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Why start-ups need to be careful from some investors

21, September 2016 | Prashant Mehta

In the start-up world you come across lawyers, designers, investors, marketers as well as finance professionals.

There have been instances when some investors and their lawyers also act as intermediaries for laundering unaccounted money.

There are many lawyer firms who give transaction advisory services for startups some of which are being used by the uncouth businessmen.

Some business people have started using the startup investing route as a means to bring black money parked overseas into India.

Here is how this works

Suppose Mr. X and Mr. Y has USD 10 million cash parked in Cayman Islands or Mauritius.


1. They look for startups where they can take a majority control OR create an entity which can put together a website, an app and a small team in place.

2. Then they incorporate that company as a private limited entity and also register an overseas subsidiary.

3. Once a legal structure is in place then they start routing the overseas money into that technology company.

4. The routing can happen as a seed stage or pre-series A funding round.

5. Now to embezzle the funds, from that startup money they can buy a luxury car, pay themselves, or their relatives huge sums as directors.

6. There are other assets that can be bought with that money in the company's name.

7. They run that company for a period of two years or more till they have routed all the money into India.

Once done, they simply close that startup, declaring the company bankrupt and paying off creditors and share-holders.

There are many businesses in India which generate cash.
Even if this cash is not transferred overseas, dabbling in startups by opening up incubators or mentorship firms has become a route to use that money legally.

Now usually, this kind of diversion of funds can only happen in early rounds of funding

Later rounds require success of a company and institutional investors who look for audited structures to put their money.

Methods used by unscrupulous investors 

1. Asking for too much equity and control of the startup (often over 70%)

2. Demanding that their relatives be appointed on the board of directors and in the senior management

3. Appointing their own companies as vendors to the start-up and quoting ridiculous prices for a service or product.

4. An unsavory investor can actually fly his family (who can be board members of that startup) overseas on grounds of a business visit.

5. A large diversion of funds towards an entity by the start-up

There are some unsavory investors who look at startups as a means to an end.
Clearly India's entrepreneurs and start-ups need to be cautioned against such angel investors.

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