Most startup founders are often great designers, engineers, coders etc. However, one integral thing that most founders aren’t the best at is the basic legalities that go into starting a business. We probably don’t need to tell you how important a factor this is as nobody likes being on the wrong side of the law. The last thing you want is getting penalised over some trivial legality that was an honest mistake on your part.
The first thing to do when you embark on your startup journey is to register your startup as a company. Why? Well, because you mustn’t ever use your private savings account to make business transactions that could seriously come to bite you in the behind in the future. There are three basic types of companies you could register as; a sole proprietorship, a partnership and a Pvt. Ltd. company. So, let’s talk about what sort of company you should register as and why.
It only makes sense to register as a sole proprietorship if you’re looking to do a market test to see if your startup has what it takes to make it big. If you’re already sure that your idea has legs and you have co-founders ready to jump on the bandwagon with you should register as a Pvt. Ltd.
Well, a partnership form of company, has its fair share of limitations that can prove to get in the way of you running your startup. Let’s look at a few of these reasons:
If you ever plan to raise funding (which all startups do hope to do), investors will only even consider listening to you if you’re a Pvt. Ltd company. This is because when someone invests in your startup, you’re going to have to issue shares and meet a whole bunch of compliances that a partnership fundamentally does not allow you to do.
Another major problem with a partnership is that your liabilities are capped. (the only exception being a limited liability partnership). So, for example, say your capital contribution to your startup is 10 lacs as is that of your two co-founders. Say for whatever reason your co-founders decide to run away with the money and the partnership suffers a loss of INR 30 Lakhs. Then the entire amount of capital is on you and you’re responsible for the entire amount.
In the case of a limited liability partnership or Pvt. Ltd, your liabilities will be capped at INR 10 Lakhs and so you’ll only be held accountable for the amount of capital you’ve invested and not for the total amount invested. Also, unfortunately, it’s close to impossible to register a partnership without having to grease some greedy palms. Another major problem with a partnership is that you cannot have more than 20 partners.
Another downside to a partnership is that if your product ends up creating any form of issues for any customers, you are directly liable and held responsible for any issues faced. In the case of a Pvt. Ltd company, you’re creating a layer and hence if there’s ever a hit, it will hit the company first and then go onto hit the founders.
Pvt. Ltd. Company
Let’s now look at a few more reasons why a Pvt. Ltd company is the way to go:
A Pvt. Ltd company allows you to play around with the capital structure, you can also play around with the rights distribution, which isn’t so easy in a limited liability partnership. Hence, investors will ask you to convert from an LLP to a Pvt. Ltd. company.
Keep in mind, if anybody ever tells you that they will convert your partnership into a Pvt. Ltd company, that’s absolute rubbish as there is no legal document in India that allows this. Basically what the person is doing is creating a new company for you from scratch.
A few more quick facts about a Pvt. Ltd. company are:
- You need a minimum of two shareholders, two directors and a minimum capital of INR 1 Lakh.
- The share strength can be decided by you.
- The moment you have your company incorporated you must first decide the name. Check websites like MCA to see if your desired name is even available. You get up to two attempts to apply for a particular name.
- Just because your logo has a particular name or word on it doesn’t mean that your company name has to be the same. For example, Oyo Rooms is registered under the name of Oravel Stays Pvt Ltd. So, if you’re worried that you’ve been running your logo for six months and now that name isn’t available, don’t! Don’t start jumping to conclusions and worrying about things like repositioning your brand etc.
- Once your company has been incorporated, you must first get all your basic tax registrations done as well as open a company bank account. Please do not make any cash transactions. If you’re ever hoping to raise funding (which we hope you are), no investor will entertain you if he finds out that you’ve made any cash transactions, as his anti-bribery and compliance red flags will go up.
Some simple practical advice to keep in mind is that you must maintain record books. For example when you register a company, the directors are supposed to meet four times a year, once every quarter. In most cases, people do not do this as the directors/founders of a company believe they are meeting and working together on a daily basis so why have a formal meeting for the same.
However, whether you like it or not, you will have to show this in your records. What you’ll have to do is create a paper meeting where you mention that the board met, they discussed the business, saw that there is prospect and the meeting convened. Simple as that!
You must do this so that paper trails are always in place if you ever need to go back to them at some point. An investor will always want to see all such paper trails before he invests a dime in your company.
The moment an investor will consider your proposal, the first thing he’ll want to do is look at every single one of your documents.
To illustrate further, there was once a company which a large fund wanted to invest in. Upon doing their due diligence, the investor found out that the company had been running for two years but the founder had forgotten to register a trademark, not for any other reason but only because it slipped his mind. The result of this was the investor sent an army of IP lawyers to the company and did a
The result of this was the investor sent an army of IP lawyers to the company and did a three-month long extensive diligence on literally every single piece of paper in context to the company. Due to this, the founders’ funding schedule got pushed forward by eight months and he got stuck in his office with a bunch of lawyers for three months.
So always remember never miss out on any compliances as they can cost you big time.
Everything in this blog post was learnings we had during a Legal 101 workshop that took place at our Noida hub. This workshop was conducted by Pratik Mohapatra who graduated from the National Law Institute in Bhopal and has more than 6 years of hands-on experience working with national as well as international startups.
During his tenure with Platinum Partners which is one of India’s largest law firms, he closely worked with foreign investors who wanted to invest in Indian companies. After spending the significant amount of time in the corporate world and having built a name for himself in the field, he is now dedicatedly helping early stage companies structure their business and investments.
[This post first appeared on 91springboard.com and has been reproduced with permission. 91springboard is a vibrant coworking community created for startups, freelancers and business owners with a startup mindset.]