Starting a business often requires significant capital and for many entrepreneurs, securing funding from external sources is a common solution. However, using other individual’s money to finance one’s business comes with several legal considerations that must be carefully managed to avoid future complications. Whether one is seeking investments from friends, family, private investors or financial institutions, it’s crucial to establish clear agreements and understand the legal implications of such transactions.
Here are some key legal factors one must consider when leveraging external funds to launch their business.
1. Establishing clear terms with investors:
When raising funds from outside sources, clarity on the terms of the investment is essential. Investors typically expect a return on their contributions, whether through interest, equity or profit-sharing. It is important to formalise these arrangements through well-drafted contracts that specify the obligations, timelines, and rights of each party involved. Failing to document these details can lead to misunderstandings or even legal disputes later on, especially if expectations regarding returns or control over the business are unclear. Having an attorney draft or review these agreements ensures that the terms are both legally binding and enforceable.
2. Types of investment arrangements:
External funding can take many forms, including loans, equity investments or convertible notes. Each option has its own legal and financial consequences. Loans typically require repayment with interest and the terms must outline the repayment schedule and consequences of default. Equity investments, on the other hand, involve offering a share of ownership in the company in exchange for funds, which can dilute control for the business owner. Convertible notes provide flexibility, as they begin as loans but can convert into equity under certain conditions. Choosing the right structure for one’s business requires a solid understanding of these legal distinctions and their potential impact on ownership, control and future fundraising efforts.
3. Investor rights and protections:
Investors often require certain rights and protections to safeguard their investment, such as decision-making power, a seat on the board or a say in major decisions. These rights should be clearly outlined in the contract to prevent any confusion about the level of control an investor has. A common area of conflict arises when business owners seek to retain full control while investors expect a say in the direction of the company. Establishing these terms upfront can prevent conflicts down the line and help ensure that both parties are aligned on expectations.
4. Compliance with securities laws:
Any public offering or private placement of securities must comply with the regulations set by the Securities and Exchange Board of India (SEBI). If the funding involves multiple investors and securities, the company may need to register the offering with SEBI or qualify for exemptions under SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018. Non-compliance can lead to severe penalties and legal repercussions.
5. Engaging legal counsel:
Given the complexities of using other people’s money to start a business, working with a business lawyer is highly recommended. A legal professional can guide the business owner through the intricacies of drafting investment agreements, complying with securities laws and protecting their business interests. They will also ensure that all legal documents are clear, enforceable and tailored to their specific needs.
All-in-all, leveraging other people’s money to fund one’s own business can be a smart strategy, but it requires careful legal planning. By addressing these key legal considerations upfront, one can protect both their business and their investors, setting the stage for long-term success.
At GDA, we understand the challenges of navigating legal considerations in business financing. Our expert team is here to help you through the process: www.globedetective.com
