Startups In India: Eligibility & Checklist

Traditionally, business activities were initiated through conventional forms of business, Proprietorship, Partnership, or a Limited Company. As the country matured in complexity, the Government introduced various schemes to provide incentives and encourage entrepreneurship. Banks would provide loans at lower interest rates, and regulatory compliance was relaxed.

Today, there is a growing focus on and participation in the start-up ecosystem. With the growing atmosphere towards starting business ventures at an early age, coupled with the 'Make in India' policy of the Government, the Government of India has, in many ways, “institutionalised” the concept of a 'Startup'. Many professionals are now seeking the entrepreneurial path. The following are some important points that any start-up founder or entrepreneur would need to know, from a legal lens.

A Precursor: Drafting the Startup Documentation.

The Department for Promotion of Industry and Internal Trade (DPIIT) defines a 'Startup' as an entity which 'is working towards innovation, development or improvement of products or processes or services, or if it is a scalable business model with a high potential of employment generation or wealth creation'. It is thus of utmost importance to ensure that the entity's foundational documents sufficiently indicate the scope of the entity's commercial dealings. In case the documents are not well drafted, the entity could be deprived of the benefits and advantages available to a 'Startup'.

Keeping these three crucial objectives before beginning the drafting of any commercial venture, and more particularly of a 'Startup', is helpful:

• Correct Classification: Satisfying the Government's or any other authority's requirements for being classified under a particular type of business entity – This is to get any associated benefits, advantages, and subsidies that have been announced by the Government or relevant authority.
• Strong internal frameworks: Creating a framework which prevents internal dissensions and disputes within the venture and a mechanism to resolve the same.
• Adaptable language that allows for scaling: The documentation should be drafted in a way that would allow the venture to expand its business and be conducive towards incentivising external investment into it.

The Context: Type and Formation of the Entity, Documentation Checklists and Pro-tips.

The next step to consider is the type of entity the Startup would be – the most common structures are a Partnership Firm (registered under the Partnership Act), a Limited Liability Partnership (LLP), or a Private Limited Company. The three important considerations for selecting the structure of any entity are:

• The nature of the business that the Startup seeks to undertake,
• The funding structure and
• The management structure/relationship between promoters.

Documentation Checklist

1. Foundational Documents: Foundational documents are those which give birth to the chosen entity, such as the Deed of Partnership (for a Partnership entity), or the Limited Liability Partnership Deed (for an LLP), the Memorandum and Articles of Association (of private limited companies) and so on. These documents would need to be drafted and duly registered along with the necessary authorities.

It is suggested to ensure that the language contained in and formalisation of the document satisfy the Government of India's requirements of a 'Startup' in the chosen category. For instance, while the Indian Partnership Act, 1932, does not require mandatory registration of partnership firms, the Government of India's notification requires this registration to be classified as a 'Startup'.

• ROC filings: Once the foundational documents are ready, regulatory filings such as the names and addresses of the Board of Directors (in case of a Private Limited Company) or the Partners (in case of an LLP) should be communicated to the Registrar of Companies. Procedural applications like taking digital signature certificates (DSCs) from the ROC would need to be procured in time to ensure correct filings.
• Obtain other statutory certificates: While obtaining the necessary registrations with the Central and State Government (e.g., PAN, GST Certificate, etc.) or with the Local Administration (e.g., Shop and Establishment License), the exact and accurate nature of the entity's business should be communicated.
• DPIIT application for 'Startup' status: An application to the Department for Promotion of Industry and Internal Trade is required for recognition as a 'Startup'. It is only after this recognition that the Startup entity can claim the various benefits offered by the Government to startups.
• Specific licenses: Depending upon the nature of the Startup's business, the now-recognised entity can apply for other licenses and permissions, specific to its business activities (e.g., Importer-Exporter Certificate from the Director General of Foreign Trade or FSSAI licenses and so on), before commencing business formally.

2. Other Suggested Documents: The foundation of the Startup is set, and it can formally commence business. However, from experience, it has been found that following certain additional steps helps greatly in establishing internal protocols and governance frameworks. Having the following documents in your Startup arsenal goes a long way in ensuring that the Startup does not collapse due to internal problems.

• Co-Founders Agreement: Creating a co-founder's agreement that spells out the vision and objectives of the Startup, the understanding between the co-founders, roles and contribution of each co-founder, financial contributions, exit options and methodology, dispute resolution framework etc, is of great utility when there are multiple founders. This exercise is useful in two ways – one, it creates a clear charter for the roles, responsibilities and expectations with regard to the Startup's overall operation. Two, it forces the co-founders to think deeply about issues they may not have already considered and come to a collaborative understanding on these.
• Scrutinizing any previous agreements or engagements which the founders may have, to identify any conflicts of interest or any non-disclosure obligations, may be a useful exercise at this stage.
• Shareholding or Stockholders' Agreement: A simple and straightforward stockholder's agreement (SHA) is considered a best practice, often a non-negotiable one, to avoid any problems over the shares held by each founder in the entity. An SHA typically sets out the shareholding pattern, rules regarding purchase of additional shares or increase of individual shares, consent from other shareholders for various activities, provides rights of pre-emption in case of potential transfers, and sets out the process of dispute resolution.
• Decision-Authority Matrix: Recent corporate governance failures have shown the disastrous effects of board overreach and poor internal governance frameworks. To ensure clarity, accountability and efficient workflow, it is prudent to establish a document that clarifies who in the organisation can make specific organisational decisions. A document such as this would also need to provide the levels of authority, the internal checks required to be undertaken, and guidelines to follow in high-value, strategic or pivotal decisions.
• Roles & Responsibilities Charter: A well-defined charter, where the role played by each founder or the management is specified and boundaries well demarcated, can prevent confusion, streamline operations and reduce potential disputes within the Startup. This can be vital to set the correct culture and systems in the Startup from its inception.
• Intellectual Property Protection: It is suggested that, as soon as practical after incorporation, applications for registration of all patents, trademarks, copyrights, and designs be made. This protects the Startup's innovation, the brand and allows brand building within a protected brand name, enhances its value to investments, prevents infringement, and can create a competitive advantage.

Post Formation Check-List

Once the Startup is registered and functioning, it is both necessary and wise to take certain measures to ensure smooth functioning.

• Ready Employment Agreements with Non-Disclosure Clauses: These agreements should be tightly drafted and should be comprehensive to cover all the facets of employment by the startup, including the areas which can be governed after an employee has left the employ (e.g., Non-Disclosure clauses)

• Periodic Accounting: The Startup should comply with the laws governing the Accounting of its finances and periodically file all the returns, through appropriate professionals. The cost of non-compliance with procedural obligations may appear quiet but its impact can be disproportionately significant on the business.

• Regulatory Compliance: Similarly, a well-run Startup must be adept with its compliance, including intimations of any changes, whether in the constitution of the startup, amendments in the address, changes in the nature of the business, etc. These appear mundane, but the penalties of non-compliance can have disastrous consequences on the business.

While startups have been given various benefits and advantages, the purpose of any business entity is to build and grow commercially, and not to get caught in internal corporate dispute resolution, governance issues or compliance filings. By adopting some proactive steps right from inception, a Startup can start with the right foot forward, as the proverbial English saying goes. These proactive steps could help founders safeguard their operations, reduce risk and create a space to focus on what truly matters – running the business safely and to its commercial best advantage.