So, you have this great idea. You have waited for a while to get some validation, gathered courage and finally, you have decided to take the plunge. You have either figured out who your co-founders are going to be, or you have decided that you are going to be a micropreneur and handle everything yourself.
Now what? Quit whatever you are doing and jump headlong into developing the product/service and then start marketing it? Wrong!
|Bomb Squad, Courtesy Reuters.|
Because a business is an inherently risky endeavor (stats put the failure rate at about 80%) that can potentially make you bankrupt. At the same time, one should also account for the best possible outcome (becoming the next Google/Amazon or whatever is your role model), in which case you will need a structured organization to get investors on board or issue equity. Separating your business as another legal entity is how you do this. A registered company is also a great credibility enhancer for your customers, creditors and investors.
Running the business as a sole proprietorship or a partnership firm lets you skip the formalities,time and money involved in getting your business incorporated. But this saving can prove very expensive in most of the cases.
Once you have decided to that you are going to create a separate legal identity for your startup, the first thing that you need to decide is whether it is going to be Private Limited Company (Pvt. Ltd) or a Public Limited Company.
For most startups, Private Limited is the way to go, as it necessitates fewer statutory compliances, and yet offers limited liability by separating the business as an individual legal entity. Maintenance cost is also far less than a public limited company. You can always convert to a Public Limited Company as and when the company grows to a size that warrants going public and raising funds.
Since 2009, another option has become available to small companies and startups, that of an LLP ( Limited Liability Partnership). An LLP can be described as hybrid between a company and a partnership, as it has elements of both a corporate firm and partnership firm.
Each business and management team has its own set of unique requirements and constraints and the solution suitable to one business may not apply to another. Thus, one has to carefully consider the following aspects before choosing from the aforementioned three options.
1) Extent of protection needed from legal liability.
2) Tax implications.
3) Cost of formation and annual expenditure.
4) Record keeping and compliance requirements.
5) Flexibility in management, change of ownership and acquiring funds.
6) Future needs.
7) Impact on credibility.
8) Need for disbursing equity to founders or ESOPs for employees.
It is natural that your current focus is on your grand idea and that you do not want to get into the nitty gritty of creating a legal identity for your business. Hiring a professional or a firm to do this for you is an obvious next step, but make sure that they have worked with similar startups before, and understand the unique needs of a startup.
Watch this space for more articles on best practices for startups.
I was inspired to write this article after I met a startup entrepreneur who was signing deals worth crores in his name, without incorporating a company. When I queried about the reason, he said he doesn't have the time or money to go through the process.ReplyDelete
Do you know anyone like that?
I don't know what he is talking about that. I think it was on his strategy on how to improve his business even he doesn't have that time or money to go through the process.Delete
Appreciate, the effort for writing this blog. You have rightly pointed out some common mistakes people make while starting a new venture especially, when it comes to legal issues, most of the times it happens to due to sheer negligence of an individual.ReplyDelete
I believe issues of this sort can be overcome if there is team in place, and basic management principals are followed.
Thanks Che. But the reality with startups is that they can barely afford to start with a team, and even if they do, that team is so passionately focused on building the product and getting it out into the market, at the same time grappling with all the monetary hurdles, that they tend to forget to have some safety harnesses in place.Delete
@Do you know anyone like that?ReplyDelete
Frankly, most of the entrepreneurs I know prefer to first build a product than to build a legal entity. Getting investors is important, but more important is to have right team and prove the product in market. Entrepreneurs rarely worry about startup success rate. All they are concerned,and duly so, is about validity of Idea. I guess most will be aware of distinct possibility of going "bankrupt" once they think of becoming entrepreneur...
Very good thoughts. Though I feel the legal entity part should not be given too much attention initially. This tends to drive the focus away from the idea. Setting up a business to scale later is important, but it should be done when the time is rightReplyDelete