Fund raising challenges of startups under the Companies Act

27 March 2023

Recently, the Registrar of Companies, NCT of Delhi and Haryana[1], has levied penalty on M/s. Anbronica Technologies Private Limited (‘Company’) and two of its directors for contravening Section 42(7) of the Companies Act, 2013 (‘Act’) vide its Order dated 1 March 2023 (‘Order’).

Section 42 of the Act deals with issue of shares on private placement basis. Section 42(7) states that a company shall not while issuing securities release any public advertisements or utilise any media, marketing or distribution channels or agents to inform the public at large about such an issue. Explanation I to Section 42(3) defines the term ‘private placement’ as any offer or invitation to subscribe or issue of securities to a select group of persons (other than by way of a public offer).

The Order states that the Company had approached M/s. Tyke Technologies Private Limited (‘Tyke’), which is running a technology-based community platform under the brand name ‘Tyke’. It was observed that on its platform, Tyke had created a network of individuals from the business industry, corporate executives and professionals who are part of the Startup ecosystem. These members have access to the content on the platform, thereby Tyke facilitates in knowledge sharing on investing in Startups and organising online pitching sessions. Tyke also facilitates in setting up of an escrow bank account for accepting investment in a separate subscription bank account, verifying the identity of the investors, etc.

The Order records the terms and conditions of using the Tyke platform, which includes a statement that the platform has an internal mechanism to restrict the number of investors that view the detailed profile to 200 by default; and that the information provided through Tyke should not considered as (i) an offer, or solicitation of an offer, to purchase or sell any security, other asset or service, (ii) investment advice or an offer to provide such advice; or (iii) a basis for making any investment decision.

Tyke also confirms that it organises online pitching sessions in the format of an AMA (‘Ask Me Anything’) for a company seeking investment to interact with community members of Tyke and to collect investment interest. The AMA sessions are accessible by all community members, which are running into 1.5 lakhs currently, and thereafter the recorded sessions are uploaded onto Tyke’s YouTube channel.

In the case of the Company, while the Board Approval was received for the issuance of CCDs on 10 July 2021 itself, the Company created a brand name ‘DECIWOOD’ on Tyke and initiated a campaign for raising funds towards the issue of CCDs until 25 July 2021. On receipt of communication of interest to invest, the Company identified 28 members to whom 125,000 Compulsorily Convertible Debentures (CCDs) of INR 10/- each were issued at par. For this purpose, a special resolution was also passed authorising issuance of CCDs on 2 August 2021 and also the PAS – 4 (Private Placement Offer Letter cum application form) was circulated to invite the subscription money from the identified investors, which was received from the identified persons in the virtual Escrow Account to the Company’s separate bank account. While that is so, the amount so invested was received into the Escrow Account before the date of the Extraordinary General Meeting (EGM) itself in which the special resolution was passed on 2 August 2021. Further, there was over-subscription for the CCDs, as displayed on the website of Tyke.

As a consideration for the services, Tyke charged 2% plus GST on the amount transferred in the Escrow Account by the community member. The Company has access to the list of community members anytime who have parked their money in their own virtual Escrow Account, which can exceed beyond 200.

Tyke also charged the Company a service fees, which is calculated as a percentage ranging from 1% to 4% of the amount raised from the investors and transferred to the Company’s Escrow Account. Noticing all of these facts, the ROC had issued a Show Cause Notice for the violation of the provisions under Section 42 of the Act.

On behalf of the Company, it was argued that the Company has only availed value added services (VAS) provided by the Tyke platform, which are in the form of facilitation of connecting like-minded people community with start-ups, verification of KYC, opening of escrow account, etc. For this purpose, a Service Agreement was executed between the Company and Tyke.

The Adjudicating Officer held that the provision requires that the company should adhere to the limit of 200 persons not just with respect to the number of persons who ultimately subscribe to the securities of the company, but also that this limit cannot be exceeded at the time of making an offer or invitation to offer of the securities of the company.

Considering that community members showing interest in the company can exceed 200 as per Tyke, the AO had concluded that the offer/ invitation had taken place or been made to more than 200 persons. The AO had also noted that based on the role played by Tyke, it cannot be relegated to mere ‘generation of interest in the company’, instead it is an active facilitator for allowing the companies to raise investments through its portal and is providing the services of media/ marketing/ distribution channel/ agent to inform the public at large about the issue of securities. The AO also noted that Tyke has collected commission at various stages of the campaign from the Company and from the investors.

Concluding remarks

Private limited companies are the favoured entity structures in India due to their wide recognition, limited liability concept and acceptance by the regulators and stakeholders. Startups have been given impetus and privileges so that they can thrive in the competitive market. Undoubtedly, Startups need a special treatment for attracting investments. They cannot be treated on par with other traditional companies. However, companies like Tyke that are running unique platforms for bringing investors and startups together need a special treatment under the Act, without of course, compromising on the quality of information circulated through them and also securing adequate protection.

Thankfully, the Companies Act does not have specific provisions punishing the ‘abetment’ of offences for contravention of Section 42, and therefore Tyke cannot be held liable for any consequences for abetting the contravention of the provisions of the Act by the Company. However, in this regard, the provisions dealing with fund raising by Startups could do with a fresh look particularly due to the nature of business and the need for funds. Otherwise, there is always a high risk of a liquidity crisis. 

[The author is a Partner in Corporate and M&A practice at Lakshmikumaran & Sridharan Attorneys, Hyderabad]



[1] Appointed as Adjudicating Officer under Section 454(1) of the Companies Act, 2013 for adjudicating the penalties under the provisions of the Act.

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