This article has  been written by Hemang Mohanlal Doshi pursuing a Personal Branding Program for Corporate Leaders from Skill Arbitrage.

This article has been edited and published by Shashwat Kaushik.

Introduction

Let’s begin by understanding what a startup means!!

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As per the DPIIT (Department of Promotion of Industry and Internal Trade), an entity shall be considered a start-up:

  • From the date of incorporation/registration of the entity, as a private limited company or partnership firm or limited liability partnership, up to a period of 10 years from its date of inception.
  • Annual turnover of the entity has not exceeded 100 crore rupees for any of the financial years since inception, up to a period of 10 years
  • The entity is a highly scalable business model that has potential to generate employment and wealth in the fields of innovation, product development or improvement of processes and services

Corporate governance in startups

Corporate governance in startups refers to the system of principles, practices, and processes by which a startup is directed, controlled, administered and governed. It encompasses the framework through which a startup’s founders, investors, and other stakeholders ensure that the company’s objectives are met while promoting transparency, accountability, and ethical decision-making processes to drive the sustainable growth and success of the startup. This includes defining the roles and responsibilities of key individuals, maintaining financial transparency, and adhering to legal and regulatory requirements. The aim is to foster confidence among stakeholders, attract investment, and nurture a culture of responsible business conduct within the dynamic and innovative environment of a startup.

Why do startups need corporate governance

The Economic Survey 2021–22 has reported that India is the third largest country in the world after the US and China to have 70,000 startups, and many of those have even become unicorns in the industry. However, with the increasing number of scams like BharatPe, toxic work environment and cyber crimes, there is a demand for strong corporate governance in Indian startups. Good corporate governance maintains a healthy balance between the interests of investors, promoters, employees and customers. The four pillars of corporate governance are transparency, accountability, Responsibility and honesty, which promote better control and administration in startups. Good corporate governance helps to solve the following top 10 challenges and issues faced by any startups.

  • Founder-driven decision making: This helps to balance the autonomy of founders and helps in structured decision-making.
  • Transparency: Always ensure open communication and transparency in financial reporting and decision processes.
  • Board composition: Helps to build a diverse and skilled board to provide strategic guidance.
  • Conflict of interest: Helps mitigate conflicts of interest among stakeholders, particularly founders and investors.
  • Compliance: Helps to adhere to legal and regulatory requirements to avoid legal pitfalls and revenue losses.
  • Succession planning: Help develop plans for leadership transition to ensure continuity.
  • Ethical practices: Helps promote ethical behaviour and responsible business practices.
  • Risk management: Helps identify and mitigate risks associated with the operations.
  • Shareholder rights: Helps to define and protect the rights of shareholders by implementing policies and shareholder agreements.
  • Innovation and adaptability: Helps to integrate governance practices that foster innovation and adaptability.

Indian government and startup initiatives

The Startup India scheme is an initiative by the Indian Government to promote startups to generate employment and wealth creation. This scheme aims to merge India as a job creator nation instead of job seekers. This scheme is managed by the Department for Industrial Policy and Promotion (DPIIT).

Following are the benefits provided to a startup under DPIIT.

  • Self certification: Easy self certification allows startups to self certify compliance with 6 labour laws and 3 environmental laws using simple online procedure. Startups will be classified as ‘white category’ for environmental laws and only random checks will be done for self certified companies.
  • Simplification and handholding: Simplified process for compliance, exit process for failed startups, legal support, fast-tracking of patent applications.
  • Funding & Incentives: Exemptions on Income Tax and Capital Gains Tax for Eligible Startups under 80 IAC and Section 56.
  • Incubation & Industry-Academia Partnerships: Grants of 20 lakhs and 50 lakhs are provided by Seed Funds for startups to showcase prototypes and commercialisation.

Following are the business type suitable for startups in India:-

 Sole proprietorshipPrivate   LimitedCompanyLimited Liability partnershipPartnershipFirm
RegistrationNo registration is mandated by law. Good   for        very small        scale start-ups,home-grown businesses led by a single person.Needs to beregistered underCompanies act, 2013.Needs to be registered under Limited Liability Partnership Act,2008Registration is Optional. But it is recommended to be done.
Legal StatusPromoter/owner personally responsible for all liabilities.Separate entity. Promoter is not responsible for the Liabilities of such acompany directly.Separate entity. Promoter is not responsible for the Liabilities of such a company directly.Promoter/owner personally responsible        for all liabilities.
TaxationTaxed as anindividual on the basis of the proprietor’s income.Private Limited Companyprofits are taxed as per the slabs provided underIncome Tax Act, 1961 plus surcharge and cess asapplicableLLP profits are taxed as per the slabs provided under Income Tax Act, 1961 plus surcharge and cess asapplicablePartnership profits are taxed as per the slabs provided underIncome Tax Act, 1961 plus surcharge and cess asapplicable
Foreign ownershipForeigners not allowed to own soleproprietorships in India.Under the Automatic route, FDI in Pvt Ltd is allowed without prior approval of RBI. (Subject to conditions, please check for the latest policy.)Foreigners can invest in LLP without prior approval of RBI. (Subject to conditions, please checkthe latest policy.)Foreigners not allowed to be part of partnerships.

Current status of corporate governance for startups in India

As of 2024, the startup ecosystem in India is witnessing an increased recognition of the importance of corporate governance. While many startups are making strides in implementing governance practices, challenges such as regulatory complexities and varying maturity levels persist. Investors are increasingly emphasising governance during funding rounds, signalling a positive shift towards a more disciplined approach.

With upcoming many challenges and issues, startups in India are facing the following top 10 risks and those risks can only be mitigated by implementing good corporate governance and management practices.

  • Founder resistance: Resistance to relinquishing control may hinder the implementation of effective governance.
  • Lack of resources: Startups may struggle with limited resources to establish and maintain governance practices.
  • Rapid growth challenges: Scaling quickly may lead to gaps and challenges in adapting to growth and implementing good governance.
  • Regulatory changes: Adverse changes in regulations may impact the startup’s governance structure and day to day operation.
  • Investor expectations: Managing different expectations of founders, customers and investors regarding governance practices.
  • Cybersecurity threats: Due to usage of the internet and advanced technology in operation, startups are exposed to cybersecurity risks.
  • Talent retention: Good policies and HR practices are necessary to survive in today’s market dynamics.
  • Financial instability: Startups need to have sufficient funds and share capital to support daily operation in a very uncertain and volatile market.
  • Global expansion: Expanding internationally introduces new governance challenges and hurdles in the roadmaps ahead.
  • Brand and good will: Poor corporate governance can damage the brand name and good will of a company in the long run.

Provisions and sections set up by the government of India for startups

In India,the Companies Act 2013 has laid down legislation for good corporate governance for startups.This legislation outlines several provisions and sections that startups need to adhere to for effective governance:

  • Section 149: Specifies the mandatory appointments of directors, also specifies the minimum number of directors and the inclusion of independent directors.
  • Section 177: Specifies need of an Audit Committee to oversee financial statement disclosures and compliance.
  • Section 188: Requires companies to monitor related party transactions, onboard approval and shareholder consent.
  • Section 203: Startups need to appoint KMP(key managerial personnel) such as CEO, CFO, Company Secretary and Managing Directors mandatorily.

Mandatory government compliance and regulations for startups in India

All startups in India have to adhere to and comply with one or more requirements from the Companies Act, 2013, a few obligations from the Income Tax Department, and mandates from both the Central Government and the ROC. These compliances help streamline the operations of a startup and ensure effective corporate governance.

Rules and regulations from the Companies Act 2013

The Companies Act 2013 lays down specific requirements for corporate governance in startups from a regulatory point of view.

  • Appointment of directors: Startups must appoint directors, ensuring a balance between executive, non-executive, and independent directors.
  • Audit committee: Startups must have an audit committee for financial reporting and compliance.
  • Board meetings: Startups must conduct regular board meetings to discuss strategy, performance, and risk management.
  • Disclosure and transparency: Startups must be transparent through accurate financial reporting and timely disclosure of all relevant information.
  • Related party transactions: As regulations often govern transactions between the startup and its related parties, such as founders or key management personnel, startups must maintain transparency and approval processes for such crucial transactions.
  • CSR committee: Startups must have a CSR committee and contribute funds as deemed necessary.

Rules and regulations from the Income Tax Department

The Income Tax Department has a few mandatory compliances that startups must follow. These stipulated requirements include the following:

  • Timely filing of returns: Startups must adhere to deadlines for filing income tax returns to maintain compliance.
  • Documented transactions: Startups must keep comprehensive documentation of financial transactions for tax assessment purposes.
  • Compliance with tax laws: Startups must comply with all tax laws as applicable to their operations.

Rules and regulations from the Central Government & ROC

The Registrar of Companies (ROC) and the Central Government have outlined a few mandatory compliances, as follows:

  • Annual return filing: Startups must submit annual returns and financial statements to the ROC within the stipulated time frame.
  • Compliance certificates: Startups must have all necessary compliance certificates and file necessary forms as required by the ROC.
  • Changes and modification filings:Changes in directorship or shareholding should be reported as part of compliance and regulations.

Structure of board of directors in a startup

The composition of the board is a critical element in startup governance and should have a good structure. Following are the key pointers on board composition.

  • Founder representation: Balance founder representation with independent directors to ensure diverse perspectives.
  • Skill diversity: Having a board with a mix of skills and experiences relevant to the startup’s industry.
  • Independent directors: Appointing independent directors to provide unbiased guidance and oversight.
  • Formations of committees: Independent directors should be part of committees like CSR, Audit, Remuneration and Nomination to improve governance.

Top startups scams in India due to poor corporate governance

Good corporate governance always gives a good flying start to many startups, Poor corporate governance results in scams and fraud, resulting in financial losses to creditors, investors and customers. It is therefore important for creditors, investors and customers to be aware of typical frauds and scams associated with startups. Following are a few scams reported in India due to a lack of good corporate governance.

  • Stayzilla Case (2017): CEO of this hotel booking startup was arrested for misleading and not paying vendor’s due. This is an example of poor governance and lack of responsibility.
  • AirAsia India Allegations (2018): AirAsia India manipulated government policies to get an international licence as per the CBI report. This raises concerns over the transparency and honesty of corporate governance.
  • Oyo Rooms Controversies (2019): Oyo faced allegations of predatory pricing, not following its own agreements, including threatening hotels, and raising questions about its corporate governance and honesty.
  • TinyOwl Closure (2015): TinyOwl faced controversy during its shutdown, with reports of employees being laid off to fulfil its cash crunch and remain profitable. This raised concerns again about corporate governance, accountability and responsibility.
  • QNet Multi-Level Marketing Scam (2013): QNet faced allegations of deceiving $5 million investors with promises of high returns through their marketing schemes. This raised concerns about corporate governance and transparency.
  • Reebok India Scam (2012): Reebok’s Indian subsidiary faced 870 crore scam due to mismanagement. This scam raised concerns about corporate governance and honesty.
  • Pearls Agrotech Ponzi Scheme (2016):This scam involved collecting money from investors in lieu of agricultural land.  This raised concerns about corporate governance and accountability.

Future status of corporate governance for startups in India

Since the Government of India has simplified the processes and regulations for encouraging startups to thrive and grow, the future of startups is promising as the need for good corporate governance is gaining importance. Greater emphasis is placed on transparency, ethical practices and accountability in corporate governance to gain the confidence and trust of investors, creditors and customers. With the increasing usage of AI and robotics, the future foresees many IT applications and systems as part of corporate governance. Also, the Company Act 2013, NCLT, independent director and rating agencies will play a vital role and see major amendments and changes.

Suggestion

It is acknowledged that various initiatives have already been  laid down by the Companies Act 2013, and the Central Government of India, following the recommendations, can help enhance the rules and regulations to protect and safeguard investors interest in startups.

  1. Recommendation for section: The Companies Act 2013 should undergo an amendment that mandates the inclusion of AI and robotics systems and applications within the governance framework of startups to foster stricter vigilance and whistleblowing as per the needs of the hour.
  2. Recommendation for section: An amendment to the Companies Act 2013 is suggested, focusing on a section that grants special powers, roles, and responsibilities to NCLT, independent directors, and rating agencies. All three bodies should be empowered to conduct random audits in suspicious situations. independent director roles should be broadened to include corporate social responsibility, audit, and nomination and remuneration committees.
  3. Recommendation for addition of Business Type: After the massive success of Google, Facebook & Instagram as startup technology companies, the Companies Act 2013 should be leveraged to have a C-Corp structure. This would help startups raise funds easily for the Science and Technology sector.

Regulatory framework for startups in India

The regulatory framework for startups in India has undergone significant evolution in recent years, with the government recognizing the crucial role that startups play in driving innovation, job creation, and economic growth. Here’s an elaborated and expanded version of the input text:

  1. Startup definition:
    A startup in India is defined as a privately held company that is less than 10 years old, with an annual turnover of less than INR 100 crores, and is working towards developing or commercializing a new product, service, or process.
  2. Startup recognition:
    The Department for Promotion of Industry and Internal Trade (DPIIT) grants official recognition to startups through its Startup India initiative. Recognized startups gain access to various benefits, including tax incentives, regulatory relaxations, and government support programs.
  3. Regulatory simplification:
    The government has introduced simplified regulations for startups, such as self-certification of compliance with labor laws and environment regulations. Startups are also exempted from certain compliance requirements, such as maintaining a minimum paid-up capital or having a physical office space.
  4. Startup funding:
    To encourage investment in startups, the government has established several funding initiatives, including the Startup India Seed Fund Scheme and the Fund of Funds for Startups (FFS). These schemes provide financial support to early-stage startups and venture capital funds.
  5. Tax incentives:
    Startups are eligible for a number of tax incentives, including a 100% tax holiday on profits for the first three consecutive financial years and a reduced corporate tax rate of 15% thereafter. Startups can also claim tax deductions for expenses incurred on research and development (R&D).
  6. Regulatory sandboxes:
    Regulatory sandboxes are experimental environments where startups can test new products, services, or business models in a controlled regulatory environment. This allows startups to innovate without the burden of excessive regulation.
  7. Startup intellectual property (IP) facilitation:
    To protect the intellectual property rights of startups, the government provides various IP-related support services, such as IP awareness workshops and fast-track IP registration. Startups can also access patent pools and technology transfer mechanisms.
  8. Startup incubators and accelerators:
    The government supports the establishment of startup incubators and accelerators, which provide startups with mentorship, training, networking opportunities, and access to funding. These incubators and accelerators play a crucial role in nurturing early-stage startups.
  9. Exit options:
    To provide exit options for startups, the government has simplified the process of winding up companies and introduced employee stock ownership plans (ESOPs) for startups. ESOPs allow startups to attract and retain talent by offering equity shares to employees.
  10. Government support programs:
    The government offers a range of support programs for startups, including mentorship programs, training programs, and access to government procurement opportunities. These programs aim to enhance the competitiveness and sustainability of startups.

The regulatory framework for startups in India is dynamic and evolving, with the government continuously introducing new initiatives and reforms to support the startup ecosystem. These efforts are aimed at creating a conducive environment for startups to thrive and contribute to India’s economic growth.

Provisions for startup in the Companies Act of 2013

The Companies Act of India aims to encourage and support the growth of startups in the country. It includes several provisions designed to provide a conducive environment for startups and address their unique challenges. Here are some key provisions related to startups in the Company Act:

  1. Simplified registration process:
    • The Act streamlines the registration process for startups by allowing them to incorporate as a company or limited liability partnership (LLP) in a simplified manner.
    • Startups can file their incorporation documents electronically and obtain approvals quickly.
  2. Exemptions from compliance requirements:
    • Certain compliance requirements under the Act are relaxed or exempted for startups.
    • For instance, startups are not required to appoint an independent director for the first three years of their operations. They also have greater flexibility in terms of board meetings and shareholder resolutions.
  3. Tax benefits:
    • Startups are eligible for a tax holiday for three consecutive assessment years out of the first ten years of operation.
    • They can also claim deductions on certain expenses and investments.
  4. Funding and investment:
    • The Act encourages investment in startups by allowing angel investors and venture capitalists to avail tax benefits.
    • It also facilitates access to funding through government schemes and venture capital funds.
  5. Dispute resolution:
    • The Act provides for a fast-track dispute resolution mechanism for startups.
    • Startups can approach the National Company Law Tribunal (NCLT) for speedy resolution of their disputes.
  6. Regulatory sandbox:
    • The Act introduces the concept of a regulatory sandbox, which allows startups to test their innovative products or services in a controlled environment.
    • This provision aims to promote experimentation and innovation in the startup ecosystem.
  7. Employee Stock Ownership Plans (ESOPs):
    • The Act simplifies the process for startups to issue ESOPs to their employees.
    • ESOPs can be used as an incentive to attract and retain talent in startups.

These provisions of the Company Act aim to create a supportive framework for startups in India. They are designed to address the unique challenges faced by startups and facilitate their growth and success. By leveraging these provisions, startups can navigate the legal and regulatory landscape more efficiently and focus on building innovative solutions to drive economic development.

The Government’s recent move to allow startups to self-certify compliance with 6 labour laws and 3 environmental laws is a significant step taken to ease the regulatory burden on young businesses. This move will significantly benefit Startups in the following ways:

  1. Reduced regulatory burden: Self-certification eliminates the need for Startups to obtain multiple approvals and licences from different government agencies, simplifying the compliance process.
  2. Time and cost savings: By self-certifying, Startups can save time and resources that would otherwise be spent on obtaining and renewing licences. This can help Startups focus on core business activities and innovation.
  3. Flexibility and agility: The 5-year period for self-certification provides Startups with the flexibility to adapt and grow without the immediate pressure of obtaining multiple regulatory approvals.
  4. Compliance assurance: Self-certification requires Startups to demonstrate compliance with applicable laws, ensuring a level of responsibility and accountability. This approach fosters a culture of compliance within the Startup ecosystem.
  5. Enhanced ease of doing business: The simplified compliance process helps improve the ease of doing business for Startups, making India a more attractive destination for investment and entrepreneurship.
  6. Promotion of startup growth: By reducing regulatory hurdles, the Government is encouraging Startups to focus on growth, job creation, and innovation, contributing to the overall economic development of the country.
  7. Encouragement of formalisation: Self-certification provides an incentive for informal Startups to formalise their operations, ensuring better access to resources and support from the Government and investors.
  8. Alignment with global best practices: This move aligns India with global best practices, where Startups are allowed to self-certify compliance to reduce regulatory burdens.
  9. Streamlined process: The online portal for self-certification simplifies the process and ensures transparency in regulatory compliance.
  10. Improved investor confidence: A streamlined compliance process can enhance investor confidence in Startups, attracting more investment and fostering a vibrant entrepreneurial ecosystem.

Overall, the government’s decision to allow Startups to self-certify compliance with labour and environmental laws is a positive step that will support the growth and success of young businesses, contributing to economic development and job creation.

Conclusion

In a nutshell, this article covers all the mandatory requirements from the Companies Act 2013, Income Tax, Central Government & Registrar of Companies (ROC) for startups in India. This article also suggests using C-Corp structure and a well structured board of directors with an independent director as one of the key managerial personnel to attract & gain the trust of investors. Articles highlight that only good corporate governance in startups can help establish a permanent footing in today’s dynamic market and gain success and prosperity.

References

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