As a startup in India, closing on U.S. venture capital is similar to doing so if your company was completely US-based, with a few notable differences. I’ve represented several India-based startups through venture capital financings. To name just a few, clients have included Freshworks (formerly FreshDesk), WizRocket, and Shopalyst. They, along with other clients, have closed financings with the India-based or branches such as Accel Partners, Kalaari, Sequoia, Helion and Matrix, and not to mention with several US venture capital counterparts.
The common denominator with these entities is that such investment has come through a Delaware corporation. Note that even India-based VCs will invest in Delaware entities, although they of course invest in a private limited or another country’s entity (e.g., Singapore). There’s many different reasons to structure the investment through the US entity, such as making the financing compatable with future US-based investments or just speed. And, of course, there are different tax reasons which either make the US-entity favorable or at least neutral with respect to a foreign jurisdiction registration.
My India-based clients tend to relay to me that the biggest difference regarding the venture capital process when you’re incorporated in India and outside India can be seen in how quick or how delayed the investment process can be closed. India has government regulations on foreign investment coming into the country; VC funding for a company incorporated in India will have to cross certain clearance checks, and sometimes may need approval from the finance ministry, and this delays the process. For a company incorporated outside (i.e., Delaware), the process is much swifter, since these regulations are not applicable.
So, this post is intended to highlight some of the differences, and provide a general overview of the process and how it works in the US as opposed to in India. But the reality is, it’s not that different. I’ll also walk you through the various documents you will likely find having to execute to complete the financing process.
The Private Limited Entity in India
Most India-based startups either have an existing private limited or will form one soon after incorporation of their US entity. The private limited will typically house the India-based employees and will handle most, if not all, of the development work of the startup.
The presence and incorporation of this private limited into the financing will actually result in the majority of the differences between a financing solely in the US and one in India.
The private limited most typically ends up being a subsidiary of the US corporation and all investment during a financing will go through the US corporation in order to make sure that any IP owned or developed by the private limited is now owned by the US corporation (where their money is being invested).
Making a private limited entity a subsidiary is a time-consuming process (based on Indian law and regulations), the timeframe can vary here, but it usually falls between 60 and 180 days. Although some clients have experienced longer delay. Therefore, we sometimes see finalization of the subsidiary process as a post-closing covenant, in order to avoid delaying the financing.
Some VCs require that each founder enter into an employment agreement with the private limited to further ensure that all IP is protected. Others will include a laundry list of conditions to close relating specifically to the subsidiary (comply with all Indian law, transfer domain names/IP to the US corporation, that the US corporation form a private limited, etc.). Of course, then there are those VCs that will insist on both…
Also, sometimes the private limited will have to become a party and signatory to the financing. Whether or not the private limited will become a party usually depends on the importance it plays in the startup and how long it has been around, though the VC could just want to be extremely careful and include it regardless. Similarly, the VC will want to make sure that the private limited will also be subject to various representations and warranties, protective provisions and sometimes they will even want the VC director, if there is a representative of the VC on the company’s board of directors, to also be on the board of the private limited in order to further protect their investment.
The Venture Capital Term Sheet
Unlike in the US, the process generally begins with the founders receiving a term sheet from a VC prior to having formed a US corporation. As discussed above, sometimes the founders will have a private limited based in India, and sometimes they will not. Because of these issues, the VC will generally have each founder sign the term sheet. Another reason for the founder execution is that India-based financings sometimes include the requirement that founders make certain representations and warranties in the stock purchase agreement, where founders making representations and warranties in a US-based VC deal is somewhat rare.
In the US, a term sheet is usually not given until well after the formation of a US corporation and therefore, the corporation itself, and not the founders, can execute the term sheet, and founder representations and warranties are less common.
Most of the venture capital deal terms are similar to US terms. Economic terms like liquidation preference, anti-dilution, etc. are usually similar to their counterparts in US-based venture capital financings. Control terms like board seat(s), board observers, and protective provisions (i.e., investors’ right to approve certain actions) are also prevalent. However, there tends to be more protective provisions in an India-based US VC financing than a US-only VC financing.
There are sometimes customary India-based terms incorporated relating to the potential exit. Usually, they will have a period of 5-7 years and if an exit does not occur by then, the VCs will require that the startup purchase their shares back or assist them in selling them to a different entity of the VCs choice. This is much more robust than a typical “redemption” provision in the certificate of incorporation.
And, similar to US-based venture capital financings, many founders in India-based startups assume that once the term sheet is signed, the deal is about closed. But in reality, there’s still a long way to go.
The Venture Capital Closing Procedure
Typically (regardless of geography), the startup’s lawyer drafts the financing documents (discussed in more detail below) and prepares a pro forma for the round. In India, however, it is sometimes customary for investors’ counsel to take the first pass at drafting.
The pro forma helps calculate the price per share and provides a snapshot of the company’s post-financing ownership. India-based VCs often want to “hammer out” the pro forma before the term sheet is fully executed, while US counterparts more commonly finalize it during document drafting.
Before documents are signed and money is wired, there is typically significant due diligence. The VC and its counsel (along with company counsel) will want to confirm that key corporate records are in order, including: (i) incorporation and governance documents, (ii) stock issuances to founders (and employees, if applicable), (iii) IP filings and assignments, and (iv) financial statements. If issues surface, they usually need to be addressed before closing, which can delay the timeline.
Overall, the process (term sheet negotiation through closing) often takes about 4–6 weeks. There is usually no true shortcut if you want the deal done carefully, with a reasonable amount of diligence and negotiation. Some deals take longer than six weeks, especially when logistics slow down wiring (internal VC procedures, banking cutoffs, or regulatory hurdles can all play a role).
The Venture Capital Transaction Documents
The forms and language of the documents will vary by financing. The goal of this section is to provide a brief overview of the main “transaction documents,” so you have a practical sense of what you and your startup are signing up for. While there are differences deal to deal, there is also meaningful standardization: India-based venture financings, like their counterparts in the US, often draw from the National Venture Capital Association (NVCA) model documents.
Stock Purchase Agreement (SPA): This is the primary agreement for the financing. As the name implies, it is the document under which the shares are purchased. The SPA typically covers the purchase price, the number and class of shares sold, representations and warranties by the company (and often founders) and by the investors, and the conditions to closing.
A few additional notes regarding the SPA: (i) if the company has convertible debt, the holders are often parties to the SPA and apply their outstanding debt to purchase shares in the round; (ii) conditions to closing in India-based deals can be more detailed than in typical US financings, even if they do not always lengthen the overall timeline; and (iii) where the company is effectively international, there are often additional representations and warranties on topics such as FCPA and other cross-border compliance issues.
Amended and Restated Certificate of Incorporation (COI): The amended and restated COI is typically the only primary transaction document that is filed with the secretary of state. The economic and control rights of the different classes and series of shares are set forth here. As a result, a COI that might have been two pages at incorporation can become 20+ pages after a preferred stock financing.
Perhaps the most important (or at least the most negotiated) part of the COI is the liquidation preference. In simple terms, the liquidation preference provides downside protection. For example, if the company sells for an amount at or near the total capital invested, investors may receive their money back first and the remaining stockholders may receive little or nothing. If the company has a strong exit, investors will typically convert and take their pro rata share instead of a preference payout.
The COI will also usually include protective provisions (actions that require investor approval). These commonly include: (i) authorizing additional shares, (ii) changing the rights of investor-held stock, (iii) approving a liquidation event, (iv) changing the authorized number of directors, and (v) declaring or paying dividends. This list is not exhaustive.
Other common terms in the COI include anti-dilution protection and redemption rights. Anti-dilution provisions can adjust an investor’s effective price per share (typically through an additional share issuance mechanism) if the company later issues stock at a lower price, subject to customary exclusions (e.g., option grants to service providers, shares issued for certain business purposes, and shares issued upon conversion of preferred stock). Redemption rights, where included, can require the company to repurchase investor shares after a specified period, providing an additional form of downside protection.
Investors’ Rights Agreement (IRA): The IRA covers investor rights that are not set forth in the COI. Common provisions include: (i) information rights (financial statements, inspection rights, etc.), (ii) board observer rights, (iii) preemptive rights, and (iv) registration rights. The IRA may also include post-financing covenants covering topics such as compliance (including FCPA), insurance, employee agreements and equity grants, and director indemnification.
Right of First Refusal and Co-Sale Agreement (ROFR): This agreement gives the company and, typically, the investors a right of first refusal on certain future issuances and transfers, along with co-sale (tag-along) rights in certain founder sale scenarios. In practical terms, if a key founder wants to sell shares, investors may have the right to participate in that sale on the same terms. Typically, the company’s right of first refusal applies first, followed by the investors’ right. Occasionally, India-based investors negotiate for priority over the company, which is uncommon in most US deals. In addition, VCs in India sometimes negotiate more expansive ROFR and co-sale rights than US counterparts.
Voting Agreement: A voting agreement is common, particularly if investors are receiving a board seat (often controlled by the lead investor). The agreement helps ensure that the agreed board composition can be maintained. It also commonly includes drag-along provisions. In India-based deals, drag-along terms are often longer and more detailed than in many US-only deals. There can also be extensive voting provisions relating to the company’s Indian private limited subsidiary (or soon-to-be subsidiary), which some investors require to ensure that negotiated control rights flow down to the operating entity.
The Venture Capital Ancillary Documents
Same caveat as above: these documents vary by financing. You will see only some of them in any given deal, and they can vary more widely than the core transaction documents. Although “ancillary documents” are generally less controversial, they are still important.
Consent of the Board: The consent of the board of directors is an ancillary document that you will most certainly see every time. Basically, this consent summarizes the transaction and serves as the corporate approval of the transaction. This written consent is in place of a physical meeting (which, technically, could also work) and investors will generally require that the written consent be used, for the sake of recordation. The following things are examples of what are typically approved via board consent: (i) authorizing the filing of the Amended and Restated Certificate of Incorporation, (ii) the financing and all financing related documents themselves, (iii) increases to the option pool, (iv) indemnification agreements for the directors, (v) increasing the board size and appointing the new investor director(s), (vi) amendments to RSPAs (if vesting schedules are being modified or added), and (vii) restated bylaws. This list, though, is definitely not exhaustive and the board consent will vary by financing.
Consent of the Stockholders: Similar to the consent of the board, you will see the consent of the stockholders in every transaction. Again, this is a summary of the transaction but it is generally shorter than the consent of the board because the approval of the stockholders is not required for every single part of the transaction. Again, this is in place of a physical meeting of the stockholders. At a minimum, the stockholders’ consent will approve: (i) the amended and restated certificate of incorporation, (ii) the financing (typically), (iii) the indemnification agreements, and (iv) any increase to the option pool.
Management Rights Letter (MRL): MRLs usually give the investor certain rights. Usually these rights include: (i) the right to attend board meetings and receive all documentation/information that the board members receive (if the investor is not represented on the board), (ii) the right to inspect the books and records, and the facilities of the startup, and (iii) generally, the right to advise and consult with the startup founders/management. If a VC asks for an MRL it is because one (or more) of the investors in the fund is a pension plan basically subject to ERISA. This means that there are rules and regulations that must be followed. And, since pension plans make up such a large pool of potential investors and if all these rules and regulations had to be followed, said potential investors would never be invested in VCs, an exception was made. In order to take advantage of this exception, the VC has to have the above-described rights.
Indemnification Agreements: Indemnification agreements protect board members. If you are going to have an investor on the board, they will almost always ask for an indemnification agreement. It is also a good idea for all of your board members to have one, including the founders. Basically, the company will indemnify the board members for decisions they make which result in liability. While there are typically indemnification rights in the COI and the Bylaws, an indemnification agreement gives the directors more comfort in knowing that they have a direct agreement with the Company regarding such rights and that this agreement can therefore only be modified with said director’s consent.
Legal Opinion: The legal opinion is not always seen and tends to appear only in larger deals. The attorney for the startup will certify (offer an “opinion”) as to the current status of the startup in terms of its cap table and standing.
Founder Stock Restriction Agreements: These agreements can take different forms (such as just a “Founder Agreement” or an amendment to a prior agreement) but all do just about the same thing: restrict founder stock. Most investors will want to make sure that the founders have certain vesting and other restrictions attached to their stock and will include these desires in the term sheet, if any. These will usually be seen if there is a change in the vesting schedule. Most VCs in India (like their US counterparts) are usually fine with reasonable vesting schedules and will not reset the vesting clock entirely to go back on a 4-year schedule.
Founder Agreements. These agreements typically deal with restrictive covenants, such as non-competition and non-solicitation. The India-based VCs also typically desire a bit more coverage here than US counterparts.
Conclusion
As mentioned before, there are a lot of similarities between raising money in the US and doing so in India. However, there are also differences for the most part based on the Indian private limited entity and customary terms in India-based financings. The India-based VCs and companies do a great job of closing on typical US-based terms, but with some accommodations based on the startup’s fact pattern or customary terms in India.
Ryan RobertsStartup Lawyer
Ryan Roberts is a startup lawyer at Roberts Zimmerman PLLC with more than two decades of experience advising startups and venture capital investors. He is the author of “Acceleration” and StartupLawyer.com.
