In this Article, Peeyush Jain discusses the Legal mistakes by Startups.
To give up a well-paying job or to reject a letter of offer from a multinational company needs a rock solid thought process and a concrete backup to support the decision. A decade ago only a few had the courage to take up these decisions or we can say that situation or circumstances were such that the fresh graduates from the elite management institutes, technological institutes or the commerce experts were biased towards the high paying jobs from multinational companies or government rather than to do something on their own.
But now the thought process of young generation has changed substantially, now these young guns from top-notch schools try to build something different to create a mark on the society as well as to satisfy themselves by way of startups.
Starting a business is not an easy task, a rock solid idea or solution to a problem, a proper research work, efficient team, financial, legal aspects, must be looked up into.
Ten Legal Mistakes by Startups
Generally, it is seen that startups do not comply to the legal aspects and get themselves into legal troubles because they are not aware of these aspects as the law is like a vast sea in our country with thousand pages act on companies, income, goods and services, employee benefits, information technology, intellectual property etc. So the legal aspects must be looked after especially by the entrepreneurs so as to save themselves from committing the same mistakes as others did.
Some legal mistakes by startups are:
Not signing a Non Disclosure of Non-Compete Agreement
- Every startup founder must emboss in his mind that if he believes in his idea than someone else with whom he is interacting may also find its worth. Generally, it is seen that we cannot do everything by ourselves, so we need someone to help us on the journey either personally or professionally. While building our idea we need to disclose each and every aspect of its working to a web or app developer to present it to the general public.
- For proper functioning of the website or at least to build the prototype we need to discuss it with the tech professionals and therefore to protect the idea from being used by another person it is important to sign a Non-disclosure or Non competes Agreement with all such persons from whom we are taking the professional help. If a startup founder signs a Non-disclosure of Non compete Agreement than he can legally prohibit anyone to use his idea.
- It is generally seen that startup founders take professional help from personal friends or some known persons without signing a non-disclosure or non compete agreement to save some money or by virtue of relationships and ends up in legal trouble.
- So to protect the startup it is advisable to sign a Non-disclosure agreement or non compete agreement with all such persons a cofounder is dealing with because business must be on clear professional terms rather than on personal terms. It is also advisable to sign such Non-disclosure or non compete agreements with the co-founders.
- It is Important for startup founders to sign co-founders agreement to define the roles and responsibilities of each cofounder also the do’s and don’ts for each of them.
- Starting up without cofounder’s agreement can’t protect anyone of the co-founders from disputes and without the legal agreement, it is not possible to resolve the disputes in the court of law.
- A cofounder’s agreement is a legal document binding upon the signatories and protects the cofounder’s from any dispute along with assigning proper responsibilities to all of them.
- Startups don’t sign cofounder’s agreement because cofounders usually think that they are friends and know each other very well so it is not necessary for them to sign any such legal document. This is a big legal blunder which can shatter all their dreams as happened in the case of Facebook.
Type of business entity
- To build a multi-storey building it is necessary to have a strong foundation, so to have a long-running startup the foundation is the type of legal entity that can sustain for a long time and also has no legal limitations.
- There are five types of business entities prevailing in India namely:
- A partnership firm,
- A proprietorship firm,
- A limited liability partnership firm,
- A private limited company, and
- A one-person company.
- Out of the above five structures, a partnership firm and proprietorship firms are not advisable because they have the unlimited liability which can even extend to the personal assets of the partners.
- A limited liability partnership firm or a private limited company can be formed by the startup cofounders because both of them have the limited liability, but a private limited company wins over a limited liability partnership firm when a matter of choice arises, because company works on the basis of shareholders and is a separate legal entity, also it is a most suited option for the venture capitalists to pour funds and get a few percentages of shares. But a company has a lot more compliances in comparison to the limited liability firms.
- Another suited option can be to form limited liability partnership firm in the initial stage and then convert it into a private limited company at the stage of funding. This will protect the co-founders from excessive compliance costs as running a company costs more than running a limited liability partnership firm.
- A one-person company is formed when there is a single co-founder; it is also preferred over the proprietorship firm because of its limited liability.
So, choosing a proper legal entity is essential for the co-founders to run the business and take it up to the mark in long run. Choosing a wrong business structure is also a point of failure for the startups.
Adherence to the financial regulatory laws
- Every startup must take the advice of legal experts having the expertise in financial regulatory laws like that of RBI, SEBI etc. These laws come into play when the funds are raised by startups. These laws provide certain boundaries and prohibitions while raising funds.
- A cofounder is not supposed to have the knowledge of these financial laws, therefore to comply the financial regulatory laws an expert must be consulted to save the startup from the trouble.
Intellectual Property Laws
- Another important aspect to be checked is that the startup is not violating any intellectual property right of anyone.
- If the startup is using any symbol, mark, logo, monogram on the website it is required to protect it under intellectual property law and also make sure that it does not infringe any others intellectual property right in terms of image used on the site because while using an image we generally do not make sure whether the image is copyright protected or not.
- Again a legal expert needs to be consulted for such Intellectual property issues.
Documentation is an important aspect of building a startup. Each and every document reflecting the income and expenditure needs to be properly saved so that any legal liability can be prohibited. Generally, a nascent startup founder does not preserve the documents properly and ends up in the liquidity crunch. Also, the proper documentation helps in claiming the deduction of expenses under income tax act.
Income Tax Act & Companies Act
Both income tax law and company’s law are very vast and technical.
- Like the company’s act provides for the specific meetings of Board of Directors and shareholders for every resolution passed by a company.
- Specific resolutions have separate requirements for the majority by which a decision can be taken also for fundraising by way of loan and advances a company needs to pass the special resolution.
- These are few points of the technicality of companies act. So to have a proper compliance an expert needs to be hired.
Income Tax Act
Income tax act also requires the bifurcation of personal and business expenses because the deduction is available only for business expenditure under the act. In the same way revenue and capital expenditure requires separate treatments under the income tax act. Therefore a proper documentation under the expert advice will work.
- A startup is also supposed to hire the employees through proper contracts so that the laws relating to employee benefits can be complied along with preserving the valuable human resource because it is really tough to get good employees who can support the startup along with efficient working to get results. Signing of proper contracts with the employees save the startups from litigations and court cases.
- There are a large number of laws relating to employee benefits that a startup needs to follow like Employee provident fund act, Employee state insurance act, payment of gratuity act, payment of bonus act, labor laws etc. All these are employee savior laws which need to be followed properly.
Contract with clients
- Generally, the startups find it difficult to get clients and we know that without clients any business can bring a great failure even if your idea is really promising. While dealing with clients at the nascent stage, the startups generally do not enter into proper contacts and end up giving out of pocket expenses rather than earning.
- So, startups are advised to enter into proper contracts with the clients so that a win-win situation can be created for both clients and startup which can save the startup from any unwanted litigations.
- A properly drafted purchase order and sales order will work if they are followed strictly. Also, a proper contract can help the startup to save it from liquidity crunch by way of timely payments from clients because if a client has signed a contract with the startup that he is legally bound to follow the payment clause also which in turn will help the startup to get timely payments.
We can wind up on the note that legal liabilities need an expert to address them but as we know startups are the nascent businesses who cannot afford top notch experts but they must hire at least fresh graduates having working knowledge who are available at low remuneration and at least can save the startup from wrong legal decisions. It is advisable to morally consider the remuneration given to legal expert as an investment rather than as expenditure.