There are many different types of financing instruments any start-up business may issue to finance its growth. In general, financing instruments fall into one of two categories -- Debt or Equity.

While debt instruments generally represent fixed obligations to repay a specific amount at a specified date in the future, together with interest. Equity instruments generally represent "ownership" interests entitled to dividend payments, when declared, but with no specific right to a return on capital.

Within each of these two general finance instrument categories, there are a wide variety of rights, privileges, and limitations that may be established by a startup to its investor(s).

Now, in a latest development government of India is planning to introduce a third kind of instrument - a 'Hybrid Instrument', which will have the characteristics of both debt and equity and come with differential voting rights (DVR). A DVR share is like an ordinary equity share, but it provides fewer voting rights to the investor(s).

Right now, India allows just one class of shares, in which every equity share gives its owner one vote in deciding the company’s moves. Companies/start-ups issue DVR shares in order to prevent hostile takeover of company and dilution of voting rights or in simple words losing control over the company.

As per ET report, India will soon introduce a wide array of hybrid instruments on the lines of those available in developed markets like the US and China, which will allow promoters to retain control of an entity (~ startup) even with a minority stake, a move that will make fundraising easier, particularly for startups. In a number of IT companies outside India, startup/company founders hold less than 15% equity but exercise full control.

Government has scrapped the earlier draft that was proposed to be sent to cabinet for approval that included four instruments -- optionally convertible preference shares, partially convertible preference shares and optionally and partially convertible debentures.

The previous draft was discarded due to the fact that those were restrictive and not reflective of innovations in finance. A new policy framework may be put in place as there is a growing view within the government that these instruments need a fresh look and should not be clubbed with debt or equity.

The idea behind the fresh financing policy framework is to give companies, particularly startups, the option to raise funds without the fear of losing control.

Additionally, govt. feels that these instruments will more FDI inflow, as under hybrid instrument startup promoters can also raise funds from investors residing outside India.

Globally, such funding options have caught on with private equity and venture capital funds, a key source of funding for startups.

The US has different classes of shares with differential control. China has a variable interest instrument that allows foreign investors to have only an economic interest in companies in restricted sectors.

In order to allow startups to raise funds via different ways then available earlier, the government of India is taking a couple of commendable steps, as recently India's market regulator Securities and Exchange Board of India (Sebi) has allowed startups in India to list on the small and medium enterprises (SME) platform of the stock exchanges as an opportunity to raise capital apart from usual private equity and angel investment funding route. With this, a Delhi-NCR based cloud computing startup E2E Networks has recently initiated getting listed on NSE Emerge, the stock exchange’s platform for small and medium businesses (SMB), and raise about Rs 22 crore.


Source - Economic Times | References - Antiventurecapital.com & ETView @Economic Times | Top Image - QuestFusion.com

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