to adhere to the provisions relating to the minimum face value of the equity instruments.

Dilip’s Notes: There are a few things that a Founder should be aware of when choosing the route to be followed.

  1. Private placement allows for a valuation exercise to be conducted which may be a logical arms-length basis for an investor discussion.
  2. It sets the precedent and valuation parameters in stone. This can be leveraged in future rounds of funding.
  3. It is a lot cleaner way since it ensures that companies comply in letter and spirit of the law.

Bordia’s Notes: The ideology behind the law is the most important aspect. Though it seems slightly hard to comply with, it is instated to ensure that investors are protected (especially smaller investors coming in at the seed stage). It also prohibits a company from accepting too many such small tranches of investment to bypass the rules relating to acceptance of deposits.

 

 

 

Can we have a better understanding
of Private Placement?

Issuing capital in securities through Private Placement would require an in-depth understanding of the provisions laid out in the Companies Act, 2013 which mentions the manner, restrictions and provisions for Private Placement.

Ref: Section 42(2) of the Companies Act, 2013 read with rule 14(1) Companies Rules, 2014

We understand that a Private Placement as mentioned above is any offer of securities or invitation to subscribe to securities to 200 people or less in a financial year. The section requires that any such offer made is only through the issue of a Private Placement Offer letter and as per the prescribed conditions. This should be accompanied with an application form for the persons receiving the offer letter to indicate their acceptance.

Exception – 200 people or less does not include employees or institutional buyers.

Key procedural aspects
for a private placement

  1. Special Resolution needs to be passed approving the Private Placement terms
  2. A private placement offer letter needs to be created and circulated
  3. Offer should not be made to more than 200 people
  4. Only one kind of securities can be issued under one offer
  5. The subscription should not be for less than INR 20,000 face value
  6. The price should be based on the valuation conducted by a Registered Valuer
  7. Allotment of securities should happen within 60 days of the receipt of Application monies

 

What is the
documentation required?

A complete record of private placement offers in PAS 5, offer letter in form PAS 4, along with prescribed other details need to be filed with the RoC within 30 days. Form PAS 3, a return of allotment of securities, must be filed with the RoC within 30 days.

 

Key questions
that are on Founders’ minds?

What should the number of shares offered for a single round be?

The Offer size should be a minimum of INR 20,000 face value of the securities.

 

Dilip’s Notes: This means that if your authorized capital is INR 100,000, you will need to issue not less than 16.67% (20/120) of the capital of the company.

 

What should be the price? Can the securities be issued at any price?

The price of the securities should be based on a valuation certificate given by a Registered Valuer.

 

Nag’s Notes: A reasonably justified valuation is based on the exercise conducted by a valuer. There are no rules of thumb here. Simply speaking, a $ billion company may have an authorized capital of less than USD 100,000 also. What is important, is the valuation itself.

 

Is there a restriction on using the application money? When can I begin to use the proceeds?

The application money must be received in a separate bank account and cannot be utilized for any purpose other than for allotment of securities or repayment of monies. Further, any securities in relation to an offer made under private placement must be allotted within 60 days of receipt of the application money.

 

Roopa’s Notes: It is important to not utilize the money till the same has been issued and filed with the authorities. The maintenance of a separate bank account is also one of the most important aspects which can ensure that this does not happen.

 

What do I need to do? Do I need to obtain approval from shareholders?

A special resolution (not less than 75% of existing shareholders) has to be passed approving the private placement.

Bordia’s Notes: The simple logic for this is that any capital related transaction affects the shareholding of all the current promoters and investors. This provision protects all the shareholders from instances of future misunderstandings.

 

 

 

 

How different
is a Rights issue?

Rights Issue means offering shares to the existing shareholders (only) in proportion to their existing shareholding. Procedurally, there is no requirement for a valuation certificate for rights issue.

Roopa’s Notes: A particular existing shareholder can choose not to subscribe to the offer if he so wishes  to but each shareholder is granted with the same rights as everyone else.

 

What is the benefit
of taking the right Private Placement route?

Private Placement requires the price to be based on the valuation by a registered valuer thus the price is determined on a logical and justified basis. It also acts as an internal benchmarking exercise and helps outline the milestones.

Nag’s Notes: An investment done through Private Placement provides complete transparency of the entire transaction and reduces the complications during a Due Diligence at the times of subsequent rounds of funding/ investment.

 

On this document

 https://www.linkedin.com/in/pradyumnanag/  https://www.linkedin.com/in/rakeshbordia/  https://www.linkedin.com/in/roopakrishnamurthy/  https://www.linkedin.com/in/dilipraj/
PRADYUMNA NAG RAKESH BORDIA ROOPA MURTHY DILIP RAJ


Disclaimer: This paper is a property and copyright of Prequate™. No reader should act on the basis of any statement contained herein without seeking adequate professional advice. The authors and the company expressly disclaim all and any liability to any person who has read this paper, or otherwise, in respect of anything, and of consequences of anything done, or omitted to be done by any such person in reliance merely upon the contents of this paper.

 

Prequate works with organizations to help them understand their environment and do business in a leaner and smarter way. By helping businesses interpret their surroundings, Prequate helps amplify the impact of their strategies and executional strengths without worrying too much, or with a lot more clarity, as to how their environment may be respond.

A Critique on the 9 Crucial Factors for Successful Strategy Implementation using Dilbert

The success of a plan is not in the planning but in the execution. It is estimated that over 60% of strategies fail because they are not implemented. When asked about challenges, managers responded that their biggest concern is “It’s the successful implementation of a strategic plan” or “It’s getting your strategy done.”

With the number of management executives who are trained on building strategy plans and attend executive programs on various strategies, the one thing that needs to be emphasized is the ‘act of getting things done’ as outlined in the book ‘Execution:  The Discipline of Getting Things Done’  by Larry Bossidy and Ram Charan.

According to Larry Bossidy and Ram Charan, the heart of any Strategy Execution lies in 3 core processes: Strategy, People and Operations.

STRATEGY

1. STRATEGY FORMULATION

1The process of laying out the strategy is a significant factor, but not the only crucial factor. However, it defines all the other factors and how they can be achieved. As laid out in the paper, the central conclusion of research indicates the importance of procedural justice. All levels of the organization have different perceptions of strategy and interests in the formulation process. Unifying them is the task of the management function. Thus, unifying strategy must be consistent and accommodative.

 

2.ORGANIZATIONAL STRUCTURE

2Organizations are continuously thinking of adapting to times. Having a strongly thought out Strategy supported by an organizational structure is half the process in successful implementation. Further, different strategies require different organizational structures that can allow action items to flow down smoothly across levels. For example, executing a strategy to permeate leadership requires having a structure that allows more decentralisation of decision making activities. As pointed out by Olson, Slater and Hult (2005) four different combinations of structure/behaviour types of: management dominant, customer-centric innovators, customer-centric cost controllers and middle ground have to be matched with behaviours that best serve to facilitate the process of implementing a specific strategy.

PEOPLE

3.EXECUTORS

3

Organizations are made up of people. People in an organization take up responsibilities and become responsible for certain activities. According to the paper, enrolment of the top, middle and lower level management is essential for the purpose of rolling out a strategy. However, organizational structures are dynamically changing to become more flat so that they can be quicker and more responsive. While the hierarchical structures worked in the 20th century. In the 21st century organizations, people at various levels are required to take ownership of functions that work directly with the strategy as well.

Further, the most important part of the execution with relation to the executors will be the selection of the team of executors and arriving at how they need to be motivated to ensure that they work proactively for the success of the strategy.

 

4.COMMUNICATION

4While the strategy and team can be put in place in an organization, what makes the glue is establishing the right channel and mode of communication. Once the strategic plan is in motion, the organization needs to be brought into a single binding communication philosophy which ensures that right things are escalated as and when they become critical and avoiding failures due to inaction/ indecision. Further, organizations need to also be aware the importance in learning from one another to avoid future failures at the granular level. As put very beautifully by Alexander (1985), the content of such communications includes clearly explaining what new responsibilities, tasks, and duties need to be performed by the affected employees. It also includes the why behind changed job activities, and more fundamentally the reasons why the new strategic decision was made in the first place.

 

5.CONSENSUS

5Getting the buy-in from the organization and all levels is extremely important to ensure that the strategy is played out as envisioned. This can only happen when the organization feels that they are in on the decision making consensus. People care only about leadership that they have willingly provided, be it on strategies or on the leader itself. Further, a lack of consensus can lead to creation of obstacles in the implementation of a strategy.

As Floyd and Wooldridge argue, strong consensus exists when managers have both, a common understanding of, and a common commitment to their strategy.

 

6. COMMITMENT

6No amount of consensus can lead to execution unless supported by commitment.  As pointed out in the paper, strategy implementation efforts may fail if the strategy does not enjoy support and commitment by the majority of employees and middle management. This will hold true irrespective of whether or not consensus was achieved at each and every level of the planning. Commitment means that degree or extent to which each owner feels associated in order to support it without an immediate benefit accruing to him/ her. In flatter organizations, authority has no place. It’s all about accountability and ownership. Hence, commitment needs to be existent and permeating across the organization to ensure that the plan gets implemented.

OPERATIONS

7.RELATIONSHIP ACROSS FUNCTIONS AND LEVELS

7The relationship between corporate business units and inter-functional processes defines the functional competencies, allocation of resources, decision-making participation and influence, inter-functional conflict and coordination. As pointed out by Slater & Olson (2001), the relationships between different strategy levels also reflect the effect of relationships among different cross-organizational levels on strategy implementation (Slater & Olson, 2001). There is a significant trust required between functions in order to understand the long term implications of a strategy. If any lose sight of the end goals or get disheartened, the implementation may fail completely.

 

8.IMPLEMENTATION TACTICS

8The planners and executors both need to be a part of the implementation. The planners need to facilitate an environment that is conducive for the smooth implementation. Nutt (1986) identified four types of implementation tactics used by managers in making planned changes: intervention, participation, persuasion, and edict. In order for implementation to work, there must be sufficient direct and indirect motivational methods that need to be used as well as a certain sense of urgency to facilitate the change in thinking and direction of efforts.

 

9.ADMINISTRATIVE SYSTEMS

9While strategy is being implemented, the organization needs to have a strong enough review function that ensures that progress is monitored and managed. In the absence of review, there is absence of control over the manner in which the organization is carrying on implementation. Further, a strategy without accountability cannot be successful and monitoring systems are the only way to ensure accountability is taken seriously. In the absence of proper administrative systems, you cannot have cohesive and sustained implementation.

 

This document is a critique on the paper ‘Making Strategy Work: A Literature Review on the Factors Influencing Strategy Implementation’ (written in 2006 by Yang Li, Sun Guohui & Martin J. Eppler at the Business School, Central University of Finance and Economics, Beijing, China in collaboration with Institute of Corporate Communication, University of Lugano (USI), Lugano, Switzerland) which puts together a synopsis drawing out the nine most acknowledged crucial factors for a successful strategy implementation.
 

STARTUP: IS IT REALLY MY CUP OF MAGIC?

“Integrity is the ability to stand by an idea.”
― Ayn Rand

You want to be an entrepreneur.

You want to be a part of the start-up buzz.

You have an idea but what you really need is a kick-start.

If you identify yourself with one of the lines above, read on.

One doesn’t start a business just because he has an idea and wants to be a part of the new generation of entrepreneurs trying and doing new things and expanding the scope of business. To start with you need an idea, an idea which is feasible. An idea that you believe will change not just your life but others’ as well.

We speak to budding entrepreneurs and have worked with them over their journey from idea to enterprise. These are our views.

Differentiation

To be successful in an ocean of start-ups you need to reap on your “differentiators”. You may be creating a completely new product or category or another approach to convention. You need to get noticed by your differentiator, whether internally in your operations or externally, in terms of your product/ service.

Additional work hours to ensure delivery or goodies and freebies to your customers is like trying to make yourself heard in the noise of the crowd. When everybody in the crowd is shouting to be heard, you need to do more than just shout. You need to whisper that ‘change’.

Differentiation

http://bit.ly/BillGatesOnTED

Conviction

What makes you the next big thing, is conviction. You need to be a convict of your idea. Bound by it, measured by it and breathing it in, day in and day out.

The world around you must buzz about your conviction. People must talk about your conviction like gossip. You must be part renegade and part Rambo. Deep down, you must truly believe that in your idea is that something everyone never knew they wanted so bad till now. And your idea must be radically changing or solving a problem that they never knew they had or persistently had it. Slice of a large market pie, will leave you with just that.

Conviction

 http://bit.ly/TonyOnTED

DIY King + Knowhow Master

The world is full of Mr. Tom, Mr. Dick and Mr. Harry, who have an idea that other people also have. You may be Mr. Tom or one of the other two. That’s not a bad thing.  As long as you are able to do what others have failed to do and get the right mix of the other things that made the ones before you fall.

DIY Yourself

BUT, hear us out. There may be no prerequisites to be an entrepreneur. But not everyone will be a good one.

While there is no compulsion for an entrepreneur to have work experience, gaining experience in your field of interest helps. Think of it like a 3 dimensional matrix between work experience, DIY love and sense (common+business). Experience of being a part of an established business or in another startup wormhole teaches you structure and problem solving with faster decision-making. We have seen startup clients redesign their websites within 4 hours from when we have our sessions. A non-startup client made it a 3 month plan to rejig their website!

http://bit.ly/NewAgeIndustrialRevolution

Drive

2 very important sets of questions to answer before you jump your cushy job up is:

“Where are you going? Don’t you know uncharted territories are always longer than you can imagine and really lonely?”

“Why do I really want to do this? Is it the money you will make? The picture bulbs going off? The hordes of adoration? The jobs you will create? The people you will touch? The big change that’s going to touch a million people?”

The answers to these questions will help you set goals for your company and frame you vision for the next 10 years (anything longer and you’re kidding yourself!). Your vision is what will help you last beyond the 20 employee mark. If you aren’t able to envision it, hang on to your job. If it’s the money, hold onto your job! – You won’t see money till you’re 10 years in and will probably reach bankruptcy many times in your first 2 years. If it’s the fame, hold onto your job! – Only one in Ten thousand will be heard about. If it’s the adoration, hold onto your job! – You may not even get time to maintain your relationships? If it’s the other two, you don’t care about the first 4 anyway.

http://bit.ly/RSAnimateOnDrive

Drive

If you have an idea and are ready to stand by it come what may, do not wait for someone to validate. Take the risk and Jump right in.

 

START YOUR MOVEMENT