Disclosure obligations in funding rounds

Introduction

Disclosure obligations in funding rounds refer to the legal responsibility of companies, founders, directors, and promoters to provide accurate, complete, and material information to potential investors before receiving investment. A funding round is a process through which a company raises capital by issuing shares, preference shares, convertible securities, or other financial instruments to investors. These transactions commonly occur during seed funding, angel investment, venture capital financing, private equity investment, and subsequent growth-stage funding.

Disclosure is an essential element of investor protection because investors make financial decisions based on the company's financial position, business model, ownership structure, intellectual property rights, legal liabilities, commercial risks, and future prospects. If a company conceals material information, provides misleading financial statements, or makes false representations, investors may suffer financial losses and seek legal remedies.

In biotechnology companies, disclosure obligations become particularly important because funding decisions may depend on clinical trial results, patent ownership, regulatory approvals, laboratory safety, research data, licensing arrangements, and intellectual property rights. Therefore, companies must maintain transparency throughout the fundraising process.

In India, disclosure obligations are governed by the Companies Act, 2013, the Securities and Exchange Board of India (SEBI) regulations, the Indian Contract Act, 1872, and other applicable corporate and securities laws.

Legal framework governing disclosure obligations

1. Companies Act, 2013

The Companies Act, 2013 establishes important disclosure requirements for companies raising investment through securities.

Section 42 regulates private placement of securities. Companies issuing securities through private placement must comply with prescribed procedures, including issuing an appropriate offer letter, maintaining records, and following restrictions on the number of identified persons.

Section 26 establishes requirements concerning the contents of a prospectus where a prospectus is issued.

Section 34 provides criminal consequences for statements in a prospectus that are untrue or misleading in form or context.

Section 35 provides civil liability for misstatements in a prospectus. Investors who suffer loss because of misleading statements may seek compensation from persons covered by the provision.

Section 447 addresses punishment for fraud, including serious fraudulent conduct in corporate transactions.

These provisions promote transparency and discourage misleading disclosures during fundraising.

2. SEBI regulations

The Securities and Exchange Board of India regulates securities markets and protects investors.

The SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 establish disclosure and compliance requirements for public issues and certain other securities transactions.

The SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 require listed entities to disclose material events and information to stock exchanges.

The SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Market) Regulations, 2003 prohibit fraudulent and unfair practices in securities markets.

These regulations are particularly relevant when a funding transaction involves listed companies or securities falling within SEBI's regulatory jurisdiction. Ordinary private placements by unlisted startups are primarily governed by company law, contractual obligations, and other applicable regulations.

3. Indian Contract Act, 1872

The Indian Contract Act provides legal remedies where funding transactions involve fraud, misrepresentation, or improper consent.

Section 17 defines fraud and includes certain acts committed with the intention of deceiving another party.

Section 18 defines misrepresentation.

Section 19 provides that agreements entered into through consent caused by coercion, fraud, or misrepresentation may be voidable at the option of the affected party, subject to the statutory conditions and exceptions.

These provisions are important when founders deliberately conceal liabilities, exaggerate revenue, or provide false information to attract investors.

4. Foreign Exchange Management Act, 1999

Where funding rounds involve foreign investors, the Foreign Exchange Management Act (FEMA), 1999 and applicable foreign investment regulations become relevant.

Companies receiving foreign investment must comply with applicable pricing guidelines, reporting requirements, sectoral restrictions, and other regulatory conditions.

Non-compliance with applicable foreign investment reporting requirements may result in regulatory consequences.

5. Limited Liability Partnership and intellectual property laws

Where the fundraising entity is an LLP, applicable LLP legislation and contractual requirements govern relevant disclosures.

Intellectual property laws are also important because investors generally examine whether the company owns or legally controls its patents, trademarks, software, research data, and proprietary technologies.

For biotechnology startups, undisclosed patent disputes, licensing restrictions, or ownership disputes may materially affect investment decisions.

Major disclosure obligations during funding rounds

1. Financial disclosure

Companies must provide reliable financial information to investors.

Important financial disclosures include:

Audited financial statements, where applicable.

Revenue and expenditure details.

Existing loans and outstanding liabilities.

Cash flow and financial projections.

Tax obligations and pending tax disputes.

Related-party transactions.

Financial information should not be manipulated to create an artificial impression of profitability or financial stability.

2. Disclosure of ownership and shareholding structure

Founders must provide accurate information about the company's ownership structure.

Investors generally examine the capitalization table, existing shareholders, outstanding convertible securities, employee stock options, and previous investment agreements.

Concealing existing shareholding arrangements or undisclosed rights attached to shares may create serious legal and commercial disputes.

3. Disclosure of material legal disputes

Companies should disclose material litigation, regulatory investigations, contractual disputes, intellectual property claims, and pending proceedings that may affect their financial or operational position.

Failure to disclose significant legal liabilities may constitute misrepresentation or breach of contractual warranties, depending on the circumstances.

4. Intellectual property disclosure

Intellectual property is often one of the most valuable assets of a technology or biotechnology startup.

Companies should disclose:

Registered and pending patents.

Ownership of research inventions.

Patent licensing arrangements.

Existing infringement allegations.

Technology transfer agreements.

Restrictions on commercial exploitation.

In biotechnology funding, investors may also examine ownership of genetic research, laboratory technologies, biological processes, and proprietary manufacturing methods.

5. Regulatory compliance disclosure

Companies must disclose relevant regulatory approvals, licences, permissions, and compliance issues.

For biotechnology companies, these may include clinical trial permissions, applicable CDSCO approvals, biosafety permissions, environmental clearances, and other regulatory authorizations.

A company must not represent that an experimental treatment has received regulatory approval when it remains under investigation.

6. Disclosure of material risks

Founders should provide investors with a realistic explanation of significant business risks.

These may include technological failure, market competition, regulatory uncertainty, supply chain disruption, cybersecurity threats, dependence on key employees, and difficulties in obtaining future funding.

Risk disclosures help investors evaluate the commercial viability of the proposed investment.

Disclosure obligations in biotechnology funding rounds

Biotechnology companies face additional disclosure responsibilities because their business activities frequently involve scientific uncertainty and regulatory risks.

For example, a biotechnology startup developing gene therapy products should disclose the actual stage of clinical development, relevant research findings, known safety concerns, patent ownership, and regulatory status.

Similarly, a pharmaceutical biotechnology company must not misrepresent manufacturing capacity, product efficacy, or clinical trial outcomes.

Failure to disclose material scientific or regulatory information may result in investor disputes, contractual claims, regulatory investigations, and potential fraud proceedings.

Important case laws

1. Sahara India Real Estate Corporation Ltd. v. SEBI (2012)

The Supreme Court examined fundraising through optionally fully convertible debentures issued by two Sahara companies.

The Court considered the distinction between private placement and public fundraising and emphasized compliance with applicable securities laws and investor protection requirements.

Relevance: This judgment demonstrates that companies cannot avoid applicable regulatory disclosure obligations merely by describing a fundraising transaction as a private placement. Companies must follow the legal requirements governing the actual nature of the securities issue.

2. N. Narayanan v. Adjudicating Officer, SEBI (2013)

The Supreme Court considered corporate accountability and the responsibilities of directors concerning financial disclosures.

The judgment emphasized the importance of accurate financial statements and the responsibility of company directors to ensure compliance with legal disclosure requirements.

Relevance: Founders and directors involved in funding rounds must ensure that financial information provided to investors is accurate and supported by proper records. Deliberate manipulation of financial statements can create serious legal consequences.

3. Dale & Carrington Investment (P) Ltd. v. P.K. Prathapan (2005)

The Supreme Court examined the misuse of corporate powers in relation to the issue and allotment of shares.

The Court emphasized that directors must exercise their powers for proper purposes and in the interests of the company.

Relevance: During funding rounds, directors must ensure that share allotments are undertaken lawfully and transparently. Manipulating shareholding arrangements to unfairly benefit particular individuals may lead to corporate disputes and judicial intervention.

4. Needle Industries (India) Ltd. v. Needle Industries Newey (India) Holding Ltd. (1981)

The Supreme Court considered issues involving share allotment, corporate powers, and oppression of minority shareholders.

The judgment explained that the exercise of corporate powers must be assessed in light of fairness, proper purpose, and the interests of shareholders.

Relevance: Companies raising funds must ensure that new share issues do not unfairly prejudice existing shareholders or conceal arrangements affecting their ownership rights.

5. LIC of India v. Escorts Ltd. (1986)

The Supreme Court examined corporate ownership, foreign investment, and regulatory requirements concerning share acquisition.

The judgment discussed the legal framework governing foreign investment and the exercise of shareholder rights.

Relevance: Funding rounds involving foreign investors must comply with applicable foreign exchange laws and investment regulations. Companies must accurately disclose relevant ownership and investment arrangements.

Consequences of failure to disclose material information

Failure to comply with disclosure obligations may result in several legal and financial consequences.

Civil liability: Investors may seek compensation for losses caused by actionable misstatements or contractual breaches.

Criminal liability: Fraudulent conduct may attract prosecution under applicable provisions of the Companies Act and other laws.

Contractual remedies: Investors may exercise negotiated indemnity, warranty, termination, or other contractual rights.

Regulatory penalties: Authorities may impose penalties for violations within their statutory jurisdiction.

Cancellation or rescission: Certain agreements may be challenged or avoided where the legal requirements for such remedies are satisfied.

Reputational damage: Misleading disclosures may reduce investor confidence and affect future fundraising opportunities.

Conclusion

Disclosure obligations in funding rounds are essential for maintaining transparency, protecting investors, and ensuring responsible corporate governance. Companies must provide accurate information about their financial position, ownership structure, legal disputes, intellectual property, regulatory approvals, and material business risks.

In India, the Companies Act, 2013, SEBI regulations, Indian Contract Act, 1872, and FEMA, 1999 establish important legal requirements governing fundraising and investor protection.

Judicial decisions such as Sahara India Real Estate Corporation Ltd. v. SEBI, N. Narayanan v. Adjudicating Officer, SEBI, and Dale & Carrington Investment (P) Ltd. v. P.K. Prathapan demonstrate the importance of corporate transparency, proper share allotment, and director accountability.

Ultimately, effective disclosure practices strengthen investor confidence, reduce funding disputes, and promote sustainable business development. For biotechnology companies, transparent disclosure of scientific progress, intellectual property ownership, clinical trial results, and regulatory approvals is particularly important because investment decisions depend heavily on the reliability of scientific and regulatory information.