Legalities in starting a Startup
In a rapidly developing world where capitalism have stemmed its roots deep in the economic development of nations, the idea of startup is its wonderful product. Concept of startup is not new but rather all big players today were startups at their initial stage. Now, more and more countries are providing an inclusive environment for startups to grow and to compete with other big players. In India, the startup ecosystem was realized after the LPG reforms of 1991, but the real spike in startup ecosystem was seen after the 2008 economic recession. Now, India is among the most startup friendly nations in the world. Their number is in the rise and they are now considered as important engines of growth and job creation. India is often described as “the posterchild of emerging markets” for its vast commercial potential for startups. Setting up a startup is not easy and to keep it afloat requires a lot of hard work. It has to comply with various laws and regulations which we will discuss later, but first, let us discuss what actually is a startup.
What is a Startup
Startup is a business in its initial stage of operations which is struggling to find its business model, through trial and error, or doesn’t have a fully developed business model. Startup is founded by one or more entrepreneur to develop a product or services for which they think there is demand for it. It isn’t like a regular company. Moreover, it is not necessary that it should be a company. It can be a –
- one person company (OPC),
- limited liability partnership (LLP), or
- private company.
Indian government has realized the importance of startups in an economy and had gotten up to the task of promoting startup culture by launching Startup India initiative in 2015. The eligibility criteria for startups to be recognized under this initiative is –
- The startup should be incorporated as a private limited company or registered as a partnership firm or a limited liability partnership, but it shouldn’t be a sole proprietorship.
- Turnover should be less than INR 100 Crores in any of the previous financial years
- An entity shall be considered as a startup up to 10 years from the date of its incorporation
- The Startup should be working towards innovation/ improvement of existing products, services and processes and should have the potential to generate employment/ create wealth.
An entity which is formed by splitting up or reconstruction of an existing business shall not be considered a “Startup”.
Setting up a business is not a child’s play. There are various legal compliances which needs to be fulfilled by a startup as well as an established business to work without any hindrance of any kind. Proper agreements should be drafted before engaging in any kind of business. There should be proper rules and regulations within which every member has to work. In fact, a lot of paperwork has to be done in form of agreements and contracts before a startup can carry on its business without any obstruction.
Before drafting agreements, the founders should be aware and updated about the laws governing their business and market. Therefore, it is advisable to approach a lawyer for all the legal work. Below are mentioned the legal compliances and regulations one must be aware of for starting a startup –
Type of Business –
Before setting up a business, it is very important to choose what type of business you want to pursue whether it is partnership, LLP, private company or proprietorship. However, a sole proprietorship is not recognized as a startup under Startup India initiative. Each business type has its own merit and demerits and comes with its own set of legal requirements and regulations, so one should be very cautious while choosing a business type. Although there are also provisions regarding conversion from one business type to another.
Registration/Incorporation of Startup –
After deciding the business type the founder wants to proceed the startup with, the next and one of the most important step is to register the startup. With the ease in startup registration process, many aspiring entrepreneurs wish to bring their startup into reality.
This process involves 2 steps-
- Incorporating the startup – It involves incorporating the business as a partnership or limited liability partnership or a private company. In case of partnership, it has to be registered with the registrar of firms of the state in which the firm is situated, in case of LLP and private company, all designated partners/directors have to obtain Director Identification Number (DIN) and Digital Signature Certificate (DSC) and then incorporate it with the registrar.
- Registering with Startup India Initiative – This has to be done after incorporating the business. The entire step is simple and online. After uploading required documents and fulfilling certain conditions, the startup will get the recognition of Department for Promotion of Industries and Internal Trade (DPIIT). This recognition will help in availing a number of benefits like tax exemption for 3 consecutive years, access to high quality Intellectual Property services and resources, relaxation in public procurement norms, self-certification under labour and environment laws, easy winding up process etc.
If there are multiple partners, it is advisable to draft a founder’s agreement. Although it is not necessary, but having a founder’s agreement will come in handy in the long run. Founder’s agreement is a document which specifies all the necessary details about founders and business such as roles and responsibilities of the founders, operational details, executive compensation, conflict resolution clause and exit clauses among others. Founders’ agreements also help in tackling uncertain occurrences like the death of the co-founder, resignation, which directly affects the sustained growth and smooth running of the business or firm.
Applying for Business Licence –
Licences are important to run any kind of business. Business licenses are the legal documents that allow a business to operate while business registration is the official process of listing a business with the official registrar.
Depending on nature and size of business, several licences are applicable in India.
Ex- a restaurant may require licenses like Food Safety License, Certificate of Environmental Clearance, Prevention of Food Adulteration Act, Health Trade License and an e-commerce company may require additional licenses like VAT registration, Service Tax Registration, Professional Tax etc.
Adhering to Labour Laws –
Every business when it grows require more and more employs. Founders have to keep in mind their responsibilities as an employer and ensuring compliance with all requisite labour regulations which includes laws on payment of wages, provident fund and gratuity, workplace sexual harassment, maternity benefits, etc.
If the startup is registered with the Startup India initiative, for the first one year from the date of incorporation or registration of partnership, founders can sign a self-declaration and be exempted from inspection under the following laws:
- The Industrial Disputes Act, 1947
- The Contract Labour (Regulation and Abolition) Act, 1970
- The Employees’ Provident Funds and Miscellaneous Provisions Act, 1952
- The Employees’ State Insurance Act, 1948.
- 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 Trade Union Act, 1926
- Building and Other Constructions Workers’ (Regulation of Employment and Conditions of Service) Act, 1996
Employees Contract –
It is also necessary to sign a contract with the employees to make sure the role and responsibilities along with the respective jurisdiction of the work done by the employee for the startup. An employment agreement should include-
- term of employment,
- intellectual-property safeguard,
- probation period if any,
- Terms of termination (standard and immediate termination)
- Contract of service or for service clause
Non-Disclosure Agreement –
A non-disclosure agreement is must for a new startup which is just beginning to establish its presence in the competing world by providing unique products or services or both. A non-disclosure agreement is a written contract between two parties that prohibits the sharing of confidential information shared between the contracting parties. It ensures that the privacy of the company, as well as that of the other party, remains protected. Many-a-times, ideas and business information shared in goodwill may be misused. Hence, to avoid such situations, startups must use the drafted NDA while discussing critical business information with people outside the organisation. There are generally 3 types of non-Disclosure agreements-
- Unilateral NDA- it is between 2 parties but only one party discloses the confidential information and expects other party not to disclose that information.
- Bilateral NDA- it is also between 2 parties and both of the discloses confidential information to each other with an intention protect that information from external parties.
- Multilateral NDA- here more than 2 parties are involved where only 1 party shares the confidential information with others while others are obliged not to disclose that information.
Safeguarding Intellectual Property –
Intellectual property is the secret ingredient for most businesses today, especially for tech centric businesses. Codes, algorithms and research findings among others are some of the most common intellectual properties owned by organizations. It covers copyrights, patents and trademark laws which are crucial for every startup. IP rights are important because they can:
- set a startup apart from competitors
- be sold or licensed, providing an important revenue stream which is crucial for startups
- offer customers something new and different
- form an essential part of marketing or branding
- be used as security for loans
Startups can make use of the ‘Scheme for Startups Intellectual Property Protection’(SIPP) under the Startup India initiative. The objective of this scheme is to reduce the cost and time taken to acquire a patent by the startup, making it financially viable for startups to protect their innovation and encouraging them to innovate further.
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. GST also forms part of this regime. Different business and operating sectors attract different taxes and knowing this beforehand can prove to be useful. There are several tax benefits under the Startup India initiative to startups with aim to promote the startup culture in the country. These benefits include income tax exemption for 3 years as well as tax exemptions from capital gains and investments above the Fair Market Value. Having a good knowledge of taxation laws can save the startup handsome amounts of capital.
Having a Prudent Winding Up process –
Having a clear and prudent winding up process is also crucial for a startup. Although taking a decision of winding up is most difficult, it also requires a lot of compliances. 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.
There are 3 ways to shut down a startup-
- Fast Track Exit Mode– It is best suited as it requires companies to shutdown at a lower cost and lesser time. To apply for this mode, company should not have any assets and liabilities and have had no business operation in the past year.
- Voluntary Closure– For voluntary closure, the shareholders and creditors must be on same page with regards to details of closure. It is generally not preferred.
- Courts or Tribunal- It is the traditional mode and can lead to prolonged court proceedings and is generally not suited for a startup.
Startup India initiative also provides for mechanism to wind up operations with ease. Its objective is to allow entrepreneurs to reallocate resources and capital to new avenues faster. As per Insolvency and Bankruptcy code, 2016, startups with simple debt structures, or those meeting certain income specified criteria can be wound up within 90 days of filing an application for insolvency. It will encourage entrepreneurs to experiment with new and innovative ideas, without having to face complex and long-drawn exit processes where their capital becomes interminably stuck in the event of business failure.
Having met with all these compliances will not ensure success of the startup automatically. It is upon the hard work of its members that will bear the fruits of success. However, having met with all these legal compliances with utmost precision will definitely improve the chances of success of the new venture. Adhering to legal formalities is very important for any business; knowledge and compliance to applicable laws is the initial step to ensure smooth business operations. This is where a professional and experienced lawyer will serve the needs of the startup by safeguarding it from any legal complications or consequences.
Author: Harkirat Singh Jagdev,