What do start-ups do to be investor ready?

Structure your equity shareholding

Most of the times start-ups do what they are supposed to do, that is to source funds from friends and relatives at cheap cost. And the best way is to commit a certain % of equity from their holdings. But in the hurry of getting funds to sustain the business, start-up commits some common mistakes like:

  • Accepting fund from friends and relative without understanding who is eligible to send funds in the company’s bank account.
  • Accept money and commit the equity % without having a valuation of the company.
  • Committed equity is not regularised with Ministry of Corporate Affairs.
  • Income tax rule is not discussed before issuing of shares.
  • Proper business valuation not performed.
  • Committing employees and vendors shares without properly structuring it as per MCA rules.

Accepting Loans

A common mistake done by start-ups in the urgency of taking funds for their bootstrapped operation is to accept the money without proper documents and reasoning in the form of loans. Friends and family support them but the implication of not following compliances attracts penalties, which may not be investor friendly. Some of the common mistakes like:

  • Accepting funds from friends and showing them a loan in the books.
  • Accepting funds from relatives who are not the director’s relatives.
  • Accepting funds from shareholders more than their statutory limits.
  • No documentation at which the rate of interest is decided.
  • No timely accrual of the rate of interest.
  • Commitment to convert the loan into equity after a certain period without proper documentation.

ROC & Tax Compliances

There are many ROC & Tax compliances that have to be completed from time to time to ensure the business is investor ready. When a company complies with ROC, it creates a first impression of being a disciplined company in the mind of the investor. And as you know the first impression is the last impression. Common mistakes:

  • Not holding a structured board meeting. A board meeting is more an informal meeting than a formal one where the agenda is chalked out, the decision is made, business strategy is discussed and finally, the future of the company is tabled. It is good to have these documents ready and meetings are conducted timely;
  • Monthly, quarterly and annual tax compliances are important and any delay in completion attracts a penalty. Companies think it is ok to have penalties and pay, but investors take it seriously and link it with the usage of funds. No investor is interested to put his money in a company who is negligent of government compliances.
  • Annual return filing before the due date is important as this depicts that the co-founders are serious to complete all compliances.

Employee compliances

Employee-related compliances like, provident funds, employee state insurance, professional tax are small but critical monthly compliances. They attract penalties if not done timely. Companies should ensure such compliances are completed with the help of professionals. CFO Angle helps the organization to be investor ready by ensuring monthly compliances are completed timely.

Annual audit and accounting

Accounting is an important aspect of financial discipline, where it is insourced or outsourced all the expenses and incomes should be recorded timely. When an accounting activity is performed timely it helps co-founders to understand their current cash burn rate and it not only helps them to control unwanted expenses but also understand how many months they can sustain. Common mistakes are:

  • At times accounting is not given due importance and it is just considered as an extra activity.
  • To ensure the audit is completed on the due date as this depicts the true health of the organization.
  • Annual tax filing needs to be done immediately after completion of audit as this is a must to have a good business history;
    Generate monthly MIS from the accounting consolidation like monthly P&L, Balance Sheet, Schedules, Cash Flow statement, Cash burn, Budget vs. Actuals, Product costing, and Cost of customer acquisition and other MIS to show the business progress.

Timely creation of ESOP’s Pool

Employee stock options widely called an ESOP’s is the most popular option to give equity to employees who are part of the start-up ecosystem and would like to work at lower salaries which are compensated by equity in the hope that during the valuation they can cover up. Investors always look up to the co-founders who have intelligently and timely structured the ESOP’s and used it effectively to retain the right talent. Not only the product and services are important but the employee is also valuable assets. Investors are keen to understand how start-ups have planned to retain talent. Some of the common mistakes made are like:

  • Timely creation of ESOP’s pool. Hard working, loyal and committed employees will not wait when a better opportunity strikes.
  • The balance between the offered salary and shares.
  • Vesting time period and allocation of the number of shares.
  • Vesting conditions should be properly linked to the accomplishment of corporate objectives not available through others.
  • Number of shares for each designation, when structured correctly, results in improved productivity, profitability and overall corporate performance as employees tempted to work hard to achieve.

Effects of Non-Compliances

  • Every noncompliances attract penalty and can have multiple impacts including Balance sheets not signed, Ministry of Corporate affairs and Income Tax department sending notices and similar such issues.
  • Low investor confidence in the basic financial health of the company.
  • Low employee and vendor morale.
  • Directors disqualifications.

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