Wondering why startups fail frequently in India? 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 are required to be paid for non-compliance or delays in compliances. Such factors gradually dampen the entrepreneurial drive of young business owners and discourage them from taking risks in the market.
The objective of this article is to point out the most common legal mistakes of startups during or prior to the incorporation of their businesses. This article shall be of immense help if you’re planning to start a new business in India in the near future. 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 to ensure that they avoid all such legal mistakes made by startups in the future and hence, save themselves from paying huge penalties for non-compliance.
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.
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 compliances must not distract you from choosing a status that best suits your business aspirations.
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.
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. A failure to acquire the proper documentation not only hinders the process of setting up a startup, but is also a major reason why startups fail in India. Some of the important documents are listed below:
Another important reason why startups fail is the poor maintenance of 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.
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.
It is never advisable for founders to spend their personal incomes on operating their businesses. Merging the is a legal mistakes of startups that must be avoided. 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.
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 is not only a legit reason as to why startups fail but shall also 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.
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. Not complying with these laws is why startups fail in India frequently. A few of these laws are
Not seeking professional help is one of the most gruesome mistakes among the 10 big legal mistakes made by startups. 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 and is one of the many reasons why startups fail in India. 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.
The above mentioned 10 big legal mistakes made by startups 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.