Choosing the Right Legal Structure for Your Start-up

Introduction

No matter what your business is, you need a basic legal understanding and the ability to see what you really should have done and should do in future. As a startup, you invest every minute in growth and related activities, and thus, legal matters of the business often get ignored. This leads to common legal mistakes that impact your company’s success or failure in the long-run. Hence, it is prudent to be aware of the legal matters of your business from the start. Starting from the correct choice of a legal structure to know about the registration process for the same, and finally, decide on the right location for establishing your entity – all these aspects need your attention.

Of course, to get all your assumptions and decisions checked, you must seek advice from a law firm or any expert lawyer. For this, you need to have clear selection criteria based on which you can select your legal counsel.

Common Legal Mistakes

As an entrepreneur, you launched or are likely to launch your startup with the best of intentions, but that may result in trouble if legal issues are handled in a wrong way. A careless attitude can lead to very bad results, but a careful watch to avoid these mistakes can save you and your venture a lot of time, money and efforts. Let’s look at a few of the common legal mistakes usually made by entrepreneurs in their journey:

  1. Ambiguity in terms of the agreement:  An element of ambiguity in the terms of the agreement between multiple shareholders may lead to consequences like co-founders leaving the organisation, differences on the rights and responsibilities, etc.
    So the founders’ agreement is something as basic as laying out all these rights and obligations of the parties is something that often gets missed
  2. Infringement of IP rights: In case of infringing upon someone else’s IP rights, your business ends up facing immense damage to its goodwill, consequently leading to heavy monetary penalties and wastage of time in resolving the same.
  3. Non-disclosure of privacy policies: If you have an online presence, it is necessary to put the terms and conditions along with relevant privacy policies upon your website. This is a must to build user confidence as well as to protect you from legal lawsuits by consumers in case of a dispute.
    For example, many websites take important sensitive information of the person who visits their website. Whether it is simple information like their name and age, including their address as well. There are laws in India that are very sensitive about privacy protection and data protection where you are required to have a policy that sets forth how you maintain this confidential information and that you don’t sell your customer’s sensitive information to other companies and all of these would lead to significant noncompliance issues. Another classical mistake in the early days is to opt for.
  4. Appointment of inept legal counsel: Wrong selection of lawyer makes it difficult for firms to troubleshoot legal hurdles in their journey. This also leads to extra costs especially when the lawyer is unable to deal with legal lawsuits.
  5. Formation of wrong entity: Selection of a wrong legal structure leads to trouble for entrepreneurs, either in the form of higher tax liability for the firm, recourse on personal liability of the owner in case of non-fulfilment of the company’s debt, etc.

Entrepreneurs should try and address these problems from day one itself to prevent these mistakes from becoming big, complex and costly enough to avoid later.

Types of Legal Structures

Of all the choices that you make when starting a business, one of the most important is selecting the right legal structure for your company. Now, when it comes to deciding on which legal structure to choose for your venture, you should consider certain basic points:

  1. Your company’s Tax liability – where the idea is to constantly seek opportunities to minimize tax
  2. Your personal liability, where you save yourself from risking your personal assets
  3. The ease of raising funds, where certain forms of entities are more common than others and are preferred by investors to protect themselves and facilitate future funding processes
  4. The level of record-keeping obligations, where certain forms of entities’ require a significant amount of personal collaterals
  5. The cost related to the creation of the entity, since certain entity forms are more expensive to register than others. And lastly
  6. Your Future Business goals of the business, say, in terms of scaling up or diversifying, where some forms offer more advantages than other
  7. Under the Indian legal system, there are essentially four types of legal components that are available. Each has its own set of outcomes:
  • Sole Proprietorship – A business run by one individual with no distinction being drawn between the individual and the business. You are in business easily and have minimal filings and compliance requirements. Talking about its pitfalls, the individual is personally responsible for all the businesses’ liabilities. It is also non-scalable given that it appears less professional when compared to other forms of entities.
  • General Partnership – Relevant when there is more than one founder. While the time required for being operational is relatively less, similar to a sole proprietorship, you run the risk of unlimited liability here. A Partnership Deed is signed by the partners to create a General Partnership.
  • Private Limited Company – Efficient and widely used, this type offers greater accountability because of mandatory registration and books to be maintained. Through a company, you can also seek investments against shares. Employees can avail stock options, and there is no unlimited liability to worry about.
  • Limited Liability Company – A hybrid entity created out of both a company and a partnership, this entity has a restricted liability clause to support the founders of the company. It is also administratively easier to manage as compared to a company

The choice of entity-type will vary the basis of several factors like liability, taxation and compliance, but the key is to find the best fit for your organisation. It is advisable to take professional guidance in this area, and for this, some legal experts would be able to give you a solution for your specific situation.

How to Choose a Base Location
Often it becomes difficult to decide on where to set your base. There are multiple reasons for choosing one and rejecting the other. It is at this point that most entrepreneurs make mistakes. This choice has to be a function of the resources critical to your success.
The location is important but from a legal perspective, you can have offices all over the country. You need to have only one registered office. Generally speaking, the registered office is really going to be where the headquarters. The registered office is where the company documents etc. are kept. So it’s also important that the operations people and the legal people as well as the people who look after finance etc. are based in that office. There
is no restriction on the number of offices you can have. The most critical aspect of location is going to be where is your market, right. If your market is in Mumbai and you don’t want to open an office in Calcutta, you’ll have to open it in Mumbai
So your market is very important. That then leaves you to 2-3 considerations. Where are your clients who are part of your market, where are you going to get people? What kind of skillset are you looking for employees? So I’m asked many times by clients that where should I open an office? I’ll say “okay, where is it that you’re going to sell your products or services”. If it’s not important from a market perspective, was an online venture and you are going to sell it all across the country then it’s going to be that where you’re going to be easy for you to operate from and where you are going to get people that you need.

Need more help in setting up a business in India reach us at [email protected] or drop a message at www.vPlus.co.in

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