The excitement and the rush you get when working for your own start-up is incomparable. However, in this excitement, founders often overlook certain legal considerations This brieficle aims to throw light on some that get missed out.

A.    Form of Start-up
Once the entrepreneur decides to execute his idea, he must consider a few questions –
•    Is the entrepreneur going to go solo or do they intend to have co-founders?;
•    Is the start-up going to be boot-strapped or funding will be needed?;
•    Is the start-up in a regulated industry?

These questions will help the entrepreneur in deciding between proprietary concern, a partnership firm/ LLP or a Company (Private Limited or One Person Company) for the start-up.

B.    Founders’ Agreement

Where the start-up is founded by multiple persons, it is best to have an agreement between the founders (popularly known as “Founders’ Agreement”). It should outline, inter alia, the following:

•    the overall high-level understanding between the co-founders like the mission and vision;
•    the roles and responsibility each founder will undertake;
•    how the funding-related decisions will be taken;
•    the business that the start-up is to undertake;
•    the remuneration model of how and when a co-founder will be paid including clarity on equity vesting;
•    mechanism and timing of exit for founders;
•    the non-compete rules that will apply to a co-founder if they decide to leave;
•    the voting power of co-founders on various matters.

The vision of the founders, the reason the start-up was started and the reason the founders came together to start the venture should be core of the Founders’ Agreement. It may sound like a sentimental thing to do, but when the start-up grows and Startup will have many routes and options available – these reasons will keep the start-up from being uprooted or get divided. One of the most famous founders’ falling outs is that of Facebook, where Mark Zuckerberg cut Eduardo Saverin from Facebook and diluted his stake. A Founders’ Agreement in such a case can outline the initial intentions and the powers of every co-founder to take decisions.

C.    Obtaining Start-up Registration, Business Licences, and IP Registration

By registering the start-up with DPIIT, a start-up becomes eligible for host of schemes along with various other benefits like exemptions from strict legal compliances. An application can be made online on the Start Up India website to register the business as a start-up¹.  A registration under the MSME Development Act can also be considered to avail the benefits of being an MSME.

Moving on, having established an entity and formalised the start-up, the next legal hurdle in chasing the dream would be that of licenses. Every business is unique and may require different licenses to carry out business. As much as the government is trying to improve the Ease of Doing Business in India, as of 2020, India still ranks at 63 among the chosen 190 countries as per the World Bank Report² . As compared to the past, it may be good, but that doesn’t mean that it’s as simple as setting up your vada pav stall on the road (FYI – even this requires a permit from Municipal Corporation and FSSAI at the least!).

1. https://www.startupindia.gov.in/content/sih/en/startupgov/startup_recognition_page.html
2. https://www.makeinindia.com/eodb

There is a saying – there is nothing new under the sun. I disagree with the saying, because if that were true, we would not have start-ups with such innovative ideas. Raising the question of IP (Intellectual Property), if a start-up has any IP that needs to be protected it must go ahead and get it registered. After all, the uniqueness of a start-up is its IP. There are various schemes related to IP offered by the Government. Details of the same can be found at https://ipindia.gov.in/SIPP.htm

D.    Systems for Accounting and Compliances

One of the main elements of a successful start-up is its ability to scale. Scalability requires certain fool-proof processes which can repeat automatically. Automation is the key. Be it in operations or in accounting. The earlier such processes are established, the easier will it be for the founders to focus on business. Proper processes can help in generation of reports on real-time basis (as far as possible). This helps the founders be on top of their financial situation and keeps them aware of the runway left with them. A qualified Chartered Accountant can help them prepare the process flow and understand the action points. These reports can be used for making investor presentations as well.

Once the start-up is up and running, various questions of compliance may arise. While this is the time when the start-up should start complying to the relevant laws, it would be ideal if the founders get in touch with a consultant and understand the compliance requirements early on. Compliances under Income-tax Act, GST Act, Securities laws, FEMA, Banking laws and other commercial laws (including labour laws) will require attention from the early stage. Various exemptions from compliance requirements are provided by the Government to start-ups but it  cannot justify the ignorance and non-compliance.

E.    Forms of Fundraising

As mentioned earlier, founders may decide to boot-strap a start-up, but on the other hand in most of the cases, founders raise external funds. It is for the founders to decide whether the capital is to be sourced through equity or debt. A concept that has seen widespread acceptance is the use of SAFE documents – Standard Agreement for Future Equity. These are essentially in the form of Compulsorily Convertible Preference Shares where the conversion happens in the future at the future valuation. This helps the founders keep control of the entity while at the same time provide the investors equity-linked rewards. It is essential that the founders consider all terms of the investment carefully before diluting their stake and control of the entity for funding. A Chartered Accountant or a Lawyer can help with the finer aspects.

F.    Using Legal Opinions

Lately, I have observed a lot of start-ups have come up where they are providing new services based on aggressive opinions/ stands obtained from their advisors. A well-established rule of law – what cannot be done directly, cannot be done indirectly – should be remembered while these aggressive opinions are obtained. This could go two ways – either the regulators may strike down such services or they may invite you to help them figure out legislation for the new services that are being offered. In case of the former, it could be fatal for the start-up and could land the founders in soup not just with the authorities but with the investors as well. While, in case of the latter, one should consider approaching the regulators under their respective “Sandbox” schemes. Various regulators including SEBI, IRDA, PFRDA provide such opportunities to start-ups where under some conditions certain regulations will be relaxed so that the start-up can experiment its solutions in a controlled environment.

Conclusion

While India is a land of budding start-ups, it is also a land of budding laws and compliances. Thus, it is very important for a new business owner to be aware of necessary laws and processes that are applicable to their business. The first thing that is taught in law – ignorentia juris non excuta (Ignorance of law is not an excuse) is applicable to all the founders too.