10 Common Legal Mistakes That Could Heavily Cost A Startup

  • Setindiabiz Team
  • January 9, 2024
10 most common reasons why startups fail in India

The objective of this article is to point out the most common legal mistakes that business owners often make during or before the incorporation of their businesses. This article shall be of immense help if you’re planning to start a new business in India shortly. as a solid legal foundation is imperative for the commencement, protection, and growth of a business. A complete reading of the article will help the readers avoid such mistakes in the future and save them from paying huge penalties for non-compliance.

BRIEF SUMMARY
Establishing a business in India can be extremely challenging for young entrepreneurs, owing to their lack of awareness regarding the legalities and technicalities of the procedures and compliances involved. This often compels them to outsource such services to legal professionals and experts in the market, thereby increasing their overall expense. Added to it, are the heavy amounts of penalties that must be paid for non-compliance or delays in compliance. Such factors gradually dampen the entrepreneurial drive of young business owners and discourage them from taking risks in the market.
Dhirubhai Ambani
Things to ensure before starting a business
1.
Choose appropriate legal status
2.
Acquire necessary documents
3.
Claim and register IPR
4.
Draft a business policy
5.
Track your expenses regularly
6.
Record capital and revenue expenses separately
7.
Record personal and business expenses separately
8.
File regular tax returns
9.
Comply with labour laws
10.
Seek professional help

Common Reasons why Startups fail in India?

Startups begin as small businesses, with meagre funding and a limited scale of operations. Their customer base is also restricted to the locality they are situated in. However, a slow start does not, usually, dampen the huge aspirations of such businesses. Their desire to grow and expand is aptly reflected in their innovative ideas and enthusiastic entrepreneurial drive. However, despite consistent efforts by entrepreneurs, data suggests that only one in a thousand startups in India manage to succeed and make it big. The rest either fail to continue with their operations or remain incapable of breaking the glass ceiling. The probable causes for such low success rates are manifold, the common ones among which are mentioned below.

1. Choosing the inappropriate legal status for your business

Choosing the right legal status (Business Type) for your business is critical at the stage of its inception itself. An Indian business has the option to register and operate as a proprietorship, a partnership firm, an LLP, or a company, whereas a business with foreign direct investment is allowed only in a Company or the LLP subject to the regulatory framework under FEMA and applicable FDI policy in force in India.
A company may be owned by an individual (OPC) or by a group of individuals (limited company), both of which are mandatorily required to get registered under the Companies Act 2013. Registration is also mandatory for an LLP under the LLP Act, 2008. However, a proprietorship firm need not get registered under any law, while registration is optional for a partnership firm under the Partnership Act, 1932.
For determining the appropriate legal status for your business, you must consider its scale of operations, area of operations, funding and investment, and future prospects of growth and expansion. If you are looking forward to making it big in the industry, the cost of business incorporation and compliance must not distract you from choosing a status that best suits your business aspirations. Need Assistance? You can consult our advisors and let them understand your business needs. They’ll suggest you the available options and help analyse their pros and cons to make a wise and informed choice!
Types of business
Small-scale businesses, with a limited prospect of growth and expansion, and a negligible amount of funding, often chose proprietorship, partnership firm, or OPC as their legal statuses because the number of compliances to be fulfilled is fewer than companies and LLPs. However, the demerit of registering as a proprietorship, partnership firm, or OPC is that the owner is burdened with an unlimited liability toward the business and is considered inseparable from it.
Contrarily, a company or an LLP is operated by multiple owners with liabilities limited to the percentage of capital contributed by them. The owner and the business here operate as separate entities. Moreover, there are no restrictions on the issue and the transfer of shares in the case of a company/LLP. Hence, even if your business has started small but has the potential of receiving huge investments in the near future for growth and expansion, a limited liability company is best suited to its legal status.

2. Non-drafting of a proper business plan and policy

Before launching your business, you must draft a detailed business policy containing the terms and conditions, privacy policy, disclaimer, return, refund, and cancellation policies. This will prevent you from landing into any trouble in case of disputes with customers, vendors and employees. The shareholder’s agreement or founder agreement should form part of the business policy as this sets the responsibilities of each of the founders and comes as a very useful document in case a dispute arises among the founder shareholders. Incorporating the important covenants of the shareholder’s agreement in the Articles of Association is considered a good practice.

3. Lack of proper documentation

For all legal and practical purposes, a business must acquire and store the original copies of necessary documents that they might often require as proof of their existence, identity, address, legal and tax compliances, business agreements, business transactions, capital invested, and Intellectual Property. The necessity of acquiring and storing documents properly also extends to the shareholders and directors of the business. Some of the important documents are listed below:
  • PAN, TAN, GSTN, and other tax registration certificates for tax compliances
  • Certificate of Registration,
  • Rental/property documents as proof of the existence of the business
  • MoA, AoA in case of Company
  • LLP Agreement in case of LLP and partnership deed in case of Firm
  • Share Certificates as proof of capital investments into the business
  • Trademark registration certificate
  • DIN as proof of identity of directors
  • DSC as proof of identity of subscribers and directors
  • Documents related to the business bank account
  • Minutes of the annual general meeting and other special meetings of the company

4. Not protecting your IPR

Types of IPR
Intellectual property rights (IPR) are the most valuable asset of a business. However, most start-ups often tend to be careless and neglect towards claiming their intellectual property rights like names, brands, labels, patents, or trademarks under the Trademark Act. A common reason for this is misinformation among the owners about the consequences of non-compliance.
IP registrations help protect your business from the theft and misuse of your original and unique creations and enable you to challenge any violation by any entity in a court of law. Therefore, under any circumstances, you must claim your IP entitlements, and seek professional guidance if needed.

5. Not tracking the expenses of the business

Start-ups often find themselves in a pickle when it comes to maintaining their account books. Recording the incomes and expenses of your business is necessary for tax compliances and may land you in a pool of hefty penalties if you fail to meet the necessary requirements under relevant tax laws. Moreover, a lack of accurate records of incomes and expenses may increase your challenges in preparing the annual and long-term budget for your business. Hence, it is advisable to maintain proper records on incomes and expenses, and seek professional guidance or service if necessary. Nowadays the option of cloud-based accounting and payroll services is very popular. We help you set up a robust accounting and payroll system and train the administration or the accounts staff on a need basis.

6. Not differentiating between capital and revenue expenses

Maintaining separate accounts for revenue and capital expenses is recommendable for businesses from the points of view of finance and accounting. Revenue expenses record the day-to-day operational expenses of the business, whereas the capital expenses are spent as long-term investments into the business. For proper short-term and long-term budgetary planning of the business, the owners must be aware of the overall expenses, including their nature and purpose.
Besides, businesses also receive different kinds of deductions on different categories of expenses from the IT department. Such deductions are capable of increasing the disposable income of the business, which can further be invested in its growth and expansion. If applicable, revenue expenses can receive tax deductions on the entire amount spent in a financial year. However, capital expenses made in a financial year shall be adjusted for depreciation and shall receive tax deductions for several years to come.

7. Not differentiating between personal and business expenses

It is never advisable for founders to spend their personal incomes on operating their businesses. They must either borrow or sell the equities of the business in return for investments that can be further spent on operational and capital expenses of the business. Mixing the two together is not a wise business decision, as it is bound to increase the burden on the pockets of the founder-owner and enhance the risks of losing money. Additionally, tax deductions on expenses can only be availed if the transactions are in the name of the business and not its owner.

8. Missing the filing of tax returns

If you have maintained accurate records of the income, expense, profit, and loss of your business, you must now shift your emphasis toward filing income tax and GST returns, in accordance with the prescribed norms. Missing tax returns shall bring hefty penalties for your business, which will probably be difficult to afford at such a nascent stage. If you are unable to file tax returns yourself, you must immediately seek professional help or expert guidance in order to avoid charges of non-compliance and evasion.

9. Non-compliance with labour laws

Businesses cannot commence their operations without hiring employees or labour. For this, the owners need to apply for certain mandatory registrations with the Department of Labour. These are
  • Registration under the Shops and Establishment Act with the department of labour, having jurisdiction, within 30 days of incorporation of the business.
  • Registration under the Provident Fund Act can be applied either on the official website of the EPFO or through the business incorporation application forms like SPICe+.
  • Registration under the ESIC Act can be applied either on the official website of the ESI or through the business incorporation application forms like SPICe+.
Labour & Compliance

10. Not seeking professional help

Most startup owners are either unaware of the necessary compliances they must meet before commencing their businesses, or avoid doing so due to the high professional cost involved. It is obvious that they themselves do not possess the legal and technical knowledge and experience for the same.
However, they often fail to realize that the penalties imposed for non-compliance are way more costly compared to the amount charged by professionals for compliance services. Additionally, legal proceedings can be initiated against your business, which might result in its closure. Hence, to avoid such serious consequences for your business, we recommend that you hire professionals and seek compliance services from them.
You can also avail of our services at SetIndiaBiz, where we specialize in providing company registration and post-registration compliance services to all sorts and sizes of businesses, for the past several years. Our services are backed by a team of professional legal experts, who also provide guidance and suggestions to clients, wherever necessary. Our services are quick and cost-effective with no compromises on their qualities. You can check out the necessary details of our services on our website.

As a small business startup, non-compliance with the above-listed legal mandates may result in hefty penalties levied by the government. Spending huge sums of money on penalties is bound to adversely impact the growth prospects of your business. Hence, it is highly recommended that you comply with all the legal requirements within the prescribed time limit so that you can avoid facing issues in the future. You must seek professional assistance from legal experts, wherever necessary.

Conclusion

FAQs

Electing the right legal status is vital as it determines your business’s compliance requirements, financial liability, and growth potential. Whether it’s a proprietorship, partnership, LLP, or company, understanding the implications ensures alignment with your business objectives.

Q2: How can I protect my business's Intellectual Property Rights (IPR) effectively?

Intellectual Properties are important intangible assets of your business enhancing its brand potential in the market. They can be categorized into trademarks protecting your brand symbols, patents protecting its products, copyrights protecting any original literature associated with it, and design protecting its unique industrial creations. To protect your IPR, you can identify and register your intellectual properties through the prescribed process.

Q3: What are the key elements to include in a comprehensive business plan for a startup?

A well-crafted business plan is a roadmap to success. Its essential elements include terms and conditions, privacy policies, and shareholder agreements, to avoid disputes and foster a thriving business environment.

Q4: How can startups avoid hefty penalties for non-compliance with tax and labor laws?

To avoid penalties, startups must adhere to mandatory tax returns, labor law registrations, and other regulatory requirements. Understanding and fulfilling these obligations ensures legal compliance and financial stability.
Seeking professional assistance is crucial for startups. Professionals provide expertise in navigating complex regulations, minimizing the risk of legal issues, and ensuring smooth operations. The cost of professional services is an investment in the long-term success and sustainability of your business.

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