Risks And Rewards Of Investing In Startups: Legal Precautions For New Angel Investors

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Rahul Hingmire

By Rahul Hingmire, Founding Partner at Vis Legis Law Practice, Advocates

Investments as a segment have always been there in the form of land, gold, stocks, mutual funds, and investing in other people’s businesses/startups as an asset class. Angels are those who have additional cash in hand and who want to invest it in other vehicles for rewarding arrangements. While earlier investments in other people’s businesses were made with lower risk appetites, in today’s time, the market has opened up and so has the risk appetite. But the startup investment asset class is a different ball game. Very rewarding but very risky, if essential elements are overlooked.

Some angel investors are seasoned players and well-informed about this asset class, while newer players are not accustomed to the workings. What are some precautions they can take care of to enter (and/or exit) smoothly?

  • Make sure investments are strategically planned, such that, in case you lose money, day-to-day life is not hampered.
  • Give importance to the legal due diligence of the founder + company + business structure + investment documentation

Legal due diligence can be defined as a process that collects, reviews, and assesses legal issues and risks present in the investment transaction, from details on founders, the company, the business model, key risk factors, leadership team, funding strategy, etc. along with a thorough vetting of the documentation outlining the transaction.

Many times, investors are seen following the lead of an investment fund (VC), and ‘invest with the herd’. But all angels don’t have access to the documents before the fund planned the investments. In these cases, risk/fall-back plans, protection plans, etc. are overlooked. If terms are vetted thoroughly, risk can be mitigated. If not, one may not know that the investment is not in their best interest.
In the event that the forecast is that of a 2X + return, keep the cost for legal assistance in mind and not just the money being put in as the investment ticket. Getting legal assistance for due diligence has to be planned strategically.

Sign contracts with the presence and assistance of a lawyer

While the startup industry is booming in India, it is volatile. Monumental changes can occur in the span of a day. To ensure that changes do not negatively impact the company and the angel investor, any legal document should be signed in the presence of a lawyer.

Lawyers are equipped to understand the jargon and certain rules that may be overlooked by an investor. A minor legal clause may cause a major issue – it’s best to avoid it by having a lawyer help with legal documents.

Planning exit strategically

Appropriately designed exit strategies are not merely at the mercy of founders. Investors must carefully carve exit clauses out in their agreement.

Many times, the success of a company is attached to the brand image of the founder (for example BharatPe). The founder’s presence matters and if they resign, the company can be in serious trouble. As an investor, tagging yourself to founders as much as possible, is possible with well-defined exit terms, especially if the startup is founder specific. This will safeguard your investment.

Founders are observant about how things are unfolding with the current market scenario and hence, they are also particular about their terms. The road to a fulfilling investment journey is that which is a healthy win-win for both, investors and founders, and the shared goals for the business at hand.

Conclusion

Investing in a company/startup is a great opportunity to promote new talent and boost the country’s economy, but the legal aspect of it all should always be considered to safeguard investments thoroughly. Well-rounded contracts and knowledgeable lawyers can save the day.

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