Successful startups are ones that are driven by passionate entrepreneurs who are focussed on building unique solutions that deliver customer delight. While it is very important to have a strong focus on customers and the market, it is equally critical to have a good understanding about the basic laws, rules and regulations that are applicable for the smooth running of the business.
From formalising a founders’ agreement to safeguarding intellectual property to enforcing business contracts, it is essential that entrepreneurs are aware and up to date with the latest laws governing their business and market. Here are some important legal basics that startups and entrepreneurs in India should be aware of before embarking on a business venture:
1. Formalizing a business structure and founders agreement
The first thing to starting any business is to be clear about the nature and type of the business. Founders will need to incorporate the business as a specific business type – sole proprietorship, private limited, public limited, partnership, limited liability partnership etc. It is very essential to have this clarity at the very beginning as this will be integral to the business’ overall vision and goals, both short term and long term.
Each business type comes with its own set of legal requirements and regulations and businesses should pay special attention to them before incorporating the business.
Here is a quick look into the legal implications for the major business types in India:
|Legal Details||Business Types|
|Proprietorship||Partnership||Limited Liability Company (LLP)||Private Limited Company|
|Registration||No formal registration required||Registration is optional||Has to be registered with the Ministry of Corporate Affairs under the LLP Act 2008||Has to be registered with the Ministry of Corporate Affairs under the Companies Act 2013|
|Legal Status||Not recognised as a separate entity and promoter is personally responsible for all liabilities||Not recognised as a separate entity and promoters are personally responsible for all liabilities||Is a separate legal entity. The promoters of the LLP are not personally liable towards the LLP||Is a separate legal entity. The promoters of the company are not personally liable towards the company|
|Member Liability||Unlimited liability||Unlimited liability||Limited liability to the extent of contribution towards to the LLP||Limited Liability to the extent of share capital|
|Number of Members Required||Can only have one person||Minimum of two persons required to start a Partnership||Minimum of two persons required to start a LLP||Minimum of one person required to start a Private Limited Company|
|Transferability||Not transferable||Not transferable||Ownership can be transferred||Ownership can be transferred by means of share transfer|
|Taxation||Taxed as individual, based on total income of proprietor||Partnership profits are taxed as per the slabs provided under Income Tax Act, 1961 plus surcharge and cess as applicable||LLP profits are taxed as per the slabs provided under Income Tax Act, 1961 plus surcharge and cess as applicable||Private Limited Company profits are taxed as per the slabs provided under Income Tax Act, 1961 plus surcharge and cess as applicable|
|Annual Statutory Meetings||No requirement for annual statutory meetings||No requirement for annual statutory meetings||No requirement for annual statutory meetings||Board and General Meetings should be conducted periodically|
|Annual Filings||No requirement to file annual report with the Registrar of Companies. Income tax to be filed on the income of the proprietorship||No requirement to file annual report with the Registrar of Companies. Income tax to be filed for the partnership||Must file Annual Statement of Returns & Solvency and Annual Return with the Registrar every year. Tax returns must also be filed annually||Must file Annual Statement of Returns & Solvency and Annual Return with the Registrar every year. Tax returns must also be filed annually|
|Existence or Survivability||Proprietorship existence is dependant on proprietor||Partnership existence is dependant on partners. Can be dissolved at will or upon on the death of partner(s)||Existence not dependent on partners. Can be dissolved voluntarily or by order of the Company Law Board||Existence not dependent on directors or shareholders. Can be dissolved voluntarily or by Regulatory Authorities|
|Foreign Ownership||Foreigners are not allowed to be sole proprietors||Foreigners are not allowed to be part of a partnership||Foreigners are allowed in invest with/without the approval of the Reserve Bank of India (RBI) and other applicable permissions for the relevant Government of India authorities depending on the category of business they are interested to invest.||Foreigners are allowed to invest with/without the approval of RBI and other applicable permissions for the relevant Government of India authorities depending on the category of business they are interested to invest.|
Another important question that startup founders should be asking themselves is if they are looking to raise external funds or bootstrap their business. A private limited company is the best option for startups looking to raise funds as it provides the required flexibility to manage external investments and company stock.
Given how dynamic the startup ecosystem in India is, it is also advisable to draft a Founders Agreement. A Founder’s Agreement is essentially a document that specifies important details about the founding team and the business, such as, roles, responsibilities, executive compensation, operational details and exit clauses among others.
The purpose of such an agreement is to reduce the possibility of surprises when the company is fully functional. Having a clear Founders Agreement with all basic details clearly laid out forms a solid foundation to start and scale a business. The agreement can also act as the go to guide should disagreements arise.
2. Applying for business licenses
Licenses are integral to running any business. Depending on the nature and size of business, several licenses are applicable in India. Knowing the applicable licenses for your startup and obtaining them is always the best way to start at business.
The lack of relevant licenses can lead to costly lawsuits and unwanted legal battles. Business licenses are the legal documents that allow a business to operate while business registration is the official process of listing a business (along with relevant information) with the official registrar.
The common license that is applicable to all businesses is the Shop and Establishment Act which is applicable to all premises where trade, business or profession is carried out. Other business licenses vary from industry to industry.
For instance an e-commerce company may require additional licenses like VAT registration, Service Tax Registration, Professional Tax etc. while a restaurant may require licenses like Food Safety License, Certificate of Environmental Clearance, Prevention of Food Adulteration Act, Health Trade License etc along with the above mentioned licenses.
3. Understanding taxation and accounting laws
Taxes are part and parcel of every business. There are a broad variety of taxes, such as, central tax, state tax and even local taxes that may be applicable for certain businesses. Different business and operating sectors attract different taxes and knowing this beforehand can prove to be useful.
Recently, the Government of India launched the ‘Startup India’ initiative to promote startups, and introduced many exemptions and tax holidays for startups and new businesses. According to this initiative, a startup can avail income tax exemption for a period of 3 years as well as tax exemptions from capital gains and investments above Fair Market Value. The conditions that startups need to qualify in order to leverage these exemptions are:
- The startup should not be more than 7 years old (or 10 years for biotech) from the date of incorporation.
- Is incorporated as a Registered Partnership, Limited Liability Company or Private Limited Company.
- Turn over in any year should not have exceeded 25 crores.
- The startup should not have been formed by splitting or reconstructing an existing business.
As far as business accounting is concerned, it is good hygiene to maintain proper books of accounts and audit them from time to time in order to ensure that relevant accounting and taxation rules are adhered to. Given the small size of business, many startups initially do not pay close attention to accounting requirements. However, this situation cannot be ignored for long as it can lead to serious accounting discrepancies.
Having a sound payment and invoicing system for customers is one part of ensuring a clear accounting system. If you are an online business, take a look at Razorpay’s payment solutions that ensure easy, effective and secure payment solutions.
4. Adhering to labour laws
Adhering to labour laws are integral to every organization, small or big. When you are established as a company and have hired people to work for your organization, you are subject to several labour laws regardless of the size of the organization.
Laws with regards to minimum wages, gratuity, PF payment, weekly holidays, maternity benefits, sexual harassment, payment of bonus among others will need to be complied with. It is best to consult a legal counsel to assess the laws applicable to your startup and ensure that your startup is compliant to the required labour laws.
With regards to labour laws, startups registered under the Startup India initiative can complete a self declaration (for nine labour laws) within one year from the date of incorporation in order and get an exemption from labour inspection. The nine labour laws applicable under this scheme are:
- The Industrial Disputes Act, 1947
- The Trade Unit Act, 1926
- Building and Other Constructions Workers’ (Regulation of Employment and Conditions of Service) Act, 1996
- The Industrial Employment (Standing Orders) Act, 1946
- The Inter-State Migrant Workmen (Regulation of Employment and Conditions of Service) Act, 1979
- The Payment of Gratuity Act, 1972
- The Contract Labour (Regulation and Abolition) Act, 1970
- The Employees’ Provident Funds and Miscellaneous Provisions Act, 1952
- The Employees’ State Insurance Act, 1948.
Startups under this scheme will have to file self-certified return for the second and third year in order to continue with the exemption.
Startups also often hire consultants or freelancers in addition to full time staff, hence employee policies should cover all employment details with regards to employees both fulltime and part time.
Having a well designed employee policy can be a major differentiator for startups. An attractive employee policy can be the key to attract and retain good talent. Employee policies can also prove to be the starting point for boosting employee morale and increasing productivity.
5. Ensuring protection of intellectual property
Intellectual property is the secret sauce for most businesses today, especially for tech centric businesses. Codes, algorithms and research findings among others are some of the most common intellectual property owned by organizations. Startups can leverage the ‘Scheme for Startups Intellectual Property Protection’(SIPP) under the Startup India initiative.
The scheme was set up to nurture and mentor innovative and emerging technologies among startups and help in the protection and commercialization of intellectual property. For the effective implementation of the scheme, facilitators have been empanelled by the Controller General of Patents, Trademarks and Design.
Such facilitators help startups by providing advisory services, assisting in patent filing and disposal of patent application among other services at a minimum charge. Complete details with regards to SIPP can be obtained here
The Office of the Controller General of Patents, Designs and Trademarks controls all patents in India and startups can also directly e-file their patents here.
6. Ensuring effective contract management
Contracts lie at the crux of running any business. A contract is required to ensure the smooth functioning of work and is a great mechanism to ensure recourse in case of non-fulfillment of work. Having basic knowledge about various aspects of contract management can prove to be useful for entrepreneurs.
As per the Indian Contract Act, 1872, all agreements are contracts if they are made by the free consent of parties competent to contract, for a lawful consideration with a lawful object, and are not expressly declared to be void.
Employee contracts are one of the most crucial aspects to be looked into while starting a venture. Founders many a time collaborate with their own trusted circle of friends in the beginning and while this ensures a certain ease and efficiency to business operations, outlining and formalizing employee contracts with details about salary, scope of work and stock options (if any) with even your first few employees is always recommended. Having this clarity from the very beginning helps startups reduce risks at a later point in time.
In the early stage of operations, startups also tend to hire contract staff and vendors and having an effective contract management system will ensure that the right checks are in place for the timely fulfillment of required work.
Another important contract that startups might find useful to have are NDAs. Startups often thrive in a crowded market with stiff competition and they often discuss ideas with a host of people from potential investors to employees to customers.
While this is much needed for the growth of the business, it exposes new startups to risks like the theft of ideas and other proprietary business information. Ideas that might have been shared in goodwill might be used inappropriately to the disadvantage of the business.
Hence, to avoid such scenarios, non-disclosure agreements or NDAs need to be drafted and used by startups while discussing critical business information with people outside the organization.
7. Details about winding down the business
Closing a company is a difficult call to make for any entrepreneur. When a startup decides to shut down, all the stakeholders from vendors to employees to customers and investors need to informed in advance and the whole process must be properly planned and executed in order to make the exit easy on everyone.
From the legal standpoint, there are basically three ways to shut down a startup:
- Fast Track Exit Mode
- Court or Tribunal Route
- Voluntary Closure
Of all the three ways, the Fast Track Exit Mode is the best suited for startups as it allows companies to expedite shutdown at a lower cost and a shorter time period. In order to apply for a fast track exit, a company should (a) not have any assets and liabilities (b) not have had any business operation for the past year. If these two conditions are met, the company can be struck off the registrar of the Registrar of Companies (RoC).
If you are looking at winding up your company via the Fast Track Mode, you can get all details and forms here
Another quick way for a company to shut down is through Voluntary Closure; however, this requires the shareholders and/or creditors of the company to be on the same page with regards to the details of the closure. While it is an easy route, it might not always be practical or applicable at all times. The traditional mode of closure via courts or tribunals is not the best suited for startups as it involves several meetings with various stakeholders leading to prolonged court proceedings.
In addition to the above stated means, The Insolvency and Bankruptcy Bill, 2015 is a new closure tool that entrepreneurs can use. Leveraging this bill requires startups to have simple debt structures, where an insolvency professional is hired to liquidate the assets of the company within 90 days, in accordance to the ‘Startup India Action Plan’.
If a startup does not wish to operate but also not shut down, it can apply to be a ‘Dormant Company’, that allows a company to stay afloat with minimum compliance. However, a company dormant for a period of 5 years is automatically struck off from the RoC.
Adhering to legal requirements is very important for any organisation; knowledge and compliance to applicable laws is the first step to ensure smooth business operations. Hiring a professional legal counsel to provide advice, oversee and maintain legal records is one of the best ways to ensure that your company is always safe and does not face legal complications and consequences.
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