In this article, Varsha Balasubramanian pursuing Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata, discusses how to close down a start-up legally.
What is a start-up?
A start-up company (or start-up) is an entrepreneurial venture which is typically a newly emerged, fast-growing business that aims to meet a marketplace need by developing or offering an innovative product, process or service. A start-up is usually a company such as a small business, a partnership or an organization designed to rapidly develop scalable business model. Often, start-up companies deploy technologies, such as Internet, e-commerce, computers, telecommunications, or robotics. These companies are generally involved in the design and implementation of the innovative processes of the development, validation and research for target markets. While start-ups do not all operate in technology realms, the term became internationally widespread during the dot-com bubble in the late 1990s, when a great number of Internet-based companies were founded.[1]
The exact definition of “start-up” is widely debated. However, at their core, most definitions of a start-up company are similar to this one “business that is typically technology oriented and has high growth potential”.[2] The reference to “growth potential” may mean growth in revenues, number of employees, or both or to the scaling up of a business to offer its goods or services to a wider or larger market. Another popular definition defines a start-up as an “organization formed to search for a repeatable and scalable business model.”[3] In this case “search” is intended to differentiate established late-stage start-ups from traditional small businesses, such as a restaurant opening up in a mature market. The latter implements a well-known existing business strategy whereas a start-up explores an unknown or innovative business model in order to disrupt existing markets, as in the case of the online merchant Amazon, the “app“-based ride service Uber or the search engine Google, each of which pioneered the development of their respective market categories. Blank and Dorf add that start-ups are not smaller versions of larger companies: a start-up is a temporary organization designed to search for a product/market fit and a business model, while in contrast, a large company is a permanent organization that has already achieved a product/market fit and is designed to execute a well-defined, fully validated, well-tested, proven, verified, stable, clear, unambiguous, repeatable and scalable business model. Blank and Dorf further say that a start-up essentially goes from failure to failure in an effort to learn from each failure and discover what does not work in the process of searching for a repeatable, high growth business model. Yet another view is that[4] “a start-up is a company designed to grow fast. Being newly founded does not in itself make a company a start-up. Nor is it necessary for a start-up to work on technology, or take venture funding, or have some sort of “exit“. The only essential thing is growth. Everything else we associate with start-ups follows from growth.” Graham added that an entrepreneur starting a start-up is committing to solve a harder type of problem than ordinary businesses do. “You’re committing to search for one of the rare ideas that generate rapid growth.” The value of a start-up firm[5] “rests entirely on its future growth potential.” His definition emphasizes the stage of development rather than the structure of the company or its respective industry. Consequently, he attributes certain characteristics to a start-up which include, but are not limited to, its lack of history and past financial statements, its dependency on private equity, and its statistically small rate of survival.
Why close down start-ups?
As seen from the above, start-up entities are essentially working on a radically new concept, idea or business model, which can have a huge growth potential as an upside or might end up completely unfit to the market.
Thus, it is only expected that there is a significant possibility for the start up to also fail and have no future. This would require that the legal entity of the start up needs to be shut down to complete the formalities.
Steps involved in closure of a start-up
Step 1 – Decide whether the start up really needs closure or not.
A clear evaluation is required to determine whether the start-up idea has really no future and hence the entity requires to be closed. The decision may also require internal discussion amongst the co-founders (such as partners or shareholders).
It would also be pertinent to ensure that the decision is documented in a legal form as may be required such as by way of a resolution of the partners in case of LLP or by way of a resolution of the members in case of a Company. In case of a sole proprietorship, this may not be a legal requirement. However, in other forms of business, this would be necessary from a legal documentation perspective also.
Step 2 – Tax clearances to be obtained
It is also a legal requirement to ensure that the income tax clearances are obtained for the assessment years that have gone by and also ensure that payment of indirect taxes, as well as the various returns to be filed, have been completed and assessments for the years the business has been in operation are completed or will not lead to non compliances. Where required, the entity may obtain appropriate expert advice also. Where refunds are to be received or there are unutilised credits, evaluate these and take professional advice ahere required to determine the course of action before closure of the entity.
Step 3 – Surrender or cancel licences, approvals etc.,
The startup may have obtained various licences, approvals etc., for operating the business. All these need to be evalauted on a case to case basis to determine if any of these require specific intimation/declaration to the authorities concerned that such licences / apporvals are being surrenderred or are to be cancelled in view of the closure of business. It would be in good order to intimate all the authorities from whom such licences/approvals were obtained irrespective of whether there is a specific provision in the related regulation. It would also become important in cases such as registration with RBI for foreign investment, Import Export Code etc., also with regard to registration with ESIC, PF authorities. In case of company having unfinished export obligations related to its imports, these may have to be dealt with and settled with the department/authority concerned before closure of the business. Further, many such authorities also require that compliances are completed for the period of operations, such as for instance, filing of utilisation of advance licenses and clearances obtained from DGFT.
Step 4 – Settle employees and complete labour law compliances
Closure of business would require that the employees be settled for their pay and also benefits which may have to be paid in view of the closure of business. End of service benefits such as leave encashment and gratuity may become payable. Further, it is also possible that there may be a legal requirement to pay retrenchment compensation to the employees if so applicable under the relevant regulations. Returns which are to be filed under various labour regulations should be completed before the closure of the business.
Step 5 – Settle dues to creditors and lenders
All dues to creditors and lenders to be identified negotiated and settled. Where the entity does not have adequate resources to settle the creditors and lenders in full, it may be necessary to go through the Insolvency and Bankruptcy Code where applicable. Where private arrangements are made with the creditors and lenders, then there must be clear waivers from the parties concerned to accept amounts which are lower than the amounts owed actually. Any tax implication arising therefrom needs to be also considered and addressed.
Step 6 – Accounts to be closed
The company should then proceed to close the accounts and if it has surplus, take steps to distribute the same amongst the co-founders with appropriate resolutins for the same being recorded. The company should also take steps to close the bank account it has, after having dealt with all the payments and receipts.
A closure balance sheet / statement of affairs may also be required to be drawn up, which may reflect only accumulated profits / losses and dues to co-founders including capital contributions, if the regulation under which the entity was formed so requires.
Step 7 – File for closure of the legal entity such as LLP / Company
Thereafter, the entity will have to take steps with the authority under which it was registered to get its name deactivated or struck off. For this purpose, in case of LLP or a company, the required processes with the Registrar of Companies are to be undertaken.
In case of the entity being an LLP, voluntary winding up would require:
- Resolutions being passed for winding up by the partners
- Obtain approval of the lenders (secured or unsecured) if any
- Affidavits from the partners for winding up of the LLP
- Appointment of an LLP liquidator for settlement of the assets and liabilities. He will perform or direct many of the actions mentioned in the earlier steps.
- LLP Liquidator to file a report of liquidation, which needs to be approved by the partners
- Filing for dissolution of the LLP
In case of a Company
- Voluntary winding up process is available which is by and large similar to the process detailed for the LLP
- Alternatively, there is an option to under section 248 (2) for the company to approach for having its name struck off from the register of companies. The steps involved for the same are:
- The company must extingusih all its liabilities
- Prepare a statement of affairs (Balance Sheet) of the company after such settlement of liabilites
- Obtain approval of the members (by special resolution with 3/4ths majority) for closure of the company
- File with Registrar of Companies for removal of name enclosing various documents
- Provide NOC from appropriate authority which regulates the business in which the company was operating
- Once the submission is accepted, publish in the newspaper (one english and one vernacular paper)
- The ROC will intimate the various authorities (such as income tax, central excise etc.,) to seek any objections within 30 days
- Once the ROC is satisifed that there are no objections received to the move, will approve and process the removal of name from the register of comapnies
Step 8 – Retain records as may be required
Though the entity is closed in this process, the co-founders should make a conscious plan to retain critical and relevant records of the entity and its closure in a manner which is retrievable for use in case of any future query/requirement in this regard.
References
[1]https://en.wikipedia.org/wiki/Startup_company
[2] U.S. Small Business Administration
[3]Entrepreneur-mentor Steve Blank and Bob Dorf
