From IDEA To IPO: A Legal Playbook For Start-Ups Aastha Abhya

Every large business venture was once a mere idea. A seed that was sown, cared for, which then germinated and grew into what the world now sees as an enterprise. In today's competitive times, with regulatory requirements that can mire a founder in permissions, approvals, and compliance, it is not enough to merely possess an idea. To build that idea into an enterprise, one that takes into account all the legal steps and milestones involved, is almost a requirement today - one that can fortify founders from business and regulatory risks and unforeseen financial and business circumstances.

The word IPO is much heard but little understood. To put it simply, an IPO (initial public offering) is when a private company decides to sell its shares to the public (thereby converting to a publicly owned company) in order to raise equity.

Here are some key steps which can be followed for ultimately transitioning into a Public Limited Company.

1. Foundational documents:

It is vital to ensure that foundational documents (i.e. the Deed of Incorporation of a company, or Deed of Partnership in case of a partnership / LLP, etc) are correctly and professionally drafted. These must clearly set out the nature of the business contemplated, the activities within that scope, the existing relationship between the stakeholders (including individual shareholding as applicable), the monetary contributions that each of the stakeholders made at incorporation, etc. It is suggested that potential areas of dispute, such as the ratio of profit sharing, capital infusion, and management of the commercial concern, also be expressly demarcated. These documents, including any changes therein, must be duly registered with the concerned authorities.

Co-founders Agreement: In cases where there are multiple founders, it is advisable to execute a 'co-founders' agreement. This document is distinct from the business's foundational document(s). It governs the relations between the co-founders, and contains provisions including procedures to be followed in scenarios such as an individual co-founder leaving the business, right of pre-emption to buy their shares, and dissolution of the business. The biggest advantage of a co-founder's agreement, in authors view, is that it forces the founders to think of their foundational values, vision, and method of working and allows them to iron out differences at the beginning itself.

2. Intellectual Property:

Intellectual Property, such as Trademarks, Copyrights, Patents, etc., are valuable assets of any company that can provide a competitive advantage, better investment from investors and may also generate new revenue streams, if they have the right legal protection. This is why IP should be considered seriously, right from business infancy, and be registered and renewed from time to time. It is suggested that the name of the registered IP 'holder' be the name of the business (and not any individual). In case it is previously registered in an individual's name, a Deed of Assignment should be registered and noted in the Registers.

3. Contracts with Vendors and Clients

While contracts are often looked at as a mild headache, well-drafted contracts can save a business from costly mistakes, clarify expectations and mitigate risks. It is suggested that business contracts should spell out the rights, liabilities, and obligations as clearly as possible, with provisions built in for any future eventualities. This may need the parties and the legal representatives to think holistically and clearly about the engagement, the possible risks that can arise and incorporate fair and creative ways to fortify against them. It is critical for businesses to take their contracting seriously from the outset. Should the business seek to convert into a public company, or seek external funding at any stage of its operations, a due diligence will be initiated into the processes of the business. In case the business appears to be operating loosely, it will adversely affect the company's valuation and consequently, funding opportunities.

4. Compliance with various Laws

A commercial endeavour is required to follow various Laws, often depending upon the nature and extent of the business. Consultation with experienced legal and subject-matter consultants on the applicability of relevant laws and its compliance requirements is essential. It is often observed that start-ups, especially in their initial days, operate on passion, within little to no regard for processes, documentation or understanding of the legal framework within which they operate. This is dangerous because it exposes the start-up to a multitude of risks, including litigation and regulatory risk. Non-compliance with applicable regulations may render the business susceptible to action, and thus hamper the move towards the company going public.

5. Finances and Accounts

Conversion to a Public Limited Company involves a detailed scrutiny of the finances of the company. It is essential, therefore, to ensure adequate controls on inflow and outflow of money and maintenance of accurate accounts, which are audited by recognised professionals as required. This is because a company's financial statements are often a true mirror of its health and the basis on which an investor often makes their investment decision. Ensuring accurate, updated and compliant books of account may sound tedious, but they are indispensable for a start-up that is looking to scale from idea to IPO.

6. Private Limited Company – Private Placement of Shares

S.42 of the Companies Act allows 'Private Placement of Shares'. A company, before issuing an IPO, may resort to private placement in order to raise money by allowing investment into the company. This is a way adopted to infuse capital into a company and simultaneously gain the confidence of the market. For those start-ups that seek to attempt such a measure, it is strongly suggested that technical experts in these transactions are consulted from the outset. This becomes even more important given the fact that the company can be exposed to heavy fines if the relevant regulatory aspects are not adequately addressed. Cutting costs by attempting to do everything in-house has, in authors experience, often backfired. The cost of course correction is often way bigger, and valuable time is also wasted. It is clarified that such investments differ from investments made by 'Qualified Institutional Buyers'.

7. Formation of a Public Limited Company

For all companies that are not yet a public limited company by now, it would be necessary to incorporate such a company and thereafter proceed to transfer all the property of the erstwhile business entity to such a company. However, in the case of an existing private limited company, certain steps are necessary to be followed in order to convert it a public limited company. This would entail

• Alteration of the Articles of Association (AOA) of the Company. The Board of Directors would be required to schedule an Extraordinary General Meeting (EGM) in which a special resolution (requiring 75% approval of the votes cast) would need to be passed.
• As the conversion of a private limited company has an effect on the financial position of the company, the Company Secretary should ensure that the Auditor (or his representative) is present at the meeting.
• After the meeting, the necessary resolutions along with the 'Consent/No Objection' of the Creditors of the Company are required to be filed with the Registrar of Companies.
• It is also necessary to ensure that no proceedings are pending with any Government Department, as the same may hinder the process of conversion.

After all the documents (including the amended Articles of Association) are supplied, the Registrar approves the application and issues a fresh Certificate of Incorporation.

8. Issuance of the Initial Public Offering

A company may resort to an IPO for multiple reasons, such as expansion and diversification, repaying debts to strengthen the financial position of the company and so on. In this process, the entity would need to consult and comply with a multitude of rules - The Companies Act and Rules, SEBI Regulations and the rules framed by other regulatory bodies concerned with the area of the business.

A plethora of professionals: Various professionals are required to be onboarded in order to ensure an effective issuance of IPO. Apart from Legal Counsels and Auditors, the company would also engage various other professionals such as investment bankers, Lead Managers (to deal with stock exchange and related compliances), corporate communications/investor relation experts, Banks (to receive bids from the public and block the money in the bank accounts of the applicants), Underwriters (to purchase the unsubscribed shares) and so on.

Prospectus: Before the preparation of the prospectus, a 'Red Herring Prospectus' is filed with SEBI and Stock Exchanges for approval. Any variations made while issuing the final Prospectus must be highlighted. Only after all the resources are in place, the Prospectus should be issued after the same is approved by SEBI and ROC.

Once all the approvals from the concerned authorities are available, including permissions from SEBI and RBI (in case Foreign Exchange or Investors are involved), the actual issuance of the IPO can take place.

9. Post Issuance Process

The IPO is the beginning of the second innings. The company becomes accountable to the shareholders and to the public in general. It is thus very important to maintain investor confidence. To foster this, the investor relations professional can ensure that the public and the investors are aware of how the company is functioning. Ensuring adequate transparency will garner trust. Periodic and timely filings with the Stock Exchanges and the ROC would ensure that the Company does not enter perilous waters and be susceptible ot costly fines and punitive actions. Having a strong corporate and compliance team that can promptly handle and communicate regulator requests, flag and address issues and mitigate shareholder complaints, is vital for the success of any company. Investments into these are like investments into a retaining wall of a structure; they are both protective and pre-emptive.

Taking a company from idea to IPO is not merely a business journey. It is a legal journey as well, as every stage of the business, from concept to structuring to fundraising to exiting, is affected and moulded by the regulations surrounding that stage. An understanding of the applicable legal frameworks and embedding them into the company's DNA from infancy (as tedious as it might sound) can truly make the difference between a smooth transition to IPO or a stumbling, frustrating one.

Author: Aastha Abhya, Founder and Managing Partner, Atreus Law Firm Views expressed are personal. This article is intended for informational purposes only and does not constitute legal advice. Please consult with qualified legal counsel for guidance on your specific situation.