The Founder and the fine print : understanding investor contracts in indian startups

Abstract

This research sheds light on the subtle and often hidden fine print clauses within investment agreements between founders and investors. The primary objective is to provide a practical, legal understanding for law students and aspiring entrepreneurs regarding what truly lies beneath the surface of these documents. Commonly overlooked clauses such as liquidation preferences, anti-dilution provisions, and drag-along rights can significantly influence a startup’s trajectory, determining its ultimate success or failure.

The methodology involves a comprehensive analysis of real-world case studies, including the corporate governance issues at Byju’s and the public dispute at BharatPe involving its founder. This is complemented by an analysis of insights from industry veterans’ experiences, such as those shared on Ashneer Grover’s podcast. This is all supported by a legal framework analysis of foundational laws, including the Indian Contract Act, the Companies Act, and Intellectual Property (IP) laws.

Key findings reveal that a lack of legal awareness often leads to founders being compelled to make unfavorable concessions, ultimately risking their potential dilution of equity or even a forced exit from their own ventures. The research underscores how these clauses, when not properly understood, can erode a founder’s control and ownership, despite their significant contributions to the company’s growth and value creation. The BharatPe case serves as a potent illustration of how investor-founder conflicts can escalate into public and legal battles, highlighting the critical importance of a clear and legally sound founder-investor contract.

In this paper advocates for the development of specific legal safeguards to protect founders’ interests. Such measures would not only provide a more equitable environment but also foster greater trust and transparency within the startup ecosystem, ensuring that founders can innovate without the fear of being unfairly marginalized.

Introduction

India’s startup ecosystem is witnessing exponential growth, with numerous ventures emerging from Tier 2 and Tier 3 cities, often led by first-generation founders from middle-class backgrounds. With limited personal capital, these founders turn to external investors—angels, venture capitalists, or shark investors—for funding. While such investments fuel growth, they also introduce complex legal arrangements that can alter the course of the startup if not properly understood.

“Fine print” refers to the detailed clauses and conditions written in small text or buried deep within contracts and agreements. In the context of startups, it includes terms like:

1. Liquidation preference,
2. Vesting schedules,
3. Anti-dilution clauses,
4. Drag-along rights,
5. Board control provisions.

Though these clauses are designed to safeguard investor interests, they can significantly restrict a founder’s control, equity stake, or even their role within the company. The key issue arises when founders, often lacking legal knowledge or access to legal counsel, sign contracts without fully understanding the implications of the fine print. This can lead to severe consequences, such as:

Often eager for capital, founders sign term sheets and shareholder agreements without fully understanding the implications of such fine print. A well-known example is the 2022 BharatPe case, where co-founder Ashneer Grover was forced to resign due to contractual powers exercised by the board. which were granted through the contractual agreements between the founders and investors, often hidden in the fine print. This illustrates how investor-friendly legal mechanisms can override the very founder who built the company from scratch. This paper explores the legal dimensions of startup funding agreements, focusing on the founder-investor relationship, the fine print in contracts, and how lack of legal awareness can lead to the marginalization or removal of the founder. It also examines current legal protections available, key clauses every founder should understand, and proposes safeguards for preventing unfair outcomes.

By decoding the legal frameworks and contract structures behind startup funding, this research aims to provide law students and aspiring entrepreneurs with a practical, legal understanding of what truly lies beneath the surface of investor agreements.

Key Legal Concepts and Terminologies in Startup Funding

In the field of startup funding, certain legal concepts and contractual terms play a crucial role in defining the relationship between founders and investors. These provisions, often hidden in the fine print, determine ownership, control, and the long-term sustainability of the venture. To illustrate their practical impact, consider the case of a hypothetical startup, TechNova.

1. iSAFE (Simple Agreement for Future Equity) – An investment instrument where money is invested upfront, but equity is issued only in the next funding round. Example: An investor puts ₹50 lakh in TechNova via iSAFE, and shares are allotted later, simplifying compliance.
2. Term Sheet – A non-binding document outlining preliminary terms such as valuation, type of shares, board rights, and exit options. It provides clarity to both sides before final agreements.
3. Vesting – Ensures founders’ long-term commitment. Example: TechNova founders’ shares are subject to a four-year vesting with a one-year cliff. If a founder exits early, they cannot keep full ownership.
4. Anti-Dilution Clause – Protects investors if the next funding round happens at a lower valuation. They receive extra shares to maintain their ownership percentage.
5. Drag-Along and Tag-Along Rights – Drag-along allows majority investors to compel minority shareholders to sell during acquisition. Tag-along ensures minority shareholders can also sell on the same terms as majority investors.
6. Liquidation Preference – Gives investors priority in recovering their investment if the company shuts down or is sold. Example: With 1 x preference, an investor who invested ₹50 lakh gets it back first before founders receive proceeds.
7. Lock-in and Exit Clauses – Lock-in restricts founders from selling shares for a fixed time, assuring investor confidence. Exit clauses provide pathways for investors to realize returns via IPO, sale, or buy-back.

These legal concepts show that startup agreements are not merely formalities but instruments that shape ownership, control, and risk-sharing. Understanding such terms is essential for balancing founder–investor interests and ensuring long-term success.

Applicable Legal Provisions and Government Schemes for Startups in India

In India, startup funding is shaped by a dual framework of legal regulations and supportive government schemes. While the legal provisions ensure transparency, enforceability, and fairness, the schemes encourage innovation and provide financial incentives.

1. Indian Contract Act, 1872:

   This Act is the foundation of all agreements in India. It ensures that contracts between founders and investors are based on free consent, lawful consideration, and enforceability. Clauses like vesting, anti-dilution, and liquidation preference ultimately derive their legal validity from this legislation. If a clause is unfair or against public policy, it may not be enforceable under this Act.

2. Companies Act, 2013:

   The Companies Act governs the structure and functioning of private limited companies, the most common vehicle for startups. It provides rules on shareholding, private placement of securities (Section 42), further issue of share capital (Section 62), and directors’ fiduciary duties (Sections 166 and 184). These provisions directly affect how much control a founder retains and how investor rights are structured.

3. SEBI Regulations:

   SEBI guidelines apply when startups raise funds through regulated investors or Alternative Investment Funds (AIFs). These regulations ensure transparency, investor protection, and minority shareholder safeguards. For example, drag-along and tag-along rights must align with SEBI’s disclosure and governance requirements.

4. Insolvency and Bankruptcy Code, 2016 (IBC):

   The IBC determines the priority of claims in case a startup becomes insolvent. While investors often negotiate liquidation preference clauses in contracts, these may conflict with the statutory “waterfall mechanism” under the IBC. Thus, founders need to be aware that contractual rights can sometimes be overridden by insolvency law.

5. Intellectual Property Laws:

   Ownership of innovation and brand is vital for startups. The Trade Marks Act, 1999 secures brand identity, the Patents Act, 1970 protects technological innovations, and the Copyright Act, 1957 safeguards creative works such as software. Investors usually insist on clear assignment or licensing of IP to the company before funding.

6. FEMA & RBI Guidelines:

   When foreign investors participate in Indian startups, FEMA and RBI guidelines govern such transactions. They ensure compliance with sectoral FDI caps, pricing norms, and reporting obligations. Non-compliance can make an investment agreement void or expose the startup to penalties.

7. Competition Act, 2002:

   This Act prevents investors or majority shareholders from abusing their dominant position in a startup. It also regulates mergers and acquisitions that may reduce competition in the market, thus protecting both founders and smaller shareholders.

8. Information Technology Act, 2000 (with 2021 Rules):

   In technology-driven startups, contracts are often executed digitally. The IT Act validates e-contracts, digital signatures, and electronic records. It also governs data protection and cybersecurity obligations, which are increasingly important in founder–investor agreements for tech companies.

9. Government Schemes for Startups:
   • Startup India Scheme (2016): Provides tax exemptions, compliance relaxations, and IP support.
   • Fund of Funds for Startups (FFS): ₹10,000 crore corpus managed by SIDBI through Alternative Investment Funds.
   • Startup India Seed Fund Scheme: Offers seed funding for prototype development, product trials, and market entry.

Therefore, the Indian startup ecosystem reflects a fine balance between legal safeguards and policy support, enabling both innovation and investment to grow hand in hand.

Landmark Indian Startup Case Laws

The relationship between founders and investors is a complex one, often governed by intricate legal agreements. These landmark cases from the Indian startup ecosystem provide crucial insights into common disputes and the importance of a clear legal framework.

Case 1: Shaadi.com vs. WestBridge Ventures

Conflict at the Core:

The dispute arose when the investor, WestBridge Ventures, sought to exercise its “Drag-Along Right” to force the sale of the company to a competitor. The founder, Anupam Mittal, resisted this move, arguing that it was against his vision for the company and would strip him of his control. This created a legal battle over who has the final say when a fundamental disagreement arises.

The Legal Clause Explained:

A Drag-Along Right is a powerful clause in a shareholder agreement (SHA). It gives a majority shareholder (or a group of shareholders acting together) the power to force all other minority shareholders to join in the sale of a company. This is designed to make the company an attractive acquisition target, as the buyer can be assured of gaining 100% of the company’s shares.

Outcome & Lessons Learned:

• Negotiate Wisely: Founders must understand and carefully negotiate every clause in the term sheet and shareholder agreement. A seemingly standard clause like a drag-along right can be a powerful tool for an investor to take control.
• Balance of Power: The case highlights the importance of maintaining a balanced power structure on the board and in the shareholder agreement to prevent one party from unilaterally dictating the company’s future.
• Litigation is Costly: This lengthy and complex legal battle demonstrates that disputes, even with well-defined clauses, can be time-consuming and expensive.

Case 2: Tata Consultancy Services Ltd vs. Cyrus Investment Pvt Ltd (2021)

Conflict at the Core:

After being ousted as Chairman of Tata Sons, Cyrus Mistry filed a petition alleging “oppression and mismanagement” by the majority shareholders. He argued that the majority had acted unfairly and prejudiced his rights as a minority shareholder, misusing their power to make decisions not in the best interest of the company.

The Legal Clause Explained:

Oppression and Mismanagement is a legal remedy available to minority shareholders under the Companies Act, 2013. It allows them to seek a tribunal’s intervention if a company’s affairs are being conducted in a manner that is “prejudicial, oppressive, or mismanaged.” It provides a vital check on the power of the majority. The legal question here was whether the actions of the Tata board truly constituted oppression under the law.

Outcome & Lessons Learned:

• Founders Have Recourse: This case affirmed that legal remedies for oppression and mismanagement are available to protect the rights of minority shareholders, including founders who might lose their majority stake post-funding.
• Good Governance Matters: The dispute emphasizes the need for strong corporate governance, ethical conduct, and clear, documented decision-making processes. A lack of transparency can lead to serious legal challenges.

Case 3: BYJU’S vs. Investors’ Group

Conflict at the Core:

A group of prominent investors, including Prosus and Peak XV Partners, moved to oust founder Byju Raveendran from his position as CEO. Their actions were driven by mounting concerns over the company’s financial performance, corporate governance, and alleged mismanagement. The investors sought to use their collective power to force a change in leadership.

The Legal Clause Explained:

This dispute revolves around the Shareholder Rights and Board Control clauses common in venture capital agreements. These rights often include: the ability to call an Extraordinary General Meeting (EGM), the power to pass special resolutions to remove directors or change the company’s management, and protective rights that allow investors to block certain strategic decisions. In this case, the investors used these contractual rights to vote for a change in leadership, showing that even a popular founder is not immune to a challenge from investors when performance lags and trust erodes.

Outcome & Lessons Learned:

• Trust is Paramount: The founder-investor relationship is a partnership based on trust. When investors lose faith in the founder’s ability to run the company, they will use their legal rights to intervene.
• Performance is Key: Consistent and transparent financial performance and a strong governance record are the best defenses against investor challenges.

Case 4: Infinity Solutions vs. Zen Force Ventures

Conflict at the Core:

When the company was sold for a modest valuation, a dispute arose over how the proceeds of the sale were to be distributed. The investor, Zen Force Ventures, received its entire investment back, while the founder and other common shareholders received nothing.

The Legal Clause Explained:

This outcome was a direct result of the “Liquidation Preference” clause in the investment agreement. This clause ensures that in the event of a liquidation or sale, the investor gets their money back first, before any of the remaining proceeds are distributed to the common shareholders. The clause can be “non-participating,” where the investor gets their money back, or “participating,” where they get their money back and also participate in the remaining proceeds, further reducing the founder’s share.

Outcome & Lessons Learned:

• Understand Your Returns: Founders must understand how liquidation preference works and its impact on their financial returns. Even if a company is successfully sold, a founder could walk away with little to no money if the exit value is not high enough.
• Negotiate the Cap: Founders should aim to negotiate a cap on the liquidation preference to ensure that they also receive a meaningful return on their years of hard work.

Discussion and Analysis

1. Lack of Founder Legal Acumen

   Founders, often focused on business and product, may lack the legal expertise to fully understand complex funding agreements. This puts them at a disadvantage, as they may sign a term sheet without grasping the long-term implications of its “fine print.” A prime example is the Housing.com case, where a public dispute with investors highlighted the founder’s loss of control, ultimately leading to his removal.

2. Inherent Power Imbalance

   The power dynamic in startup deals is heavily skewed toward the investor. As the party that typically drafts the term sheet, the investor can insert clauses that secure their interests while limiting the founder’s authority. This was evident in the Housing.com dispute, where investors, despite the founder being the face of the company, leveraged their legal position to assert control and force a founder’s exit. This demonstrates that control often resides with investors, not the founding team.

3. Insufficient Legal Protection

   Indian law and the legal system appear to offer limited protection to founders in such disputes. When conflicts arise, courts often base their decisions on the term sheet’s language, which is inherently drafted in favor of the investor. The Housing.com saga underscores how legal clauses can empower investors to make critical decisions, leaving founders with little recourse.

In contrast, other jurisdictions offer a more robust framework. For example, in the United States, Delaware is a preferred state for incorporation due to its well-established body of corporate law and its specialized court, the Delaware Court of Chancery. This court has a long history of handling complex corporate disputes with expertise and predictability, providing both investors and founders with a clearer legal roadmap. This specialized system helps ensure that legal decisions are based on deep corporate knowledge rather than just a narrow interpretation of a contract. This highlights the need for a more balanced and specialized legal framework in India to ensure fair and equitable partnerships.

Thus, it is imperative for the Indian startup ecosystem to focus on enhancing founder legal literacy and simultaneously work toward structural legal reforms that ensure a fair balance of power in investment negotiations.

Suggestions and Reforms

Purpose: Provide solutions or improvements.

1. Promote Legal Awareness in the Startup Ecosystem:

   Many founders, especially in the early stages, are so focused on product development and growth that they often overlook legal complexities. This can lead to issues later, like the disputes seen in cases involving BharatPe’s Ashneer Grover or Rahul Yadav of Housing.com. To prevent this, incubators and accelerators should make legal awareness a core part of their curriculum. This could involve hosting mandatory workshops on term sheets, founder agreements, and vesting clauses, and making legal resources easily accessible to all founding teams.

2. Push for Founder-Friendly Standardized Templates:

   The legal language in funding agreements can be intimidating and often heavily favors investors. Widespread adoption of standardized, founder-friendly templates—such as the SAFE (Simple Agreement for Future Equity) from Y Combinator—can help level the playing field. In India, several early-stage investors are already moving towards these simpler agreements to reduce the legal costs and time involved in raising pre-seed and seed rounds. This helps founders avoid getting bogged down in complex negotiations and focus on building their product.

3. Recommend Legal Counseling as a Requirement:

   Before signing any funding agreement, founders should be required to seek independent legal counsel. This would ensure they fully understand the implications of the terms, particularly clauses related to anti-dilution, liquidation preferences, and founder vesting. This is crucial given recent disputes like the one between Shaadi.com founder Anupam Mittal and investor WestBridge Ventures over complex ‘drag-along’ rights. Making legal review a standard practice can prevent future disputes and protect the founder’s interests.

4. Promote Legal Clinics in Law Colleges Focused on Startups:

   Law schools in India can play a vital role by creating legal clinics where students, supervised by experienced professors, provide pro bono or low-cost legal advice to early-stage founders. This not only offers valuable hands-on experience for law students but also provides a much-needed, affordable legal resource for startups that may not have the budget for a top-tier law firm, helping them with everything from incorporation to intellectual property filings.

5. Government Policy and Regulatory Support:

   The government, under initiatives like Startup India, can play a crucial role by creating policies that simplify legal processes for startups. This could include providing a single-window portal for all legal compliances or offering subsidized legal consultation services. Additionally, regulatory bodies like SEBI could establish clear and founder-friendly guidelines for startup funding, ensuring transparency and reducing legal ambiguity, especially in complex deals like the ones seen with Byju’s.

6. Emphasize the Responsibility of Legal Counsel:

   It is also the professional and ethical responsibility of lawyers to ensure that founders, who may not be legally trained, are fully aware of the implications of the documents they are signing. A lawyer’s role should not just be to draft or review a document, but to educate the founder on potential risks, future scenarios (like dilution or exit strategies), and the long-term impact of each clause. By acting as trusted advisors, lawyers can play a critical role in building a more transparent and fair ecosystem.

Ultimately, the goal is to create a more transparent and equitable ecosystem. By focusing on education, standardization, policy support, and emphasizing the ethical responsibilities of legal professionals, we can empower founders to navigate the legal landscape with greater confidence. This will not only protect their interests but also encourage innovation and sustained growth in the Indian startup sector.

Conclusion

My research focused on the significance of “fine print” in contracts between founders and investors. The main objective was to give aspiring entrepreneurs and law students a practical understanding of the legal aspects hidden within these agreements.

Through an analysis of various podcasts, books such as the Indian Contract Act, Company Law, and case studies (Byju’s, Shaadi.com, etc.), it became clear that a lack of legal knowledge and awareness among founders is a serious problem. This has led to many founders being forced out of their own startups and suffering significant losses. The findings highlight a crucial gap in the startup ecosystem where, despite a focus on innovation, there is a clear absence of legal protection and caution. The limitations of this research are that it was confined to the startup sector and specifically focused on founder-investor agreements.

For the future, this research offers several important suggestions. It recommends promoting legal awareness within the startup community and establishing dedicated legal clinics in law colleges. Furthermore, this study emphasizes that the government should create special laws or guidelines for founder protection. Founders should not only understand contracts but also focus on developing their negotiation skills and risk management abilities. This will strengthen their position and help them better secure their business ventures.

Ultimately, the greatest significance of this research is that it raises awareness of the legal rights of founders. It stresses that a solid business plan and funding are not enough; understanding every aspect of a contract is equally vital. This will help future entrepreneurs avoid problems and losses, and it will contribute to building a more trustworthy and secure environment for India’s startup ecosystem. Thus, this research not only bridges the gap between law and entrepreneurship but also aims to empower future founders with the knowledge and confidence to protect their vision and innovation.