THE STARTUP SERIES: LEGAL POLICIES
1: Choosing the right business structure and incorporation.
· Private limited company / limited liability partnership (“LLP”) / partnership firm
· Private Company
o Governed by the Companies Act, 2013, defined under section 2(68);
o Restricted share transferability;
o Minimum of 2 to a maximum of 200 shareholders;
o Minimum of 2 to a maximum of 15 directors are required;
o No requirement of a minimum paid-up share capital;
o Charter Documents: memorandum of association (inter alia contains the objects for which the company is incorporated) and articles of association (act as bye-laws of the company);
o Separate legal entity, perpetual succession and limited liability (same as LLP); and
o Better management features and more flexible as compared to an LLP for transfer of ownership (as shares are concerned), a clear distinction between holders of shares and the management team, preferred for business considering FDI, equity funding, issuing stock options, etc.
· LLP
o Governed by the Limited Partnership Act, 2008 and the LLP agreement (determines the mutual rights and duties of the partners and their rights and duties in relation to the LLP);
o Minimum of 2 partners and 2 designated partners;
o No minimum contribution required;
o Separate legal entity, perpetual succession, and limited liability (up to the contribution);
o Lesser compliances compared to private companies (no mandatory holding of board and shareholders’ meetings, only couple of annual compliances – annual returns, statement of account and solvency); and
o FDI is permitted in LLP in the form of contribution or acquisition/transfer of profit shares.
· Partnership firm
o Governed by the Indian Partnership Act, 1932; and
o Not preferred structure – not a separate legal identity, no perpetual succession, unlimited liability, etc.
· Process of incorporation of a private company
o Check availability of the name and apply for name reservation with the MCA (form Part A of SPICe+ - reservation is valid for 20 days);
o After receipt of approval of name, incorporation documents (declaration by subscribers, consent of directors, documents related to registered office and address proof, etc.) need to be prepared;
o Apply for digital signature certificate;
o Preparation of charter documents of the company – model formats are available in the Companies Act, 2013;
o After reservation of name, form SPICe+ is filed for name reservation, incorporation, DIN, TAN, PAN, EPFO, ESIC, and GSTIN;
o MCA will generate a certificate of incorporation;
o Procedure in accordance with the Companies (Incorporation) Rules, 2014; and
o Tentative timeline – 3 to 4 weeks.
2: What is a startup, process of recognition, and benefits.
· ‘Startup’ defined under notification dated February 19, 2019, by the Department for Promotion of Industry and Internal Trade (“DPIIT”), Ministry of Commerce;
· Eligibility criteria for startup and process of recognition:
o Up to a period of 10 years from the date of incorporation/ registration, if it is incorporated as a private limited company or registered as a partnership firm or an LLP;
o Turnover of the entity for any of the financial years since incorporation/ registration has not exceeded INR 100 Cr;
o Entity is working towards innovation, development or improvement of products or processes or services, or if it is a scalable business model with a high potential of employment generation or wealth creation; and
o Should not be an entity formed by splitting up or reconstruction of an existing business.
o Online application over the mobile app or portal set up by DPIIT, along with the certificate of incorporation/registration and write-up on nature of business.
· Benefits of recognition:
1. Under the Companies Act
o ESOPs may be issued to the promoter/director holding 10% or more in the startup up to 10 years from the date of incorporation or recognition; other companies are prohibited from issuing ESOPs to promoters; [Section 62(1)(b) r/w Rule 12 of the Companies (Share Capital and Debentures) Rules, 2014]
o Sweat equity shares to the maximum limit of 50% of paid-up capital of the startup (up to 5 years from the date of incorporation or recognition) may be issued; other companies may only issue up to 25% of their paid-up capital; [Section 54 r/w Rule 8 of the Companies (Share Capital and Debentures) Rules, 2014]
o Other procedural relaxations like - no requirement to maintain cash flow statement as part of financial statement, minimum of one board meeting in one half of the calendar year; where other companies are mandated to hold at least 4 board meetings in a year, etc.
2. Under tax laws
o Special Deduction: Section 80-IAC of the Income Tax Act, 1961 (“IT Act”) provides 100% deduction for 3 consecutive years out of 7 years (10 years w.e.f April 1, 2021), to profits and gains of ‘eligible startups’. ‘Eligible startup’ means (a) a company, or an LLP incorporated on or after April 1, 2016, but before April 1, 2021; (b) the total turnover of its business does not exceed INR 25 CR (INR 100 Cr w.e.f April 1, 2021) in the previous year relevant to the assessment year for which deduction is claimed; and
(c) holds a certificate of eligible business from the Inter-Ministerial Board of Certification (“Board”). The startup needs to make an application to the Board for availing this exemption.
o Angel Tax Exemption: A startup can also claim angel tax exemption under clause (ii) of the proviso to clause 56(2)(vii)(b) of the IT Act, provided it is a recognized startup and aggregate amount of paid-up share capital and share premium of the startup after issue or proposed issue of share, if any, does not exceed, INR 25Cr.
o Other exemptions on capital gains tax, etc.
3. Other Miscellaneous
o FDI in startups is permissible per the sectoral caps;
o Convertible notes may be issued by startups; may be purchased by a foreign investor for an amount of Rs. 25 Lakhs or more in a single tranche;
o Self-certification of compliance under Labour Laws: for up to 5 years of certain labor and environmental laws;
o Certain rebate in filing a patent application and other IPR;
o Relaxed norms for public procurement and hence it would be easier for the startups to become suppliers to the government or apply for tenders because of the relaxations in prior turnover and prior experience required; and
o Fast track corporate insolvency resolution under the IBC 2016: within 90 days and maximum extension of 45 days.
3: Intellectual property rights pertaining to the startup and information technology.
Every Startup uses a trade name, brand, logo, advertisements, inventions, designs, products, or a website, containing IPR. Protection of IPR improves valuation, generates goodwill, gives a competitive edge, etc.
1. Trademark
· Governed by the Trade Marks Act, 1999 (“TM Act”)
· “Trademark” means a mark capable of being represented graphically and which is capable of distinguishing the goods or services of one person from those of others and may include the shape of goods, their packaging, and combination of colors…. (section 2 (zb))
· Logos, marks, symbols, trade names, etc. can be trademarked;
· Registration is valid for 10 years; and
· Can be protected under the TM Act and the common law.
2. Copyright:
§ Legal right of an author/artist/originator to commercially exploit his original work which has been expressed in a tangible form and prevents such work from being copied or reproduced without his/their consent;
§ Governed by the Copyright Act, 1957;
§ Registration of copyright is not mandatory in India; and
§ Term of copyright is, in most cases, is the lifetime of the author plus 60 years thereafter.
3. Patents:
§ Governed under the Patents Act, 1970;
§ Protection of ‘inventions’, where 'invention' means “a new product or process involving an inventive step and capable of industrial application”; and
§ Term of the patent is for 20 years from the date of application.
4. Domain Name: Since most of the startups have a website, it is important to register such addresses in their name.
5. Information Technology:
· Any body corporate dealing with personal data of users is required to comply with the Information Technology Act, 2000 and the Information Technology (Reasonable security practices and procedures and sensitive personal data or information) Rules, 2011; and
· Such a body corporate will need to have a privacy policy – seeking the consent of users for dealing with their data, setting out the type of data collected, purpose of collection and usage of data, disclosure of information, etc.
4: Other important post-recognition compliances.
· Obtain state-specific shops and establishment registration certificate – most of the states require this certificate if more than 10 employees are employed out of such premises;
· Obtain any other sector-specific registration/license, labor laws’ related registrations (which generally depend on the number of employees employed);
· Other routine corporate compliances under the Companies Act, 2013 (like board meetings, annual filings, etc.) and applicable labor laws (maintenance of statutory registers, filing of annual returns, etc.)
· Issue offer letters/employment agreements to its employees (containing provisions of confidentiality, non-compete, IPR protection);
· At the stage of seeking investment – documents like term sheets, investment agreements, etc. may be executed.
By Siddharth Dalmia, the Startup Sherpa
+91-9971799250
Startupsherpa21@gmail.com
