Common mistakes made by Startups-Legal & Compliances

It is not a piece of cake to set up a startup. It needs quite a bit of effort and resources to create a successful business idea and commence its operation.?

Many tasks need determination and focus to launch a certain product in the market, safe and sound. There are several actions required to consideration before Startup a reality. The founders generally disregard the legal and compliance requirements of their startup during their initial stage. Due to this, the founders fail in?creating a firm and legal foundation for their startup.

These legal mistakes can prove to be lethal to the company (and your fortune) in many serious lawsuits. Due to the ignorance of founders, meeting the legal standards can cease the startup from being financially sound & viable to accelerate the business.

Some of the most legal mistakes committed by the startups are:?

1.??????Choosing the right Business Entity to launch your business?

Picking the perfect entity plays quite a deep role in creating your startup legally reliable while launching a new business. There are multiple structures available to pick from sole proprietorship, partnership firm, LLP, Private Limited Company, Public Limited Company, etc. The startup owners that rush directly into the registration process without researching much about the right option can regret later particularly when you want to bring partner or bring investors to finance your idea. Some of the most important rules that a rookie founder must establish while making a decision are liability, growth plans, tax treatment, and legal expenses. (Separate article is available by this author)

2.??????Founders’?Agreement?

Change is the only constant in this world. Startup founders tend to work in a constantly changing environment. Hence, it is necessary to develop implantable founders’ agreement to avoid any issues or waste any time. A properly drafted Founders’ Agreement highlights the major roles of a co-founder that minimizes the probability of conflicts in the future. Some of the most important clauses to be reflected in the Founders’ Agreement are decision-making authority, intellectual property rights, remuneration, exit clauses, operational responsibilities, and mechanisation to sort out differences via a Reconciliation process, capital contribution, authority levels and equity breakdown. Remember to sign this agreement on a stamp paper required in respective state, which is mostly through e stamping.

3.??????Protection of Intellectual Property?(IPRs)

The highly valuable for a startup is intellectual property. Infringement has become quite easier due to the large expansion of technological adoption. Whether it is the domain name, company name, or even the product, infringement has become way easier than it was before. Safeguarding their IP, startups can secure their ideas and stand in the big leagues against large players in the industry once they patent their invention. If a startup is unpatented, industrial giants can copy or plagiarize their invention to progress to the top in the market.

4.??????Non-compliance with Security Laws

One of the most commonly committed legal mistakes by the startup founders is their non-compliance with the security laws. Angel investors generally help startups in raising money. Friends or family can also do that without having any concerns about security laws. Disclosure is needed to comply with the applicable security laws. Serious consequences such as huge financial penalties for the startup founders can befall the company if the stocks are issued without complying with the law.

5.??????Not getting Accounts audited by Auditor (CA)

Many Startup Companies fail to get their accounts audited. There are also issues as regards maintenance of accounts, records, registers which they ignore.

6.??????Not preparing Accounts accurate & timely

Many Startup Companies do not give sufficient attention to this aspect of compliance and just focus on Bank Balance. For this it’s suggested that they buy licence of popular software like Tally and assign regular accounting to an accountant. Cost of Package would be Rs.50,000/- and Accountant may cost Rs.3,000 monthly for only 1 day accounting work in a week. Accountant has to activate all major modules like Payroll, GST, TDS, MIS, Fixed Asset Register and Account & Group heads in Financial Accounts so that Founders & Investors receive regular MIS and Company is able to share data with Auditor & Tax Consultant for compliances.

7.??????Company Law Compliances

Most Startups are registered as Limited Company under Companies Act, 2013. But there are many compliances required like maintaining registers, passing resolutions, filing (uploading) many of these resolutions & returns on MCA website, obtaining Certificates from CSs, getting accounts audited, filing tax returns, uploading Annual returns on MCA website.

8.??????Not taking Tax Issues seriously?

To operate securely and safely, every business owner needs to pay different kinds of taxes. Without any kind of professional help, the founders might find themselves have to pay hefty fines and penalties. Factors such as take registration, deduct & pay TDS (Withholding Taxes), charge, recover & pay GST, tax consideration with the option of stock options, pay entity level taxes, apply for tax incentives and file regular returns, etc. based on the nature of the business that impact the company. Hence, startups must talk to their CAs to make sure that all the tax-related matters are complied with timely and completely & regulations are being obeyed continuously.

9.??????Not hiring a Professional Legal Counsel

Founders make every effort to cut down the expenses as startups run on a low budget during their early stage. As a result, they choose inexperienced legal counsel or accept the opinions of their friends or family. Although, this can lead to even more legal issues as there have been cases of many inaccurately drafted documents and mistakes are made based on their lack of experience and understanding. Some founders believe to do everything by themselves and draft all the legal processes on their own. To avoid all of this, founders should hire professional as well as experienced legal counsel to tackle any penalties or risks of shutting down the business completely. Legal counsel’s help should be taken for drafting any commercial contracts involving financial commitments from either side. Ensure that standard clauses like exit clause, force majeure, dispute resolution, jurisdiction of court etc. are incorporated in any agreement.

10.??Not taking required Licences and Permits?

Without obtaining required legal licenses or permits, there isn’t any business that can move smoothly. There are different kinds of permits that are based on the nature of the business and contain industry-centric permits, GST, Income Tax, PAN, TAN, Municipal registration like Shops & Establishment, taking permission from Society or Resident Association including Municipal permission to operate office from home. There are hefty fines needed to be paid if there is any kind of non-compliance in gaining licenses and permits. If the founder consults a professional legal consultant from an early stage, legal pitfalls can be avoided quickly.

11.??Labour Law compliances such as registration, maintaining registers and pay minimum wages, take their accident & medical insurance once Startup Company crosses norm of minimum employees (which in most cases is 20 employees). Plan to follow provisions as regards, leave (casual, sick & privilege), bonus, , payment of salaries on or before due dates, pay salaries by bank transfer, hiring of temps etc.

12.??Drafting Employment Agreements

Company should have well drafted Employment Contract while employing employee which should safe guard compliances with Labour code and Company’s interest. While checking out employee for indiscipline or any violating, follow the process laid down in Labour Code and deal with these cases. Contact should include conflict of interest, Non-disclosure, notice period, not joining competitor for certain grace period etc.

1.??????Financing a Business

Another issue with newbies is how they finance their startup company. Although crowd-funding has been quite popular these days, what is better is that start-up enterprises should only get funded by accredited investors. Such accredited investors are those who at least have million dollars net worth. You might land in trouble by issuing stock and taking money from non-accredited financiers. You should be careful about engaging unregistered brokers and dealers and allowing them to raise money as it is not legal and may lead to major complications for enterprises down the road. So be extra careful while raising investment capital to ensure you raise money from the person who works with accredited investors. You should either raise money on your own or only with an authorized broker-dealers.

Conclusion

Above-listed are the most common legal & compliance related mistakes that most enterprises commit while starting up. It is, therefore, suggested not to overlook the legal & compliances while starting your venture for its long-term and successful innings and avoid fines & penalties, which most Investors don’t like.

CA Harshad Shah, Mumbai ([email protected])