Student's pen: BASICS OF STARTUP COMPANIES AND LEGAL REQUIREMENTS AROUND

INTRODUCTION

A start up is an innovative company that seeks to disrupt established methods of thinking and doing business across whole industries by either creating new categories of goods and services or improving the shortcomings of already existing ones. For this reason, a lot of companies are referred to as “disruptors” in their respective fields.

In order to develop into a successful organization, a startup must overcome a variety of obstacles. The startup must consider the legal and regulatory landscape as well as the rules of the country in which it intends to establish itself, in addition to devising the best possible business plan. Many times, setting up a startup correctly can assist in avoiding problems down the road and reduce tax and regulatory concerns when the company is getting closer to maturity.

A startup must establish its offices after incorporating. Many problems arise from this process that entrepreneurs might not even be aware of. For example, the business will have to register with several labour authorities and create policies relating to human resources (HR) that comply with applicable labour regulations. Furthermore, being recognized as a “Software Technology Park” could be advantageous for an IT start up. Manufacturing facilities must abide by rules pertaining to indirect taxes, such as value-added tax and excise duty. A company must comprehend the numerous contracts it will sign with suppliers, clients, partners, service providers, and many other parties once it starts operating. A startup will also find itself positioned in different supply chains. To prevent future issues, the startup will need to make sure that its suppliers are able to perform their obligations and will need to make sure that all of the contracts it signs with its clients are in standard form. Above all, a firm that wants to safeguard its intellectual property should consider signing a non-disclosure agreement to make sure that the information it gives to its many vendors, clients, contractors, and other parties isn’t misused.

After passing the VC investment’s acid test, a firm can typically aim to secure a Series A growth investment from a private equity fund, then a Series B pre-IPO and, if required, a mezzanine investment to boost its valuation in preparation for the IPO procedure. Startup investors usually want to get out through a buyout or an IPO. They often receive a large return on investment from both options, and the promoters receive their liquidity event.

HISTORY AND EVOLUTION OF START UP

A startup is an endeavor or business that is founded with the goal of solving problems that have never been solved before or improving upon those that have already been solved.
The term startup is frequently associated with Silicon Valley, the American region that gave origin to numerous successful firms, including Facebook, Google, and others. But these days, things are shifting drastically on a global scale. These days, startups can even be found in Bangalore, India, and Shanghai, China. In fact, India is directly behind the United States and the United Kingdom on the global list of nations with the largest start up ecosystems, and it appears that this expansion will never end. In the year 2019, our nation saw the addition of over 1300 new firms; the number of tech startups reached approximately 8900–9300.
The ability to transact business has always been ingrained in Indian culture. It’s also something that our history texts demonstrate. Nonetheless, there have been historical turning points that have significantly aided in the growth of startups.

Thus, if we attempt to draw out a rough chronology of the actual beginning of this rise, we may probably conclude that the 1980s marked a significant turning point. Then-prime minister Rajiv Gandhi instituted the liberalization of the computer industry at this time, and N.A.S.S.C.O.M. was also adopted in the 1980s. The Indian digital industry grew as a result of this.
The year 2008, which came after the Great Recession, is another important point to note. Numerous economies collapsed as a result, and businesses everywhere began laying off workers. Every employee in the globe was always afraid of losing their jobs.

This has a significant effect on Indian IT professionals. A lot of people began searching for better options, and a lot of people who lost their employment made the decision to move toward starting their own businesses. It was during this time that some well-known Indian businesses, including PolicyBazaar and Zomato, were established. For Indian startups, there has been no stopping since then. Its growth rate has remained high.

REASONS FOR GROWTH OF START UP

[The startup growth in India was something that was gradual in nature, and there are quite a few reasons why India became such a sustainable environment for startups to thrive in. Some of the major reasons are:

• The pool of Talent — Our country has a pool of talent. India has a population that has a majority of the younger generation. This shows the amount of potential that our country has in terms of talent. There are millions of students graduating from colleges and b-schools every day. Many of these students use their knowledge and skills to begin their own ventures, and that has contributed to the startup growth in India. In the past, much of this talent was attracted to only the big companies, but now that is slowly changing.
• The cost of setting up businesses is low — India is a labor-intensive country rather than being capital intensive. Also, the labour here can be hired at very cheap rates. So, compared to some other countries, the cost of setting up a business here is comparatively low. In fact, this is the reason why many multinational corporations as well, decide to set up their plants and offices in India. This is one factor that was really capitalised by the startup owners as well.
• Government Boost — This past decade has seen a massive startup growth in India and one of the reasons for this could be attributed to the various schemes launched by the Government. Some of the major schemes that were introduced to boost entrepreneurship were StartUp India and StandUp India. The Government also tries to encourage ventures in new sectors or in certain rural areas by providing subsidies to them.
• Increasing use of the Internet — India has the world’s second-highest population, and after the introduction of affordable telecom services like Reliance Jio, the usage of internet has really increased. It has even penetrated to the rural areas now. India has the second-largest internet user base after China, and companies and startups can really leverage on this easy access to the internet. Not only can it be used to spread the message about a new business, but it can also be used to gather new information as well. So, communication has become much easier. This is also one of the major reasons for the startup growth in India.
• The advent of Technology — The evolution of startups in India has also been due to the advent of technology. This has led to businesses growing by leaps and bounds. Technology has made the various processes of business very quick, simple and efficient. There have been major developments in software and hardware systems due to which data storage and recording has become a very easy task. Now because of the trend around artificial intelligence and black-chain, many new startups are considering these options as well.
• Variety of funding options available — Earlier there were only some very traditional methods available for acquiring funds for a new business model, which included borrowing from the bank or borrowing from family and friends. However, this concept has now changed. There are numerous options and opportunities available. Startup owners can approach angel investors, venture capitalists, seed funding, etc. This availability of options and easy accessibility has also contributed to the growth of the startup ecosystem in India.][1]

ORGANISATIONAL STRUCTURE OF A START UP

Managers, executives, and team members are arranged in a startup firm structure. A successful tech startup team structure lays out each member’s duties and responsibilities in detail, along with the ways in which each team will work together. Depending on the particular requirements of their firm, startups can choose from a variety of organizational structure types. The organizational structure of a company will change as it expands, hires more staff, and secures further finance. Making an organizational structure chart that explains each team member’s and leader’s place within the larger hierarchy is essential to developing and executing a successful team structure.

A firm’s ability to function effectively depends on its organizational structure, which gives teams a clear grasp of their roles and duties within the company. In the absence of an organizational structure, employees may have ambiguous expectations or a confusing administrative hierarchy, and firms spend time on delayed decision-making.

In summary, creating an organizational structure for your firm has a number of advantages:

• Streamlined methods of conducting business
• Quicker decision-making
• Simplified assessments of performance
• A rise in output

Types of Startup Organizational Structures

[There are seven common types of startup organizational structures — some more popular than others. The type of startup organizational structure you choose for your company will largely depend on the type of business you’re running, the stage you’re at, and the number of team members your startup has.

Flat Structure

A flat company structure or horizontal structure essentially means there’s no hierarchy or tiers of middle management between the employees and executives or leaders of the company. This decentralized structure grants employees equal power and relies on staff members to hold themselves accountable to meet company goals.

Hierarchical Structure

The hierarchical structure is the most common organizational structure. It features a board of directors as the company’s guide and one primary leader, such as a chief executive officer (CEO), at the top of the hierarchical pyramid with the rest of the management tiers and staff below.

Functional Structure

A functional structure is similar to a hierarchical structure but rather than the startup team structure being rooted in hierarchy, it is organized by skill level and expertise into multiple teams. This is another one of the most common organizational structures.

Matrix Structure

A matrix structure requires staff members to report to more than one leader, such as a project manager and a department head. This allows team members to move seamlessly between departments as their skills are needed. This structure is similar in many ways to the hierarchical structure, but it allows management to call on talent with greater flexibility.

Team-Based Structure

A team-based structure places the power in the employees’ hands, grouping staff into teams that work cooperatively to operate the business. This allows department heads to leverage the skills of team members in several departments, providing managers with a higher level of flexibility and prioritizing experience over tenure.

Divisional Structure

Similar to a team-based structure, the divisional structure divides employees into divisions. But, each division operates independently and sometimes implements its own internal hierarchies. This structure more often occurs in large corporations or enterprises that can allow product lines or brands within the company to operate with autonomy.

Network Structure

Rather than operating as a traditional structure with a hierarchy in place, a network structure is commonly used by large corporations with globally distributed teams that often work with freelancers and contractors. This structure organizes staff by location rather than team alone, and it provides clarity on the roles and responsibilities of each team by location.][2]

STRUCTURING
The founders and promoters of startups typically establish their businesses based only on the area in which they are located, disregarding other relevant factors. The following are important considerations when choosing a site for a startup:

I. The company’s location
Where the startup plans to conduct business is one of the more crucial factors. A local customer-focused company should preferably be located near to the location of its intended business. On the other hand, if a startup wants to operate internationally (for instance, by releasing a service or application that it hopes will be used outside of India as well), it must make sure that its setup is properly structured.

II. The founders and management group are present
The existence of the management staff is the other important factor. A startup in the US might find it less economical to have a management staff that works primarily out of India.

III. Business ease of operation
A startup’s location should also take into account the convenience and speed of registering intellectual property, the ability to obtain the necessary licenses to establish a firm, and the pursuit of licenses to conduct specific types of business.

IV. Tax and regulatory aspects
It is imperative to analyze and verify that the company complies with all relevant regulatory requirements.

INCORPORATION

The startup can choose to incorporate as a partnership or as a company if its goal is to launch operations in India. Startups prefer to incorporate in India because of the limitations on foreign direct investment in partnerships. The business might be formed as a public or private entity, based on the kind of investment it wants to make as well as the size and scope of its activities. Nonetheless, the majority of startups choose to launch as private entities since they provide significantly more corporate freedom to the business and typically have lower initial capital requirements.
Additionally, a private corporation is less complicated to set up and a more straightforward means of directing foreign investments. Additionally, a private corporation is quicker to set up and a more straightforward means of directing foreign investments (through tax-effective jurisdictions). Stricter rules, compliance standards, and listing requirements apply to companies that are publicly traded. Furthermore, converting a private business into a public one at a later time is simple. In addition, the business must adhere to the below-mentioned filing requirements with the Registrar of Companies in conjunction with its incorporation.

I. Governing Act

The corporations Act, 1956 served as the controlling legislation up until recently, dictating the behaviour of corporations that were registered in India. But as of April 1, 2014, the Companies Act, 1956 has been superseded by the Companies Act, 2013 (the “Act”). While the majority of the Companies Act, 2013’s provisions are already in effect, the Companies Act, 1956’s provisions continue to govern some acts, such as mergers and amalgamations. The nodal authority for company registration in each state is the Registrar of Companies (“RoC”).

II. Types of Companies

A variety of companies may be incorporated under the Act. In general, a firm can be either privately held, publicly traded, or owned by one individual. These businesses can be limited companies or limitless companies. A “limited company” is defined by the Act as a business that is limited by shares or a guarantee. Generally speaking, Indian firms are limited by shares and can be incorporated as either private or public entities.

A minimum of two individuals may register a private business as shareholders and two directors, one of whom must be a resident director who spent at least eighteen days in India during the preceding calendar year. Furthermore, a private corporation must have at least INR 100,000 (about US$ 1,600) in minimum paid-up share capital. A private business has the following characteristics:

III. Public Company

Public corporations must have three directors and at least seven shareholders, one of whom must be a resident director who spent at least eighteen days in India during the preceding calendar year. For public enterprises, there is no upper restriction on the number of stockholders. Nonetheless, the paid-up share capital of public corporations must not be less than INR 500,000 (about US$ 7,900). A publicly traded company’s shares are freely transferable.

IV. Charter Documents of Company

1. Memorandum of Association: The primary goals for which the company is incorporated are outlined in the Memorandum of Association (“Memorandum”), which serves as the organization’s charter. The company’s name, the state in which its registered office will be located, its primary goals upon incorporation, any secondary goals that may arise in the process of achieving those primary goals, member liability, and the authorized capital are all specified in the Memorandum.
2. Articles of Association: The firm’s bylaws, rules, and regulations for managing the business are contained in the Articles of Association (“Articles”) of the company. Any rule that conflicts with the Act’s or the Memorandum’s provisions should not be included in the Articles. Both the Company and its members must abide by the Articles.

PRE INCORPORATION PROCESS

The following are the main steps in incorporating a company:

• With the launch of online filing on the Ministry of Corporate Affairs’ official website (MCA21), papers requiring a digital signature must be filed online for both business incorporation and subsequently filed. In this regard, obtaining the Digital Signature Certificate (DSC) for each and every prospective director, as well as the Director Identification Number (DIN) for the proposed directors, is a prerequisite before forming a business.
• The procedure of getting the desired name approved is the next step in the incorporation process. The names of proposed directors, the primary objectives, and the six chosen names for the new company, arranged in order of preference, must all be included in the mandated form for name approval that must be submitted online via the MCA 21 portal. There are a few requirements attached to this permission. For example, the identical name shouldn’t be used by another organization already in operation. In addition, the final words of the name must be “Limited” for a public company and “Private Limited” for a private company. Furthermore, several of the company’s important phrases, such “India,” “Enterprise,” etc., call for a higher authorized capital.
• Following approval of the name, the prospective company’s Memorandum and Articles of Association must be filed online via the MCA21 portal together with other necessary forms. Following that, these documents must be submitted with the relevant RoC. Following the RoC’s approval of the paperwork, the Certificate of Incorporation will be granted. A firm must file a certain declaration after obtaining a certificate of incorporation before it can open for business.

POST INCORPORATION PROCESS

IMPORTANCE OF DOCUMENTATION

1. Confidentiality & Non- Disclosure Agreement- In a non-disclosure agreement (or “NDA”), two parties agree that one will provide the other access to secret information about the other’s business or products, and that the other party will keep the information confidential for a predetermined amount of time. Important NDA clauses include the following:

Ø The definition and exclusions of “confidential information

Ø any applicable term for maintaining the information’s confidentiality.

Ø The following are some of the provisions pertaining to obligations regarding the use and disclosure of confidential information

Ø using the information only for authorized purposes

Ø disclosing it to those who are deemed to “need to know

Ø adhering to a standard of care regarding the information

Ø making sure that anyone to whom the information is disclosed also abides by the recipient’s obligations.

1. Offer Letter/ Employment Agreements- Offer letters are typically sent by firms to new hires in India at the time of employment. The terms and conditions of employment, including the probationary period, compensation, and other documents that must be presented at the time of joining, are briefly described in this document. Employers should execute employment contracts for each of their employees in addition to the offer letters, even though many choose to stop at this point. It is crucial to make sure that all relevant employment regulations are followed while creating the offer letter, employment agreements, and terms and conditions of employment. While there isn’t a set structure for an employment contract, some crucial terms found in these agreements are:

• Term of employment and termination of employment
• Structure of compensation: salary and bonuses;
• Employee obligations and responsibilities;
• Non-disclosure and confidentiality;
• Intellectual property and assignment, non-compete and non-solicitation agreements, and dispute settlement are all covered.

1. Non-Competition & Non- Solicitation Agreements

Employers and their staff have the option to sign non-solicitation and non-competition agreements. Alternatively, the employment agreement can contain these responsibilities. Non-compete agreements that are in effect during an employee’s employment are usually enforceable in India; but, post-termination agreements are not enforceable since they are considered to be in “restraint of trade or business” as defined by Section 27 of the Indian Contract Act, 1872 (“Contract Act”). Indian courts have repeatedly affirmed that a provision in a contract that limits an employee’s ability to look for work or to operate in the same industry after their employment has ended is void, unenforceable, and against public policy.

1. Intellectual Property Assignment Agreement — According to the Copyright Act, 1957 in India, an employer normally owns a copyright-able article created by an employee while they are working for their employer. Other types of intellectual property rights, however, still require formal assignment. To achieve this, an employee and employer typically sign a “confidentiality and invention assignment agreement,” which covers a number of topics including the following:

• the scope and extent of intellectual property sought to be covered
• a definition of the intellectual property included that includes defining proprietary information provided to the employee
• a covenant stating that all intellectual property developed by the employee during the course of employment should be adequately disclosed to the employer

1. HR Policy / Employee Handbook — In recent times the law has mandated that specific anti-sexual harassment policy be drafted in accordance with the Sexual Harassment of Women at Workplace (Prevention, Prohibition and Redressal) Act, 2013. The general provisions incorporated in an employee handbook include (but are not limited to):

• Employee benefits;
• Leave policies including paid leave, casual leave, sick leave, maternity leave etc;
• Compensation policies;
• Code of conduct and behavior policies;
• Anti- discrimination and sexual harassment policies;
• Immigration law policies;
• Complaint procedures and resolution of internal disputes;
• Internet, email and computer use policies;
• Conflict of interest policy;
• Anti-drugs, smoking and alcohol policy;
• Accident and emergency policies;
• Travel and expense policy;
• Prohibition from insider trading

1. ESOP — Plans for employee stock options, or “ESOPs,” are intended to grant employees equity in their employers’ businesses. They could be awarded immediately upon joining the company or after a specific number of years of service. The business might use ESOPs as incentives to attract and keep top talent by providing stock options to prospective hires. This is a common tactic used by businesses who are unable to offer high salaries to draw in the proper kind of personnel.

The typical method for implementing ESOPs is through an ESOP plan document, which outlines the parameters of the program and how employees would be awarded ESOPs. A “grant letter,” which is a kind of quasi-agreement reached with the concerned employee, is attached to this.

1. Other Agreements

These would include agreements such as:

PUBLIC RELATIONS AND FINANCE

Public relations (PR) is the strategic use of communications to enlighten stakeholders about an organization and cultivate favourable perceptions about it. PR is an important growth channel for startups because it fosters trust, which is necessary for them to obtain funding, enter new markets, and outsmart more established rivals. Often, startup tech PR initiatives are similar to those of established companies. But the same results cannot be expected from a startup compared to companies that have been on the market for years. Therefore, they require variations in strategies and execution — a PR strategy for startups should have startup-specific objectives. For instance, it must address the needs and challenges of being a new company, starting with a short-term and long-term focus on generating brand awareness and becoming thought leaders. When an organization has no history, getting initial media placements is challenging.

However, starting with a blank slate can provide a unique opportunity to build a brand’s reputation from the ground up. Startups can do this by being clear about what they want their audience to know about them, how they will differentiate themselves from existing companies, and how they will add more value than their competitors. In this sense, a startup company has an advantage in navigating its PR strategy according to how they wish. In other words, you have full control of the narrative at this stage.[3]

The fundamentals of PR for startups are:

• Identify your core values and goals
• Develop an effective messaging strategy
• Create engaging content
• Leverage your social outlets
• Leverage your social outlets
• Pitch it to journalists and iterate

TYPES OF STARTUP FUNDING

Working Capital

Equity Financing

Debt Financing

Grants

Brief

Equity financing involves selling a portion of a company’s equity in return for capital.

Debt financing involves the borrowing of money and paying it back with interest.

A grant is an award, usually financial, given by an entity to a company to facilitate a goal or incentivize performance.

Nature

There is no component of repayment of the invested funds.

Invested Funds to be repaid within a stipulated time frame with interest

There is no component of repayment of the invested funds

Risk

Financer: There is no guarantee against his investment.
Startup: Startups need to give up a portion of their ownership to shareholders.

Financer: The lender has no control over the business’s operations.
Startup: You may need to provide a business asset as collateral.

Financer: There is a risk of the startup not meeting the goal or objective for which the grant has been provided.
Startup: There is a risk of the startup not receiving a portion of the grant due to several reasons.

Threshold of Commitment

While startups are under lesser pressure to adhere to a repayment timeline, investors are constantly trying to achieve growth targets

Startups need to constantly adhere to repayment timeline which results in more efforts to generate cash flows to meet interest repayments

Grants are distributed in different tranches w.r.t the fulfilment of the corresponding milestone. Thus, a status is constantly working to achieve the milestones laid down.

Return to Investor

Capital growth for investors

Interest payments

No Return

Involvement in Decisions

Equity Investors usually prefer to involve themselves in the decision-making process

Debt Fund has very less involvement in decision-making

No direct involvement in decision making

Sources

Angel Investors Self-financing Family and Friends Venture Capitalists Crowd Funding Incubators/Accelerators

Banks Non-Banking Financial Institutions Government Loan Schemes

Central Government State Governments Corporate Challenges Grant Programs of Private Entities

Asset Purchase

An asset purchase involves the sale of the whole or part of the assets of the target to the acquirer. The board of directors of a company cannot sell, lease or dispose all, substantially all, or any undertaking of the company without the approval of the shareholders in a shareholders meeting. Therefore, it would be necessary for at least 75% of the shareholders of the seller company to pass a resolution approving such a sale or disposal.

Takeover Code

The Securities and Exchange Board of India (the ‘SEBI’) is the nodal authority regulating entities that are listed on stock exchanges in India. The Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (the ‘Takeover Code’) restricts and regulates the acquisition of shares / control in listed companies.

CONCLUSION

In conclusion, understanding and adhering to legal requirements is paramount for startup companies aiming for success in India. The journey from inception to growth involves navigating a complex legal landscape that encompasses several critical aspects.

The introduction of this article sets the stage by emphasizing the importance of legal knowledge for startups. The historical overview and rise of startups in India illustrate a vibrant and dynamic entrepreneurial ecosystem bolstered by supportive government policies and a thriving market.

The legal framework in India, aimed at enhancing ease of doing business, has evolved significantly, making it more conducive for startups to thrive. Structuring and incorporation processes, though intricate, are fundamental in defining the legal identity and operational blueprint of a startup.

Both pre- and post-incorporation phases involve meticulous planning and adherence to legal protocols, ensuring that the business stands on solid ground from the very beginning. The importance of documentation cannot be overstated, as it serves as the backbone of legal compliance, safeguarding the company’s interests and facilitating smooth operations.

Additionally, effective public relations and sound financial practices are integral to a startup’s success, ensuring a positive market presence and robust economic health. By prioritizing these legal requirements, startups can not only avoid potential

REFERENCES

1. https://www.startupindia.gov.in/
2. The Ultimate Guide to Public Relations for Startups”, 3rd Oct, 2023, https://prlab.co/blog/the-ultimate-guide-to-public-relations-for-startups/
3. Understanding Startup Organizational Structure”, Michaela Dale, June 12TH, 2024, https://startupsavant.com/startup-leadership/understanding-startup-org-structure
4. https://www.investopedia.com/terms/s/startup.asp
5. https://www.forbes.com/advisor/business/what-is-a-startup/
6. “ Indian Startup Culture: Evolution and Startup Growth in India”, Vanshika Bagaria, 30 Sep 2020, https://insider.finology.in/startups-india/evolution-and-startup-growth-in-india
7. “Understanding Startup Organizational Structure”, Michaela Dale, June 12TH, 2024, https://startupsavant.com/startup-leadership/understanding-startup-org-structure