A common mistake that many entrepreneurs make is that during investment they do not make necessary compliance or leave the compliance to a traditional CA Firm who has little idea of the nuances of investment market. This creates humongous problem for that start-up in the long run and hampers the growth potential of the business. Manya times it is seen that due to noncompliance the Income Tax Department and Ministry of Corporate Affairs come heavily on the start-ups imposing heavy penalty on the companies and its directors.

In this article, we shall try to analyse what are the consequence of non-compliance during Investment and why a start-up should hire an effective compliance manager for the process.

 

1. Penalty–Investors have many ways of investment but usually they prefer investment through a process called Private Placement. This is because this process is simple and involves lesser paperwork in comparison to the other process of investment. However, non compliance such as delay in filing the requisite form (even for a day) can have fatal consequence. Under section 42 of Companies Act, 2013 if there is any type of noncompliance during Private Placement the Ministry can impose a penalty which may extend to the amount raised through the private placement or two (2) crore rupees, whichever is lower! A good compliance manager will not only help to avoid any type of non compliance in this regards but also give you a timeline which shall help you to get a clear picture of the process.

2. Shutdown–Coming back to the point of the penalty of 2 crores. Don’t you think if any company specially a start-up faces such a huge penalty, they shall be forced to shut down the company? In an industry where cash crunch is almost synonym a penalty of this magnitude can destroy any start-up.

3. Taxation–Very few people know that the valuation at which investors invest in start-ups, is to be backed by a Valuation Report from a Registered Valuer. If it is not backed by the valuation report then the business needs to pay taxes upto22% on the investment. To put this on perspective imagine a start up getting an investment of 1 crore. However, the Investment is not backed by the Valuation report from a Registered Valuer (note that all CAs are not Registered Valuer). Now, if it has to pay 22 lakhs on tax the whole purpose of investment may be lost. A knowledgeable compliance manager shall guide you in this and help you to get a Valuation Certificate which shall reduce your Tax burden.

4. Distract the Investors–Non compliance is a serious concern for most investors. Imagine that you wished to purchase share of an Indian Multinational which has been doing well for quite a few years. Now suddenly it is found that the books of accounts were all botched up and hence the Ministry has imposed a heavy penalty on the organisation. Now, shall you invest in that organization? Won’t you have any concern about the Management of the organisation and how the company shall use your money? Same things happen to the investors. If they find that the start-up has done non compliance they become weary of investment. They fear that their money may be wasted as it is a very risky business to invest in a non compliant concern and hence they seek exit opportunity. It also effects your future pitch-ins where the respective VCs may not be comfortable in investing in a company who have done non compliance in the previous round.

5. Diminish Goodwill-Noncompliance reduces the goodwill of the organisation. As mentioned in the previous point that non compliance creates a sense of alarm. This is not limited to only the investor but also includes the other stakeholders. The clients may feel that they may be given products which is not par with the cost that they are paying, the suppliers may not be comfortable to give goods on credit as they may think that their money may be stuck if the company is non compliant and the associates may not be willing to have alliance with the start-up as they may feel it will harm their brand value. This is a long term phenomenon and can have a significant effect on the start-up.

6. Advice-A good Compliance Manager not only helps the start-up to carry out the necessary compliance but also advises it on the term sheet. There are lot of clauses that is mentioned in the Term Sheet and the Share Holder’s Agreement. A compliance manager can help the promoters to understand the implication of these legal clauses and in this way can facilitate a healthy negotiation with the investors. In this way the interest of the promoters are protected and it is not a one sided affair.

So, what are the things a start-up should focus while deciding his compliance manager for the investment-

• Professional Experience of the Compliance Manager in the said field
• Professionals attached with the Organisation who knows about the process and also the Tax implication of it
• Transparency of the organisation specially in the fees structure
• Flexibility of the Manager especially if he is available during the need.
• Confidentiality of the investment matters very much. Many a times investors are not comfortable with disclosing their investment and the compliance manager should respect it.
• A single dedicated SPOC is necessary in the process. Investors tend to change the terms of investment quite often and only a dedicate compliance manager who assist the start-up right from the starting can assess the impact of the change.

 

 

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For any query, support or feedback, reach us at India Tax & Legal Compliance or Call/WA us at +91-9230033070 for any support/query/feedback.

 

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