Legal Challenges Faced by a Startups in India

Startups[i] are young, rapidly expanding businesses started by one or more entrepreneurs. They are in the early stages of development and have limited resources and experience. Even though the Indian government has taken several initiatives to encourage the growth of start-ups in order to promote entrepreneurship and employment by providing easier IPR facilitation, a favorable taxation system and easier compliance for the setting-up company etc., start-ups in India still face numerous challenges such as funding, insufficient skill, and a lack of marketing strategies. Over that startups have obligations to operate in compliance with laws. Failure to respect the laws can give start-ups serious problems such as fines, punishments, revocation of licenses, expenses in litigation, etc. that can adversely affect the limited capital of startups.

Business structure

Many start-ups struggle to determine what the best business structure for their venture is since business structures differ from one to another, and what is good for one may be bad for another in terms of risk, the number of people involved, profit sharing, liability, taxation, annual meetings, and registration, among other factors. A start-business up’s structure could be a partnership, a sole proprietorship, a private limited company, or an LLP, for example. In India, the following are some of the most popular company structures.

Sole proprietorship – It gives complete control over their firm, and the best part is that the proprietor is the sole beneficiary of all profits. This structure is popular because to its simpler taxation system, which determines the tax amount based on the revenue received by the proprietor. This structure is not taxed as a separate legal entity in India, unlike other business types. The proprietors, on the other hand, file their taxes as part of their individual tax returns. For a sole proprietorship earning less than or equal to $250,000, the tax rate is nil. When the proprietor’s income exceeds $250,000, he or she must pay a 5% tax. If the income is between five lakhs and ten lakhs, the tax rate is 20%; if the income exceeds ten lakhs, the tax rate is 30%. There are some drawbacks, such as the fact that if the proprietor is unable to pay the business’s debts, his personal assets may be sold to meet the needs. Another problem of this structure is that it has a very restricted ability to raise cash.

Limited Liability Company (LLC) -This business form is best for businesses that are unstable or risky. The great feature about this structure is that the liability is restricted, which means that personal and business assets are treated separately, and personal assets cannot be utilised to repay debts. The company is treated as a separate legal entity in this structure. The costs of founding a Limited Liability Company are significantly higher than those of a sole proprietorship. An Indian LLC is subject to a 30% income tax; there is a surcharge on the income tax of 12% if the company’s income exceeds Rs.10 million; there is also a 4% health and education surcharge in India; and the LLP can be charged with the minimum alternate tax of 18.5 % on the total income of the company, it has to perform audit and has to pay tax online to the income tax department according to section 44AB[ii] of Income tax 1961.

Partnership firm – The Partnership Act and the Indian Contract Act control this business structure, which is appropriate when more than one person is participating in the business. Its taxes structure is very similar to that of a sole proprietorship. A partnership firm’s key defining characteristic is that it involves more than one individual, with the partnership deed governing the agreement between them. A partnership firm is obligated to pay 30% income tax plus a 12% surcharge if the taxable income exceeds one crore rupees – 12% Interest on capital is authorized . – Health and Education Cess is 4% of tax, including surcharges under Income c. It should be highlighted that, unlike proprietorships, a partnership firm has a separate legal identity from its partners. The real drawback of this structure is that profits are shared among numerous partners, which can lead to problems such as disagreements between partners’ views.

Licence and Permits

Start-ups may need a variety of licences, approvals, or licences to carry out their plans, as a lack of legal awareness could result in penalties. Licenses, approvals, and permits may differ from one business to the next; therefore a person should be informed of local laws, rules, and regulations before starting a business. Licenses are not always quick and easy to obtain from government officials, and they take a lot of time and money. Registration certificates, GST registration, FSSAI license, import and export code, udyog aadhar registration, and other licenses are among the licenses required by businesses. Dealing with goods or services that are prohibited by law may result in criminal charges, which could land the businessman in jail or subject him to severe fines and penalties.

GST registration – In the current scenario, for e-commerce businesses, GST registration is required. Businesses with a turnover of equal to or greater than 40 lakhs should get themselves registered for GST registration. There are certain types of businesses that should have GST registration, failure to which is known as an offence.  Casual taxable persons, non-resident taxable persons, e-commerce aggregators, those paying using the reverse charge mechanism, and others should be required to register for GST.

Trademark registration – Building a brand takes a lot of time and effort, as well as a lot of money. As a result, it’s critical to ensure that you possess the rights to use the logo, slogan, product shape and packaging, sound, fragrance, colour combinations, and anything else that gives your brand a particular character. In India, you can register a trademark under the Trademark Act of 1999. It allows for exclusive ownership rights and prevents others from using the mark, benefiting the registered mark’s owner.

Start-up registration –   The Start-up India Scheme is an Indian government initiative that was announced in 2016 with the goal of promoting start-ups, assisting in the creation of jobs, and producing income. Several programs have been launched under it in order to create a robust start up ecosystem and convert India from a majority of job seekers to job producers. The Department for Industrial Policy and Promotion is in charge of it (DPIIT).

Legal documents & Agreements

Employment contracts and offer letters – Employment agreements serve as the foundation for the organization’s workforce. It outlines employees’ rights and responsibilities, as well as rules for resolving internal conflicts. It also contains information on the hiring process, as well as confidential information that will be shared with employees. When employing new personnel, the offer letters must also be very explicit. These define what the staffs are supposed to do.

Founder and co-founders’ agreement – Signing an agreement that specifies the working coordination of all parties and shapes outlines to set boundaries becomes required in the case of businesses with numerous founders or founding parties. It’s to prevent any future squabbles. To avoid any conflicts among the start-up’s founding parties, both co-founders should sign a formal operating agreement. This document outlines each of the founders’ roles, ownership, and early investments. During the incorporation stage of a company, a founders’ agreement is recommended, which lays out the duties and tasks of each of the co-founders. It’s also a good idea to have a written format for this text.

Non-disclosure agreement – Start-ups are formed with the primary goal of introducing new and creative business models, goods, and services to the market. Persons and corporations are always eager to copy such concepts and learn about the internal business strategy, and they may try to extract information from various people involved in the firm. An NDA will be incredibly beneficial in protecting your commercial interests. The parties have agreed to protect the company’s sensitive information by signing this agreement. This is a contract that recognises sensitive information and establishes criteria for its protection. The primary goal of a non-disclosure agreement is to safeguard confidential information.

Intellectual property rights

Intellectual property rights are the heart and soul of any startup company. Many start-ups are concerned that their idea or strategy will be stolen, thus it is essential for them to secure their intellectual property rights as soon as possible. The other concern is that the start-up should double-check that what they want to do or sell has already been protected. So that they don’t have to deal with issues like trademark infringement or other intellectual property breaches after investing a large sum of money in their firm.

Annual Mandatory Compliance for Start-ups in India

In India, start-ups must adhere to a number of regulations imposed by numerous statutes. These responsibilities include filing tax and other returns on a regular basis, having board and other meetings, and keeping statutory books and accounts, among others.

Annual Compliance Checklist for Startups:-

• Appointment of Auditor[iii] – It’s important to understand what a statutory audit is and what it’s for. The distinction between a statutory audit and any other audit is negligible. The main goal of this audit is to see if a company is presenting accurate financial information, such as bank balances and financial activities. The corporation appoints an auditor for this purpose. He will be appointed for a five-year term, and if the company is new, the auditor must be hired within one month of the company’s launch.
• Annual general meeting[iv] (AGM) – An annual general meeting of the shareholders of a private corporation is required to be conducted every year. It is required that it be held in the final six months of the financial year. Certain important matters are discussed at the AGM, such as the approval of financial statements, the appointment of auditors, the salary or payment of directors, the declaration of dividends, and so on.
• Board Meetings[v] – First meeting within 30 days of incorporation, Minimum 2 meetings, one in each half calendar year.
• Reports of directors[vi] – According to the Companies Act of 2013, every director is required to file annual reports detailing their directorships in other companies. This must be done in writing, and an official report has been given.
• Income tax – The following are the conditions for income tax compliance: – Income Tax Returns, Tax Audit Reports, Periodic Returns (Monthly, Quarterly, Annual GST, TDS Returns, etc.), Monthly/Quarterly GST Returns, Quarterly TDS Returns, etc. Assessment of advance tax liability and periodic payment of advance tax, payment of periodic dues like GST liability, TDS &TCS payment,   Regulatory Assessment of business under several laws (for example, the Environment and Protection Act, the Money Laundering Act[vii], the Competition Act[viii], the Factory Act, and so on).

Corporate Governance for Startups

The set of concepts, procedures, and processes that govern a firm are referred to as corporate governance. The company has been given rules on how to direct or govern itself so that it may achieve its goals and objectives in a way that adds value to the organization and benefits all stakeholders in the long run. The company governance is carried out and is based on accountability, fairness, transparency, and responsibility.

Challenges faced by startups in establishing good corporate governance

1. Insider trading – The term “insider” refers to a person who has information of a managerial loophole that is not available to the general public or investors. The term “insider” has a broader definition that encompasses directors, officers, and employees, as well as anybody with a connection to the company’s operations. These individuals are more likely to have access to sensitive information, as it entails the misuse of secret information, which is unethical and amounts to a breach of a fiduciary duty of trust and confidence, as well as a loss of public trust. When it comes to these difficulties, the majority of businesses adhere to SEBI regulations.
2. Disclosure, Accountability, and Transparency – The disparity between those who have and those who do not will continue to grow until we make them stakeholders and learn to match the context around us with fairness and transparency, as well as create a sense of harmony and warmth with the environment.
3. Succession planning – It means deciding who to place in the right position at the right time.
4. The necessity of judicial reforms – The judiciary has raised public awareness of issues such as consumer and environmental protection. The government’s most recent action is to abolish the political system and inculcate faith and trust in the democratic government. Many additional items have been devised to lessen the burdens of the judiciary as well as to resolve conflicts quickly, such as ADR.

[i]  The term ‘startup’ is used in orientation with the definition of the federal government (Dwivedi, A. B.  (2016): The government has finally defined the word ‘startup”; https://yourstory.com/2016/02/government-definition-startup/amp.

[ii] Audit of accounts of certain persons carrying on business or profession, section 44AB, Income tax act, 1961.

[iii] Appointment of Auditors, section 139 (6), companies act 2013.

[iv] Annual General Meeting, section 96(1), companies act 2013.

[v] Meetings of Board, section 173, companies act 2013.

[vi] Financial Statement, Board’s Report, etc., section 134, contract act 2013.

[vii] The Prevention of Money Laundering Act, 2002 enables the Government or the public authority to confiscate the property earned from the illegally gained proceeds.

[viii] The Competition Act, 2002.

References

1.Anubhav Gupta, Legal And Ethical Issues Faced By The Start-Ups In India,(Mar.03 2021),https://www.mondaq.com/india/trademark/1042036/legal-and-ethical-issues-faced-by-the-start-ups-in-india.

2.Apoorv Sarvaria & Rishima Rawat, Legal Challenges Faced by a Startup in India, (Apr. 09, 2019), https://www.lawyered.in/legal-disrupt/articles/legal-challenges-faced-startup-india/.

3.Akshay Mankar, Annual Mandatory Compliance for Start-ups in India, (Aug. 20, 2018),https://blog.finology.in/Legal-news/Annual-Mandatory-Compliance-for-Start-ups-in-India.

4.Shrijay Sheth, Choosing the Right Business Structure for Your Startup, (Jan.3,2019), https://www.entrepreneur.com/article/325609.

5.Saakshi Gupta, Need of Corporate Governance in startups, (Aug.24,2020), https://www.negotiumlex.com/post/need-of-corporate-governance-in-startups.

6.Corporate legit, Open a Limited Liability Company in India, (Mar.26,2021), https://www.indiacompanyformation.com/open-a-limited-liability-company-in-india.

7.Cleartax, Partnership Firm Tax Return Filing, (Jan 05, 2021) 01:15:49 PM, https://cleartax.in/s/partnership-firm-tax-return-e-filing

8. Rachit Garg, 10 essential and important legal documents needed to start a startup in India, (Apr. 2, 2021), https://blog.ipleaders.in/10-essential-important-legal-documents-needed-start-startup-india/#Non-disclosure_agreement.