Being a startup founder, getting rejected is common when pitching with angel investors. Raising funds for a startup or an early-stage business often poses difficulties for entrepreneurs. One common approach for securing early capital is through angel investors in private equity. Angel investors are high-net-worth individuals who provide financial backing to early-stage companies in exchange for ownership equity or convertible debt. While the process might seem intimidating, it is important to understand the steps involved and the legal framework governing these transactions, particularly in India under the Companies Act, 2013, which can simplify and optimize the experience. This GrowthX article explores how to successfully raise funds through angel investors in private equity while addressing the legal provisions under the Companies Act, 2013 that govern these investments.

What is Private Equity and Angel Investing?

Let us first differentiate between private equity and angel investing:

• Private Equity (PE) refers to investments made into private companies (those not listed on public exchanges) by institutional investors, including venture capital (VC) firms, pension funds, and high-net-worth individuals. The goal is to help the company grow, improve, and eventually exit through an Initial Public Offering (IPO) or acquisition.

• Angel Investing, on the other hand, typically involves individual investors or groups of investors offering capital to early-stage startups. Unlike PE investors, angel investors usually take higher risks in exchange for potentially high returns on smaller, early investments.

Step-by-Step Guide to Raising Funds with Angel Investors

1. Prepare a Strong Business Plan

A business plan is essential to attract angel investors. It should clearly outline:

• Your product or service
• Target market and potential customers
• Revenue model and financial projections
• Growth strategy and marketing plan
• Competitor analysis
• Funding requirements and how you will use the investment

2. Identify Potential Angel Investors

Once your business plan is in place, the next step is to identify potential angel investors who are interested in your sector. Some sources for finding angel investors include:

• Angel Networks: Groups like the Indian Angel Network (IAN), Mumbai Angels, and Chennai Angels bring together angel investors who specialize in various industries.

• Online Platforms: Platforms like WellFound, LetsVenture, and SeedInvest connect entrepreneurs with angel investors globally.

• Personal Connections: Networking is key. Attend industry events, startup meetups, and pitch competitions to build connections.

3. Make a Compelling Pitch

Your pitch is your chance to communicate the essence of your business and why it is an excellent investment opportunity. An effective pitch typically includes:

• Introduction: A brief introduction to your company and the problem it solves.
• Market Opportunity: Convince the investor that there's a significant and unmet demand for your product or service.
• Solution and Differentiation: Show how your solution stands out from competitors.
• Business Model: Explain how your company will make money and your monetization strategy.
• Team: Highlight the expertise and track record of your team.
• Financials: Present clear financial projections and expected returns on investment.

4. Conduct Due Diligence

Ensure that your company's finances, contracts, and intellectual property (IP) are well-documented and accessible. Legal compliance under the Companies Act, 2013 and other relevant regulations is crucial to avoid any red flags during this stage. Before committing, angel investors will typically conduct their due diligence, examining various aspects of your business, such as:

• Financial health
• Market potential
• Competitors
• Management team
• Legal standing of the company

5. Negotiate Terms of Investment

Ensure that the investment terms align with your long-term goals and that you have a clear understanding of any implications on control, ownership, and future funding rounds. After the investor expresses interest, the next step is to negotiate the terms of the investment. Common terms include:

• Valuation: The value of your company before the investment is made. This will determine the percentage of equity the investor will receive.
• Investment Structure: Whether the investment will take the form of equity, convertible debt, or other financial instruments.
• Exit Strategy: How the investor will eventually exit the investment (e.g., SME IPO, acquisition, or secondary sale).

6. Legal Documentation and Compliance Under Companies Act, 2013

Investments by angel investors in private equity must comply with legal provisions, particularly under the Companies Act, 2013 in India. Some of the most critical aspects include:

• Private Placement Regulations: Section 42 of the Companies Act governs private placements, including angel investments. Companies must issue a private placement offer letter to the investors, which should include details such as the purpose of the offer, the investment amount, and the use of funds. The company must file the offer letter with the Registrar of Companies (RoC).

• Valuation Report: Under Section 62(1)(c) of the Companies Act, when a company issues new shares, they must determine the fair value of the shares. An independent registered valuer provides this valuation report, which ensures that the shares are issued at a fair price.

• Shareholders’ Agreement (SHA): A Shareholders’ Agreement is a critical document that outlines the rights, obligations, and protections of both the founders and the angel investors. It covers aspects such as board representation, voting rights, drag-along and tag-along rights, and liquidation preferences.

• Compliances for Allotment of Shares: After the investor agrees to fund the company, the company must issue shares following the allotment procedure under the Companies Act. This includes filing Form PAS-3 (return of allotment) with the RoC within 30 days of the share allotment.

• Convertible Notes: For startups registered under the Startup India initiative, there is an option to raise funds through convertible notes, where the debt can be converted into equity at a later date, simplifying the fundraising process.

• FEMA Regulations (for foreign investors): If the angel investor is a non-resident Indian (NRI) or foreign national, the company must comply with the Foreign Exchange Management Act (FEMA) regulations, which govern foreign direct investment (FDI) in India.

7. Closing the Deal

Once both parties agree to the terms, and legal compliance is in place, the next step is to close the deal. This involves:

• Signing legal documents such as the Shareholders’ Agreement and Subscription Agreement.
• Completing all necessary compliance filings with the RoC.
• Receiving funds from the investor.

Provisions Under Companies Act, 2013 for Angel Investment

The Companies Act, 2013 provides a robust legal framework for fundraising through private equity. Here are some key provisions related to angel investing:

1. Section 42: Private Placement

This section regulates how private companies can raise capital through private placement, which is a preferred route for angel investments. A company must issue a private placement offer letter and ensure that no more than 200 investors participate in a financial year.

2. Section 62: Rights Issue and Private Placement

Section 62 allows companies to issue new shares to investors through a private placement. The company must determine a fair valuation of shares and follow procedures for rights issues and preferential allotments.

3. Section 173: Board Meetings

For any decisions regarding share allotment and capital raising, the board of directors must convene a board meeting as required by this section.

4. Form PAS-3

This form must be filed with the RoC after the company allots shares through private placement. The form provides information about the investors and the amount raised.

5. Securities Exchange Board of India (SEBI) Regulations

For companies looking to list in the future, it’s important to consider SEBI regulations that govern private equity and ensure smooth transitions to public markets.

GenZCFO Advice

Raising funds from angel investors in private equity is a big milestone for many early-stage startups. It is important to prepare a strong business plan, identify the right investors, and negotiate favorable terms, so entrepreneurs can secure the necessary capital to fuel growth. However, adhering to the legal provisions, especially those outlined in the Companies Act, 2013, is equally important to ensure compliance and safeguard both the company and its investors. GenZCFO team makes sure to follow these steps and maintain due diligence, startups can successfully raise funds and build lasting relationships with angel investors, setting the stage for future success. Feel free to reach out if you have any queries from angel investors regarding your business compliance and valuation.