Handbook on

Venture Capital
An Entrepreneur's guide to
Early Stage Funding
lhdia's LargesI
Deal lh!ormaIioh 8ahk
Sihce '02
March 2013

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VehIure CapiIal

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DirecIory SecIioh
ExecuIive Summary

VehIure capiIal ihvesIor lahdscape ih lhdia
NegoIiaIihg 1erm SheeIs - Legal lssues
Dealihg wiIh Early Rouhd lhvesIor
AhIi-DiluIioh RelaIed Clauses:
WhaI EhIrepreheurs Should WaIch OuI For
LiquidaIioh Pre!erehce
1he EhIrepreheur's PerspecIive
Cah CapiIal ever be a Curse?
Premium LisIihgs
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21
1able o! CohIehIs
Fxeculive Summary
Whch (Investor) Doors to Knock7
And How to Go About It

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1he real news or enlrepreneurs seekin exlernal capilal loday is lhal
lhere are several pockels o Venlure Capilal irms and similar inveslors
lhal are scoulin or opporlunilies lo pick up equily slakes in youn,
rowlh orienled companies. Al Venlure lnlellience, lndia's irsl and
leadin research irm lrackin Privale Fquily/Venlure Capilal aclivily, we
have been ascinaled lo observe how lhe early slae inveslin ecosyslem
has illed oul rapidly over lhe pasl ew years wilh lhe enlry o several
acceleralors/incubalors, anel nelworks/roups, seed and early slae
ocused unds.
While lhe availabilily o more inveslors lo approach is no doubl a ood
lhin, iven how inlense and lime consumin any capilal raisin process
is, we ell a uide lhal can help idenliy lhe "rihl doors lo knock - based
on lhe nalure o lhe slarlup, lhe amounl o undin required, elc. - alon
wilh inpuls (rom inveslin induslry and advisory praclilioners) on "lhe
do's and don'ls o lhe process would serve enlrepreneurs well.
1he handbook beins wilh Venlure lnlellience's overview o lhe venlure
capilal inveslor landscape in lndia, wilh a special ocus on providin a map
o lhe various lypes o inveslors.
One o lhe key developmenls in early slae undin in recenl years is lhal
il has become a larely "dis-inlermedialed semenl wilh mosl o lhe
inveslmenl bankin advisory irms preerrin lo work only larer sized
inveslmenls. Consequenlly, lhe role o leal advisors has come lo lhe ore.
ln lhe arlicle lilled Neolialin 1erm Sheels - Leal lssues, Siddharlh Raja
and Neela 8adami o Narasappa, Doraswamy & Raja oulline lhe
commonly encounlered issues in lhe neolialion and enorcemenl o
venlure capilal inveslmenl lerm sheels. As is well known, one o lhe key
poinls o discussion in VC inancin relales lo lhe provisions relalin lo lhe
exil o lhese inveslors. ln lhis conlexl, lhe aulhors emphasize lhe need or
clarily in lhe usae o lhe lerms 'liquidily' and 'liquidalion'. "1o avoid
conusion in lhe lndian conlexls, il may be beller lo separale lhe
'Liquidalion preerence' clause inlo lwo dislincl slrands - one, whal
happens in case o windin up under lhe Companies Acl, and lwo, whal
happens in case o an exil or 'liquidily' evenl.
H. Iayesh and Sumilava 8asu o Iuris Corp wrile aboul an ol overlooked
aspecl in equily inancin neolialions: slruclurin lhe rihls o early
round inveslors in such a way il causes minimum disruplions in raisin
addilional inancin down lhe line rom newer inveslors. ldeally, lhe
inveslee company should build in lexibilily inlo lhe deinile areemenls
enlered inlo wilh lhe exislin inveslor or ulure rounds o inveslmenl.
1his in acl, avoids lon drawn-oul neolialions (and perhaps reduces a
lawyer's role siniicanlly), lhey recommend.
Anolher olen lhorny issue is lhal relalin lo anli-dilulion clauses - i.e.
provisions aimed al proleclin inveslors in case lhe company has lo raise
addilional inancin laler al a lower valualion lhan al lhe lime o lheir
inveslmenl. 1he arlicle by Kosluri Ghosh, lpsila Chowdhury and Suvojil
Halder o 1rileal hihlihls aspecls lriered by lhese clauses lhal
enlrepreneurs should walch oul or. 1he arlicle suesls lhal
enlrepreneurs should ideally neoliale or a weihled averae
adjuslmenl (vs a ull ralchel adjuslmenl) and also or includin a Pay lo
play mechanism whereby inveslors are allowed lo lake lhe beneil o
anli-dilulion only i lhey parlicipale in down rounds. 1he aulhors also
poinl oul lhe need or enlrepreneurs lo walch or lhe implicalions o anli-
dilulion adjuslmenls lhal resull in a subslanlial chane in company's
shareholdin on olher conlraclual, reulalory and lax implicalions.
1he Fnlrepreneurs' Perspeclive seclion relales lhe experience o several
enlrepreneurs who have raised and beneiled rom raisin venlure
capilal.
Given lhal capilal in lhe early slaes is becomin more plenliul, should
enlrepreneurs jump in and raise money "when lhe oin is ood? Sanjay
Anandaram o Iumpslarlup - who has been an enlrepreneur as well as an
anel and VC inveslor - provides a caulionary lale in his arlicle "Can
Capilal ever be a Curse?
We hope you ind lhe conlenls o lhis Handbook useul. Do send us any
eedback lhal mihl help us improve.
1he Venlure lnlellience 1eam
ino@venlureinlellience.in
+91-44-4218-5180
Neotatn 1erm Sheets
- Leal Issues

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Introducton
'1erm sheel,' 'non-bindin lerm sheel,' 'indicalive lerm sheel,' 'Leller o
lnlenl,' 'Head o 1erms,' 'Nemorandum o Underslandin,' 'Non-bindin
NOU' are commonly heard lerms in lhe privale equily and venlure capilal
world. 1his arlicle will look al some commonly encounlered issues in lheir
neolialion, as well as enorceabilily issues, rom lhe perspeclive o bolh
enlrepreneurs and unds, in lhe lndian conlexl. We will also consider
exchane conlrol issues lhal arise in lhe conlexl o inveslmenls by orein
/ non-residenl VC unds in domeslic lndian companies lhrouh lhe
orein direcl inveslmenl ("FDl) roule or olherwise.
Overvew of the man provsons found n 1erm
Sheets
Simply pul, a "1erm Sheel, by whalever name called, is a documenl lhal
sels oul key inancial, proleclive and overnance lerms o a proposed
inveslmenl by a VC or a PF und in a company lookin or inveslmenl.
1hey come in all shapes and sizes ranin rom a bare-bones documenl a
couple o paes lon, lo delailed documenls runnin inlo len - lwenly
paes. Whal lhey all usually have in common is lhe underslandin lhal
lhey are nol bindin amon lhe parlies unlil lhe execulion o 'deinilive
documenlalion,' such as a share subscriplion / purchase areemenl, a
shareholders areemenl (also called an inveslor rihls areemenl) and
execulive employee areemenls.
1ypically, lhe inancial provisions lhe 1erm Sheel will sel oul are lhe
proposed inveslmenl amounl, lhe valualion o lhe company, whal kind o
inveslmenl inslrumenl is proposed and a limeline or lhe inveslor's exil,
loelher wilh indicalive exil mechanisms, includin inilial public oers
("lPO), slraleic sale, 'pul oplion,' 'call oplion' amon olhers. 1he
'Liquidalion Preerence' clause is also a siniicanl one.
Governance lerms and proleclive provisions will include lhe composilion
o lhe board o direclors, some kind o lock-in over lhe ounders' shares,
and somelimes, delailed provisions overnin share lransers (includin
lerms such as 'la-alon,' 'dra-alon,' 'rihl o irsl reusal,' 'rihl o irsl
oer,' 'co-sale rihl').
Proleclive provisions will seek lo saeuard lhe und's inveslmenl and ils
relurns in several ways, or example, lhe rihl lo receive delailed
inormalion aboul lhe company's inancial heallh (includin manaemenl
inormalion syslem reporls, unaudiled monlhly inancial slalemenls, and
operalional reporls). 1he rihl lo velo cerlain aclions in board meelins
and shareholders meelins and lhe rihl nol lo be diluled in case o ulure
inancin rounds are some commonly seen and imporlanl proleclive
provisions.
fnancal provsons
What nstrument7
Once lhe parlies have been able lo aree on lhe valualion o lhe company,
lhe nexl queslion lhal usually arises is whal kind o inveslmenl inslrumenl
is desired. Available oplions are equily shares, preerence shares, and
converlible inslrumenls such as converlible debenlures or preerence
shares. Nole lhal in case o inveslmenls by non-residenl unds, all shares
musl be ully paid-up (as parlly paid inslrumenls are nol allowed or FDl
excepl wilh prior approval o lhe Governmenl), and lhe price per share
musl be above lhe 'air value' arrived al in accordance wilh prescribed
melhods. Also, converlible inslrumenls musl be ully and mandalorily
converlible in order lo be reckoned as equily. Parlly converlible or non-
converlible inslrumenls would be reckoned as debl and subjecl lo lhe
more onerous rules applicable lo exlernal commercial borrowins.
Several aclors inluence lhe und's choice o inslrumenl. 1he principal one
is how lhe und envisions ils role in lhe company. Funds which wanl lo
have a hands-on, ully involved, operalional role in lhe day-lo-day aairs
o lhe company may choose lare or conlrollin slakes o above 50% o
lhe shareholdin, lo be held in lhe orm o equily. Olher unds or which
lhe inveslmenl is a purely inancial one, and where lhere is no inleresl in
becomin inlimalely involved wilh lhe day-lo-day operalions, may
choose preerence shares or inslrumenls converlible inlo equily. 1he acl
lhal converlible debenlures, while in lhe unconverled slale, rank as debl;
and while in lhal orm, rank hiher lhan lhe equily shareholders in lhe
queue o persons eliible lo receive dislribulions (in lhe evenl o lhe
company bein wound up), are aclors lhal unds lake inlo accounl.
Whelher preerence shares are lo be parlicipalin or nol, musl also be
considered (allhouh as a praclical maller il is hihly unlikely lhal slarl-
ups will have proils lo dislribule in lhe irsl ew years o lheir exislence).
ln lhe inlernalional conlexl, 'parlicipalion' assumes siniicance in liquidily
/ liquidalion scenarios, as discussed below.

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What rhts can the nstrument have7
Nole lhal shares wilh dierenlial volin rihls ("DVR Shares) cannol be
reely issued by all companies - in case o public companies, lhere are
cerlain condilions lhal musl be complied wilh beore such DVR shares can
be issued. For example, one o lhe key condilions is lhal lhe company
have dislribulable proils in lhe lhree inancial years prior lo lhe year in
which shares wilh dierenlial rihls are lo be issued. ln lhis conlexl, lhe
'Liquidalion Preerence' clause assumes siniicance. ln jurisdiclions like
lhe Uniled Slales, where (comparalive lo lndia) companies can be wound
up or liquidaled relalively quickly, lhe lerm 'liquidalion preerence' is used
lo imply lhal in lhe evenl lhe company is liquidaled or sold, i.e, an exil
evenl is crealed, lhe und would irsl el ils relurns (1x, 2x, elc.) beore
lhe ounders el lheir share.
However, lhe use o lhis lerm in lhe lndian conlexl ives rise lo a lol o
conusion (since lhe word 'liquidalion' suesls dissolulion o lhe
company, lhe process or which is prescribed under lhe lndian Companies
Acl, 1956 (lhe "Acl). 1he Acl ilsel also prescribes lhe manner in which
available moneys musl be paid oul (irsl and paripassu lo secured credilors
and workmen, lherealer lo salisy all olher debls, and only inally lo
shareholders), and hence, any conlraclually areed clauses on lhe manner
in which moneys musl be dislribuled upon a liquidalion o lhe company
may nol be sacrosancl or iven eecl lo by a courl o law. 1he beller
expression is, lhereore, a 'dislribulion preerence' arisin upon lhe
occurrence o a 'liquidily' evenl, namely, a lransaclion lhal realizes lhe
'value' o lhe company, lypically, in cash (allhouh a share or slock deal is
nol ruled oul, excepl lhal achievin il is a reulalory challene).
Nole however lhal lhere is no conlraclual reslriclion on areein as lo
how moneys musl be dislribuled in case o olher exil evenls such as sale lo
a lhird parly (who may be a slraleic or inancial inveslor), as lon as
applicable exchane conlrol and laxalion laws are complied wilh. 1o avoid
conusion in lhe lndian conlexls, il may be beller lo separale lhe
'Liquidalion preerence' clause inlo lwo dislincl slrands - one, whal
happens in case o windin up under lhe Acl, and lwo, whal happens in
case o an exil or 'liquidily' evenl. Unorlunalely, il is nol unusual lo see lhe
lerms 'liquidily' and 'liquidalion' bein (incorreclly) used inlerchaneably.
fxt provsons
Commonly used exil provisions, in PF/VC deals such as lhe 'pul oplion'
and 'call oplion', have been in lhe eye o a reulalory slorm in lndia
recenlly. 1his is because lhe Reserve 8ank o lndia ("RI) considers lhese
oplions as ranlin orein inveslors uaranleed relurns, ivin lhe
inveslmenl inslrumenl debl-like ealures, as opposed lo equily. 1he
Securilies Fxchane 8oard o lndia ("SfI) considers lhal all oplions
musl only be exchane-lraded and cannol be o-exchane, conlraclually
areed belween parlies.
1he olher open leal issue is lhe sanclily o provisions lhal seek lo reslricl
lhe ree lranserabilily o shares, such as pre-emplive rihls, rihls o irsl
reusal and oer, la-alon and dra-alon rihls, all o which depends on
lhe lype o enlily lhal lhe company, inlo which an inveslmenl is bein
proposed, is.
Governance 1erms
oard and Shareholder meetns
Funds would wanl a say in lhe way lhe company is run, on cerlain
imporlanl ilems, al leasl. For lhis reason, lhe und will lypically nominale
al leasl one direclor lo lhe company's board, coupled wilh inclusion o a
lisl o ilems on which lhe board cannol proceed unless lhe inveslor
nominee direclor has consenled. 1his lisl is lypically replicaled al lhe
shareholder level as well, such lhal no resolulion can be passed by lhe
shareholders in eneral meelin on a speciied lisl o mallers unless lhe
und, as a shareholder has consenled. When lhe queslion o whelher
lhese 'airmalive rihls' or 'velo rihls' amounl lo lhe und acquirin
'conlrol' over lhe inveslee company or lhe purpose o lhe lakeover
reulalions came up beore lhe SF8l, SF8l ruled in lhe airmalive. 1he
Securilies Appellale 1ribunal ("SA1) reversed SF8l's order. 1he maller
wenl up beore lhe Supreme Courl, bul was unorlunalely sellled beore
lhe Supreme Courl could pass an order on lhe merils. 1he Supreme Courl
did however expressly slale lhal lhe SA1's rulin was nol lo be lrealed as
precedenl. 1here is a likelihood lhal in lhe ulure a reulalor or courl could
lake lhe view lhal unds enjoy 'conlrol' over lheir inveslee companies,
wilh allendanl leal implicalions.
Restrctons on Share 1ransfers
Shares are markelable securilies, and are movable properly "lranserable
in lhe manner provided by lhe arlicles. (S. 82, Acl). One o lhe imporlanl
dierences belween privale and public companies in lndia is lhal a privale
company musl by deinilion reslricl lhe rihl lo lranser ils shares. For
public unlisled and lisled companies, unellered lranserabilily o shares is
key.
1he abilily lo reslricl lhe lranser o shares in privale companies is
imporlanl rom lhe poinl o view o lhe unds. 1ypically, such inveslors
would wanl lo ensure lhal lhe ounders / promolers o lheir inveslee
company cannol unilalerally decide lo jump ship in lhe evenl lhal lhe
company's business is lounderin - lhereore, elaborale provisions
overnin lhe lranser o shares is lypically included in lransaclion
documenls. 1hese include rihls o "la-alon, "dra-alon, rihls o
irsl oer and rihls o irsl reusal . While lhese rihls are now airly
common in lhe induslry, lheir enorceabilily in courl is yel lo be lesled.
1his is imporlanl when one recalls lhal orein inveslmenl rules are
layered upon lhe Acl. So, while lhe above rihls may all wilhin lhe ambil
o lhe Acl's provided rihl lo privale companies lo reslricl lhe
lranserabilily o shares, FFNA reulalions slill have lo be considered.
1hereore, a orein inveslor may nol be able lo enorce ils dra rihl in
FFNA-reulaled seclors, unless lhe pricin uidelines are complied wilh.

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fnforceablty of 1erm Sheets n Inda
1his is an inlereslin queslion lhal has so ar nol been examined in lhe
conlexl o lhe VC or PF space in lndia, allhouh lhe queslion has come up
several limes beore lndian courls in lhe commercial conlracls conlexl. 1o
summarise, lerm sheels are preliminary areemenls, evidencin an
inlenlion o lhe parlies lo enler inlo a conlracl al a ulure dale. Such
'areemenls lo aree' are nol enorceable under bolh Fnlish and lndian
law, allhouh, lhere may be exceplions dependin on lhe acls and
circumslance o each case, lhe conducl and lhe inlenlion (whelher
express or implied) o lhe parlies lo creale leal relalions.
IN1RODUC1ION AND OVfRVIfW
Narasappa, Doraswamy & Raja ("NDR) is a parlner-led, solulion-orienled law irm which has been conslanlly ranked as a leadin law irm in lndia.
1he Firm is commilled lo providin smarl and qualily leal advice lo our clienls; mainlainin lhe hihesl levels o proessional inlerily; and nurlurin
our lawyers in a work environmenl lhal molivales lhem lo achieve and mainlain lhe hihesl proessional slandards. 1he irm is headquarlered in
8analore, wilh oices in Chennai and Delhi and capabililies lo work across lhe counlry wilh associaled counsel and reularly does so. NDR has
reularly received lhe hihesl accolades and rankin rom ils peers, includin reconilion in Chambers & Partners, Leal500, Asan Leal usness
and the Practcal Law Company.
Our core experlise is in 8ankin & Finance, Commercial Real Fslale, Dispule Resolulion - Arbilralion & Lilialion, General Corporale Advisory, Human
Resources & Fmploymenl, lnlelleclual Properly, Nerers & Acquisilions and Ioinl Venlures, Privale Fquily & Venlure Capilal inveslmenls & 1echnoloy,
Nedia and 1elecommunicalions. 1he irm prides ilsel on providin leal advice across various seclors and induslry and has ained experlise in lhe areas
o e-Commerce, Fducalion, Fnineerin Services and Conslruclion, Fnlerlainmenl. Heallhcare, Hospilalily, lnormalion 1echnoloy, lnraslruclure,
Pharmaceulicals Renewable Fnery & Clean 1echnoloy, Shippin and 1elecommunicalions.
SIDDHAR1H RAJA, Parlner
Siddharlh has exlensive experience in privale
equily and venlure capilal lransaclions as well as
experlise in cross-border and domeslic N&A,
corporale inance and eneral commercial law. Prior
lo co-oundin lhe Firm, Siddharlh was a Parlner or over a year al lhe
lndian law irm, Udwadia & Udeshi, where he worked on various merers
& acquisilions, corporale and corporale inance lransaclions and
assinmenls. 8eore relocalin back lo lndia, he was an Associale or
aboul 3 years wilh lhe inlernalional law irm, ONelveny & Nyers LLP, in
lheir Hon Kon oice, where he specialized in cross-border N&A,
includin represenlin Chinas leadin e-commerce company, FachNel, in
ils acquisilion by e8ay. Prior lo his slinl wilh ONelveny & Nyers, he was
an Associale al Udwadia, Udeshi & 8erjis in Numbai or 3 years. Siddharlh
has been a visilin acully member al lhe Deparlmenl o Nanaemenl
Sludies, lndian lnslilule o Science, 8analore. He is admilled lo praclice
law in lndia and in Fnland & Wales (currenlly nol praclisin). Siddharlh
has reularly been lop-ranked in lhe Chambers & Parlners Asia Paciic
Guide lo lhe Worlds Leadin Lawyers. He can be reached al
siddharlh@narasappa.com.
NffLA ADANI, Senior Associale
Neel a works exlensi vel y on i nveslmenl
lransaclions (merers and acquisilions, privale
equily) commercial conlracls, and provides
reulalory advice (exchane conlrol and securilies
reulalion). Prior lo joinin lhe Firm, Neela was wilh Amarchand
Nanaldas, Numbai. She radualed rom NALSAR, Hyderabad, and
received her LL.N rom lhe Universily o Nichian Law School, Ann
Arbor. She has been published nalionally and inlernalionally. Neela is
admilled lo praclise law in lndia. Neela has been ranked as a Leadin
lndividual in 8ankin & Finance in lhe Chambers & Parlners Asia Paciic
Guide 2013. She can be reached al neela@narasappa.com.
1hereore, lhe parlies musl employ clear and unambiuous lanuae lo
avoid dispules. Cerlain clauses like Dispule Resolulion, Fxclusivily,
Conidenlialily, 'No-Shop,' musl be expressly slaled lo be valid and
bindin, independenlly o whelher or nol lhe deal oes ahead wilh lhe
execulion o deinilive documenlalion. lmporlanlly, clauses dealin wilh
cosls or ees, and who is lo bear lhem, whelher or nol lhe deal oes
lhrouh, musl also be clearly indicaled lo be bindin, so as lo avoid
unpleasanl shocks laler. 1he concepl o 'break-ees' is anolher clause lhal
musl be made so bindin irrespeclive o deal closure.
DlSCLAlNFR: PLFASF NO1F 1HA1 1HF CON1FN1S OF 1HlS AR1lCLF ARF NO1 NFAN1 1O 8F A SU8S1l1U1F FOR O81AlNlNG LFGAL ADVlCF. l1 lS
ONLY AN lN1RODUC1lON FOR lNFORNA1lONAL PURPOSFS AND WF URGF YOU 1O CONSUL1 YOUR LAWYFRS FOR SPFClFlC ADVlCF.