Series A to Series B

It is often thought that each financing round is a fresh negotiation begun on a clean slate. In practice it seldom is. The promises made and the rights given to the first round of investors become the bedrock on which later investors build, and we have often seen how investors across successive rounds compete for the same protections, principally anti-dilution, protective covenants and the option pool, producing a heavy shareholders’ agreement and little room left on the cap table.

Protective provisions

Every institutional term sheet carries a list of reserved matters, being the corporate actions the company may not take without investor consent. At Series A this list ought to be short and structural including amendments to the charter documents, changes to share capital and to the rights attaching to shares, the issue of new securities, mergers and asset sales, related party transactions, a change in the nature of the business, and winding up. These go to the heart of what the investor has bought and are rarely objected to by founders.

Complications arise as the list expands with each new investor. First, operational items such as annual budgets, key appointments and capital expenditure above defined thresholds move from founder bound decisions to investor driven ones. Second, and more serious, each incoming investor seeks an independent veto of its own over the same enlarged list. The company is then left with two classes of preferred shareholders able to halt the same decisions while holding different views of what should be done next, and it is in this way that deadlock is created. Much of this can be averted by careful drafting at Series A. The cleaner approach is to consolidate consent into a single requisite majority vote, a defined percentage of the preference shareholders acting together, rather than a separate veto for each class; to confine protective rights to holders of a meaningful stake through a Major Investor threshold; and to provide sunset and fall away clauses, so that a veto lapses once a holding falls below a stated level and disappears on a qualified IPO.

The Companies Act issue

In Delaware protective provisions sit in the certificate of incorporation, are enforceable directly from it under Delaware law, and follow a largely standardised template. An Indian adviser cannot adopt such a term sheet wholesale, because two features of our law reshape how these provisions must be drafted. The first is enforceability. In V.B. Rangaraj the Supreme Court held that a restriction in a shareholders’ agreement but not reflected in the articles binds neither the shareholders nor the company,[1] and the Delhi High Court applied the same reasoning to affirmative voting rights in World Phone India.[2] The proviso to §58(2) of the Companies Act, 2013 has since made share transfer contracts enforceable for public companies, and in Vodafone International Holdings the Supreme Court observed that such a restriction may bind the consenting parties between themselves even if not in the articles, provided it is lawful and not in conflict with them.[3] Those observations, made in a matter not principally about shareholders’ agreements, are read as persuasive rather than as displacing Rangaraj; for private companies the principle holds, and §6 still subordinates a private agreement that conflicts with the Act or the articles. The practical rule is therefore unchanged, every protective provision must be mirrored in the articles, and the company must itself be a party to the agreement.

The second problem is that protective provisions may be characterised as control, with consequences on the takeover of a listed company. In Subhkam Ventures the Securities Appellate Tribunal held that control means proactive, positive power, the ability to compel the company to act, and not the reactive power to veto, asking whether the investor held the steering wheel, the accelerator, the gears and the brakes.[4] Ordinary protective rights were investment protection, not control, and that reasoning resurfaced with approval in Arcelor Mittal and in the Tribunal’s 2022 ruling in the NDTV matter.[5] The lesson is to keep reserved matters protective rather than operational, both to protect the founder’s autonomy and to keep the investor within the negative control safe harbour, sparing it an open offer obligation should the company later list.

These rights carry immense power, and recent history shows how readily they can be turned against a founder once relations sour. At Housing.com, after SoftBank led a large round and the board was reconstituted, Rahul Yadav, holding a low single digit stake against SoftBank’s roughly one third, was removed by the very board his financing had created.[6] At BharatPe, a board populated by its institutional investors used its governance machinery to compel Ashneer Grover’s exit and pursue an equity clawback.[7] Even though the merits of each dispute were keenly contested, the point is simply that governance rights, once granted and exercised collectively, can override the founder.

Anti-dilution

Anti-dilution protection revises an investor’s effective entry price downward should the company later issue shares at a lower valuation. It comes in three variations. The most severe is the full ratchet, which resets the earlier investor’s conversion price entirely to the new, lower price, as though the investor had always come in at the reduced valuation, transferring the maximum dilution to founders and ordinary shareholders. The most common, and the market standard in India, is the broad based weighted average, which adjusts the price by reference to both the size and the price of the new issue, measured against the entire share base, so the effect is real but moderate. The narrow based weighted average sits between the two, applying the same blended approach but counting only the preference shares.

When Square went public in 2015 below its last private round, the late stage investors who held an IPO ratchet received many additional shares, worth tens of millions of dollars, while founders, employees and earlier unprotected investors bore the cost. [8] The PharmEasy rights issue of 2023, at roughly ninety percent below its 2021 peak, was the first prominent unicorn down round and triggered anti-dilution clauses across the investor base, those who had negotiated protection were made whole through fresh allotments, while founders and option holders were heavily diluted.[9] The Byju’s rights issue, priced at a near total discount, set off both contractual anti-dilution rights and litigation, with non-participating investors facing almost complete dilution.[10] The lesson is constant, anti-dilution protects whoever holds it, and founders and employees rarely do.

One feature of Indian law matters more than any drafting preference. Under the foreign exchange rules governing instruments issued to non-residents, the conversion price or formula of a convertible instrument must be fixed at issuance, and conversion cannot take place below the fair market value then determined.[11] A full ratchet, or any anti-dilution mechanism, that would reset a foreign investor’s conversion price below that floor is unenforceable as drafted.

The option pool

Of the three features, the cost of the employee option pool is the one most easily overlooked. An investor agreeing to a stated pre money valuation also requires that a new or enlarged pool be put in place before the money goes in. Because those option shares are added to the pre money capitalisation, they raise the share count and lower the price per share, so the founders alone bear the dilution. The problem compounds across rounds, because the unused part of a pool is usually rolled into the next round rather than returned to shareholders, diluting founders again for options never granted. The answer is not to refuse a pool but to size it to a real hiring plan, to seek post money treatment or a higher valuation in exchange, and to ensure unused and forfeited options flow back into the pool.

ESOPs are governed by §62(1)(b) of the Companies Act in unlisted companies and by SEBI’s employee benefit regulations once listed, and promoters, the promoter group and directors holding above 10% are generally barred from receiving options, with a long exemption for recognised startups.[12] The costliest trap is reclassification ahead of a listing. When the founder of Paytm was classified as a promoter before the offering, his attempt to preserve his options through a family trust drew a regulator’s objection and a settlement under which he surrendered options worth well over a thousand crore and accepted a multi-year bar on fresh grants from any listed company.[13] The regulator has since permitted founders to retain, though not to be freshly granted, options issued sufficiently ahead of the IPO decision, but the episode is a lasting reminder that a founder’s own equity and the employee pool can come into conflict.

It would be wrong, though, to treat the pool only as a cost, for in India it has become the single greatest engine of employee wealth. Flipkart has returned more than one and a half billion dollars to employees through successive buybacks, including a single programme of seven hundred million dollars covering roughly nineteen thousand people,[14] and Swiggy carried an ESOP pool of around ₹9,000 crore into its 2024 listing, among the largest seen in an Indian startup.[15] A pool that is sized honestly and turned into real liquidity is one of the few genuinely renewable assets on the cap table.

Conclusion

The error that ties everything together is treating each clause in isolation, because in a down round the three mechanisms act on the same shares in sequence. First, the pre money pool dilutes the founders before the round is priced. Then the anti-dilution adjustment issues further shares, or reprices conversion, in favour of the protected, diluting founders, ordinary holders and the pool again. Then, at exit, the liquidation preferences decide who is paid and in what order, and it is at that last step that founder returns most often disappear unnoticed.

The organising idea is that Series A should be drafted in anticipation of Series B. Default to a one times non participating preference and a broad based weighted average anti-dilution, both market standard and least damaging when they compound. Attach veto and information rights only to Major Investors, with sunset on dilution and on a qualified offering. Consolidate consent into a single requisite majority vote rather than scattered vetoes that harden into deadlock. Keep reserved matters protective, not operational. Mirror every right in the articles and make the company a party. Most favoured nation rights deserve particular caution, a blanket right lets an early investor reach forward and adopt the better terms of any later instrument, migrating the most aggressive term in the company’s history onto every earlier holder.

A cap table is choked not by any single aggressive clause but by a failure to see the clauses as a system that compounds. The founders who grasp this, and the advisers who make them confront it while the leverage still exists, at Series A, reach Series B with a company that remains theirs to build.

[1] V.B. Rangaraj vs V.B. Gopalakrishnan, AIR 1992 SC 453.

[2] World Phone India Pvt. Ltd. & Ors. vs Wpi Group Inc., 2013 SCC Online Del 1098.

[3] Vodafone International Holdings B.V vs Union Of India, 2012 (6) SCC 757.

[4] Subhkam Ventures (I) Private Limited v. SEBI, Appeal No. 8 of 2009.

[5] ArcelorMittal India Private Limited v. Satish Kumar Gupta, (2019) 2 SCC.

[6] Pradeesh Chandran, Rahul Yadav does a U-turn, takes back resignation as CEO of Housing.com, The Hindu, May 06, 2015, https://www.thehindu.com/business/Industry/rahul-yadav-does-a-uturn-takes-back-resignation-as-ceo-of-housingcom/article7173981.ece.

[7] Priyali Prakash, A short history of events that led to Ashneer Grover’s resignation from BharatPe, The Hindu, March 04, 2022, https://www.thehindu.com/business/a-short-history-of-events-that-led-to-ashneer-grovers-resignation-from-bharatpe/article65187459.ece.

[8] Goncalo de Vasconcelo, Square IPO: How Venture Capitalists Made Money Buying $9 Shares For $15.46 - And Who Lost Out, Forbes, December 01, 2015, https://www.forbes.com/sites/goncalodevasconcelos/2015/11/29/square-ipo-how-venture-capitalists-made-money-buying-9-shares-for-15-46-and-who-lost-out/.

[9] Hindustan Times, PharmEasy new funding round ‘sudden death’ for founders: Ashneer Grover, July 06, 2023, https://www.hindustantimes.com/business/ashneer-grover-predicts-sudden-death-for-pharmeasy-founders-over-new-funding-round-101688641345538.html.

[10] Suryash Kumar & Supriya Roy, NCLT reserves orders on Byju’s rights issue; gives three days to file written submissions, Economic Times, February 27, 2024, https://economictimes.indiatimes.com/tech/startups/byjus-investors-allege-533-million-siphoned-off-nclt-reserves-order-on-rights-issue/articleshow/108049947.cms?from=mdr.

[11] Reserve Bank of India, Master Circular on Foreign Investment in India, July 1, 2011, https://www.rbi.org.in/commonman/english/scripts/Notification.aspx?Id=856.

[12] Rule 12, Companies (Share Capital and Debentures) Rules, 2014; G.S.R. 127(E), February 19, 2019, Department for Promotion of Industry and Internal Trade.

[13] The Economic Times, Paytm founders settle disclosure violation case with Sebi for Rs 2.79 crore,  May 09, 2025, https://economictimes.indiatimes.com/markets/stocks/news/paytm-founders-settle-disclosure-violation-case-with-sebi-for-rs-2-79-crore/articleshow/121013053.cms?from=mdr.

[14] The Economic Times, Flipkart’s $1.5 billion Esop buyback timeline; from 2018 to now, July 12, 2025, https://economictimes.indiatimes.com/tech/technology/flipkarts-1-5-billion-esop-buyback-timeline-from-2008-to-now/articleshow/122402381.cms?from=mdr.

[15] The Hindu, Swiggy IPO makes 500 employees 'crorepatis'; unlocks ₹9,000 cr worth of ESOPs, November 13, 2024, https://www.thehindu.com/business/markets/swiggy-ipo-makes-500-employees-crorepatis-unlocks-9000-cr-worth-of-esops/article68863371.ece.