The start-up culture in India has been on a rise for a few years now, especially after the launch of Start-up India Action Plan in January 2016. While we have a number of entrepreneurs lined up to revolutionize the nascent circle; few are aware of or have access to legal help that can update them of the legal nuances associated with starting a new venture and running it.
The founders, core team members, employees etc of these start-ups, are still struggling with a variety of perceptions related to starting a business that are either incorrect or incomplete information.
This article attempts to clear this cloud of confusions. The targeted audience for this article are entrepreneurs either looking to start their own venture or in the early stages of starting up a start-up.
The article is divided into two segments. The first segment deals with things to keep in mind before beginning and acts like a checklist prior to setting up an entity. The second segment focuses more on issues that deserve some attention during the course of running a newly set-up business.
1. Who qualifies as a start-up?
Many rookie entrepreneurs associate a start-up with an innovative idea that solves a current problem by masses at large. While the general idea is true, it is also pertinent to keep in mind that there are several eligibility requirements prescribed by the government of India for qualification as a start-up.
First of all, to qualify as a start-up, an entity must be registered either as a private company under the Companies Act, 2013 or as a partnership firm under the Indian Partnership Act, 1932 or as a limited liability partnership (LLP) under the Limited Liability Partnership Act, 2008. Sole proprietorships, which are the first option of most young entrepreneurs with little money and fear of legal procedures, do not qualify.
Other eligibility requirements for an entity to qualify as a start-up are:
(i) A period of 7 years has not elapsed since the day of incorporation;
(ii) Turnover is less than Rs. 25 Crore for each financial year, since the year of incorporation;
(iii) Work is focused towards innovation, development and improvement of products and/ or services or a business with potential to create high employment opportunities or wealth.
Take-Away: In order to avail the benefits rendered by the government, incorporation as a company, or partnership firm or LLP is an essential eligibility criteria.
2. How to register?
Another apprehension on setting up an entity as a private limited company is the minimum paid up share capital requirements. It is important to mention that minimum paid up share capital requirement of Rs. 1 Lakh has been done away with in 2015. Therefore, to set up a private company under the Companies Act, 2013, all you need is minimum 2 shareholders, 2 directors and some subscribed share capital which can be as low as Rs. 100.
Additionally, under the Start-up India Action Plan, the registration process is made much simpler through the launch of a mobile app called – Start-Up India. The mobile application provides easy access to completing registration processes and filings with government agencies including Registrar of Companies (for registration as a private company) and Registrar of Firms (for registration as a partnership firm or LLP). The process is much faster than the traditional incorporation procedure routed through SPICE 32 form filing with Registrar of Companies or registration as a firm with the Registrar of Firms.
Take-Away: Incorporating as a company is beneficial in the longer run, when the start-up grows in statistics and is ready for first round of investment.
3. Licenses and Registrations
Other than the registration to set up the entity, there may be several other licenses that the start-up may require. The first and foremost in the group are Business licenses, which mostly certify that the entity set up by you is functional and running and are sometimes essential to open a bank account solely for the business.
While one may to opt to obtain some of the licenses and registrations solely as proof of running the business of the start-up; some licenses may be mandatory to obtain. Obtaining a PAN/TAN for your registered entity, Goods and Services Tax (GST) registration (unless the aggregate annual turnover is more than Rs. 20 Lakhs) etc. fall in the former category. Value Added Tax registration, professional tax registration, registration under Shops and Establishment Act and other such labour laws may become essential if your start-up fulfills the applicability criteria.
Furthermore, depending upon the nature of business of your start-up, several other licenses and local permits may also be required. For example – if the start-up is associated with the food industry, a permit from Food Safety and Standard Authority of India may be required. Similarly, if the start-up deals with pharma products, a license under the Drugs and Cosmetics Act may be required etc.
Take-Away: It is pertinent to figure out what all licenses your start-up would require and apply for them in advance. The smart thing to do would be to identify the sector to which the start-up belongs to, for example – healthcare, food & entertainment etc. This will help in identifying the regulator and hence the licenses would be easy to figure out.
To register the business and open a bank account in the name of your start-up, the easiest and most convenient business license to obtain is the PAN card in the name of your start-up. It is also advisable to obtain GST registration as soon as possible to become eligible to obtain benefits under the GST Composition Scheme.
Twisted Fact: While the requirement of having the minimum paid up share capital of Rs. 1 Lakh is done away with for incorporating a company, many business licenses still require the same. So researching upon the required licenses for your business automatically becomes a pre-requisite at the time of incorporation.
4. Must Have Agreements to Execute
Building a strong legal structure since the beginning of the start-up can be a big plus for future growth. Many entrepreneurs make the mistake of communicating and building relationships on goodwill in the initial stage, which may become a cause for future inefficiencies. Following are a few must have agreements that every start-up should put in place:
(i) Memorandum of Association (MoA) and Articles of Association (AoA): If your start-up is registered as a private limited company, putting in place a MoA and AoA is a pre-requisite to incorporation. The Standard format of MoA and AoA provided in Table A and Table F respectively of Companies Act, 2013 is suitable.
Other than that, certain clauses such as entrenchment, business expansion clause, workman safety clause, doctrine of constructive notice, procedure of enquiry upon employees and directors etc, should also be incorporated to make the AoA an all-round document for the company, that will provide the employees and future investors more comfort than usual.
(ii) Founders Agreement/ Partnership Deed/ LLP Agreement: An extensive Founders Agreement must be entered into that reflects upon the relationship amongst the founders, their rights and responsibilities, privileges and obligations relating to the business. A good founder’s agreement must address the issues of ownership structure, transfer of ownership, confidentiality of information, decision making process and dispute resolution.
If your start-up is registered as a partnership firm or LLP, similar provisions can be incorporated in the partnership deed or LLP Agreement itself, as applicable.
(iii) Standard Employment Agreement: An agreement with any employee that is hired by your start-up must provide for employment terms, rights and responsibilities of the employee, termination terms etc. Inclusion of provisions relating to confidentiality and non-solicitation in employment agreement will qualify it for a well-drafted agreement.
(iv) Service Agreements: If your start-up is offering services, the standard service agreement must extensively define ‘services’ along with a list of exhaustive to-do items that will qualify as services under the agreement. Other than laying down the rights and obligations of service provider as well as service receiver, provisions relating to relationship of the parties, indemnification, insurance and dispute resolution must be provided.
Take-Away: The abovementioned agreements are sophisticated with respect to their content, which may differ from case to case basis. It is logical to seek legal advice for drafting and negotiating the terms of these agreements.
1. Stamping of the Agreements
An agreement that is not appropriately stamped cannot be used as evidence in the court of law. Laws relating to stamping and registration differ from state to state. Therefore, every agreement that is executed by the start-up must be stamped as per the laws of the respective state in which the agreement is being executed. Click-wrap or Shrink-wrap agreements are not required to be stamped since they are executed online.
Take-Away: Several high courts have held that electronic contracts are admissible in the court of law when printed out on paper and do not require stamping as such. To be on a safer side, one school of thought has taken the view that electronic contracts should be stamped at the time of enforcement. Depending upon the value of the agreement, legal advice should be taken on stamping.
Additionally, it is advisable to have the registered office of the start-up in a stamp-friendly state if debt funding is on the cards anytime in future. This is because security documents are required to be kept at the registered office and may attract huge sums of stamp duty, depending upon the local laws of the relevant state.
2. Employee Stock Options
Many start-ups use Employee Stock Options (ESOPs) to hire and retain their employees especially during the initial stages. ESOPs are options given to the employees to purchase a specific number of shares of the start-up at discounted prices. While the option is lucrative, many forget the procedure involved under the Companies Act, especially the minimum lock-in period of 1 year between issue of ESOPs and its exercise by the employees.
Take-Away: Both the employer and employees must keep in mind that at the time of issue of ESOPs, a comprehensive ESOP scheme is required to be drafted and passed by the board and shareholders. Once the same is done, an employee can exercise the option only after elapse of minimum 1 year from the issue date.
3. Compliances under Applicable Laws
Start-ups registered in either type of business structure, be it private company, partnership firm or LLP, are required to mandatorily comply with several laws. The government of India, under the Start-up India Action plan, has introduced the concept of compliance by self-certification for first 3 years for several specified labour law and environmental law statutes.
Compliance by self-certification has reduced the regulatory burden to some extent. However, compliances must be timely completed to avoid heavy penalties at a later stage; probably when the entity is out of the ‘start-up’ definition, as discussed earlier in this article.
Take-Away: While each business structure has its compliances, they are easier to fulfil if your start-up is a private limited company. Further, labour law and environmental compliances must be given special importance since their violations necessitate heavy penalty, sometimes entailing even criminal liability, such as in the case of Shops and Establishment Act.
4. Intellectual Property Rights
A start-up like any other business, must register its intellectual property. The choice of rights to obtain is a critical decision since a lot of intellectual property content may qualify for more than one type of right, i.e. an item can qualify for both a copyright and a trademark. In order to decide, which right to opt for, it is prudent to seek advice from an Intellectual Property lawyer.
Further, under the Scheme for Facilitating Start-ups’ Intellectual Property Rights, a start-up can avail benefits such as reduced patent filing fees, assistance in registering patents, trademarks and designs under applicable statutes, fast-track proceeding of IPR applications etc. To avail such benefits, a start-up must be registered under Department of Industrial Policy & Promotion (DIPP) and obtain a certificate of recognition.
Take-Away: A DIPP registration is another addition to the list of licenses to be obtained by your start-up; probably at a later stage, but a very beneficial registration if the start-up deals with innovative ideas and technology.
5. Taxation of Start-Ups
Under the Start-up India Action Plan, eligible start-ups (eligibility criteria as discussed above), incorporated after April 1, 2016 are allowed 100% exemption from tax payment in the first 3 years of its functioning. Further, a tax exemption on investments above the fair market value is also provided.
In order to motivate more and more investors to put their money in start-ups, the government has also provided rebate on capital gains, if an investor has invested such capital gains in the Government Fund that provides funding support to start-ups.
Take-Away: The 3 year exemption is available only if there is non-distribution of dividend by the Start-up. So it would be judicious to plan the usage of finances and applicable taxes since the beginning.
The Start-up culture is spreading in India like a wildfire. The recent government policies and plans are giving this wildfire the much needed push. While the start-up India action plan has been doing well, several Incubators and Facilitators are also coming up fast and helping in stimulating the growth of these start-ups. Educational institutions are also not far behind in contributing to the process. Recently, the Indian Institute of Technology, Delhi has given leeway to its PhD students to launch their own start-ups instead of submitting a dissertation. Hopefully, this culture will continue to flourish and the coming years will witness lots and lots of start-ups changing the landscape of Indian economy.
Himani is an experienced corporate lawyer practicing in Mumbai, India. She is an admitted LL.M Candidate and Dean's Graduate Scholar at NYU School of Law, 2019-2020. She has worked with several start-ups as an independent professional. She is also associated with YES Bank Limited, Mumbai as a legal consultant to the Credit Administration Team. Prior to working independently, she was an Associate at a law firm - Samvad Partners, Mumbai. She belongs to the quaint, cultural city of Lucknow, likes to paint by the beach and is also a wannabe fitness enthusiast. You can connect with her on Linkedin at - linkedin.com/in/himani-singh-51454262