Legal requirements for starting a business in India
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Starting a business is a daunting task. It requires many technicalities and procedures, which need to be followed so that the business may run with ease and make maximum profits. Firstly, a business which just steps into the industry needs to have a firm foundation. Unfortunately, many businesses start to flounder just because of the humongous amount of business formalities preceding and superseding the start of a business.
At its core, a good business structure requires an astute business model and a prudent legal foundation. The chosen legal system should ideally enable one's business to grow with minimal intervention. For this, the new business needs to know which legal system will cater to the needs of their particular business model. Therefore, it is very important to know the practical aspect of how to set-up and select one's ' business to ensure success in the industry.
"...In India, a cheque is still the most common instrument for transfer of funds. What is surprising is that even after so many years, people are still unaware about the remedies and laws that protect them against a bounced cheque... "
- Adv Najma Shaikh, Bombay High Court
Step 1 : Incorporation of a business entity
The first step in starting a business is to decide on the format of entity for conducting the business. This is an important decision: the right type of business entity will support your business plan and help accelerate your business growth. You may also be able to avoid high tax rates and prevent personal liabilities in case of a loss. A business may be set up in India by way of a proprietorship, One Person Company, Partnership, Limited Liability Company, Private Limited Company and Public Limited Company.
Step 2 : Discuss, Prepare and Sign the Founder's Contract
Often, founders start off the venture on an oral understanding of various crucial issues, without putting matters down on paper. This is mainly due to lack of knowledge, disinclination for paperwork or just mutual awkwardness to discuss the issue. However, as the business grows and prospers uncertainties about important matters could be the cause of disagreements. Even if co-founders are best friends from school, family members or trusted past-business associates, they may not be using the same vocabulary when it comes to discussing the setting up of the new venture. Therefore, it is necessary to have a very clear agreement among the founders / partners about the investments and the distribution of profits.
Some of the issues that need to be discussed and agreed upon among the founding team are:
Dealing with shares of a founder who leaves the business
The decision making system of the business
The ownership structure of the business
The roles and responsibilities of the founders
The modalities of addition of a new partner in the future
Protection of founders who do not have a majority stake in the business
It is advisable for each member of the founding team to identify and talk about the various issues that need to be recorded in writing. The impact of future plans of the company - such as infusion of venture capital – should be discussed. On the basis of these discussions, a legal agreement should be drawn up in simple terms, capturing the key details. The founders’ agreement should be read and understood by each founder to his or her satisfaction, before signing. An original set of this agreement should be retained by, with each partner, and the agreed upon provisions should ideally be included in the Articles of Association of the venture.
Step 3 : Obtain the Required Registrations and Licenses
A business is required to be registered with various government authorities, depending on its nature and activities of the business. In most cases, your business will be required to file statements with the government from time to time.
The following are the various registrations and licenses which may be required by your business to operate a business in India:
Import Export Code (IEC) if the business involves import or export
Employees' Provident Fund Organization
Value-Added Tax (VAT) if the business involves sale of goods
Shop and Establishment License for physical premises
Permanent Account Number (PAN) for income tax
Taxation Account Number (TAN) for withholding of tax
Service Tax Number if your business involves providing services
Professional Tax Registration
Employees' Insurance (ESIC)
Further, depending on the industry in which it operates, the business may be required to obtain specific licenses, such as a FSSAI license for food manufacturers, storage, transporters, distributors, etc.
Step 4 : Trademark your Brands
As your business grows, so does its goodwill. It is therefore necessary for you to protect your trade name, logo, tag line, and key phrases from misuse. Trademark is a combination of words and pictures which is registered with the government as belonging to your business. Trademark gives you protection against misappropriation of value that you create in your business through branding and advertising. Under the process of the existing law, registering a trademark typically takes about two to three years; however, your business can start using the term "TM" next to its name from the date on which the application for the same is filed. . It is advisable to file for your trademark at an early stage, before you start your branding activities.
Step 5 : Organise your Accounting and Taxation Systems
A well-designed accounting system is among the most important parts of your business. Without it, you would not be able to keep a track of the various transactions conducted by your business - the assets it owns, to whom it owes money and amounts receivable from its customers.
A strong accounting system could be the dashboard of your company's finances, helping you understand the answers to various questions such as:
How could you scale up your operations and how should you finance this growth?
In what areas could course corrections be made to ensure a healthier financial position?
Are things going as per your business plan or are there any course corrections that you need to make?
What discounts and credit periods can you afford to offer to your customers?
How could you prepare and analyse meaningful 'what-if' scenarios for taking strategic and tactical decisions?
Failure to have a well-designed and robust accountancy function robs you of the opportunity to review rich data and draw meaningful inferences for decision making. As a corollary, having a capable accounting team helps you gain the advantage of foresight for your business.
Step 6 : Create Business Policies
Building an industry-leading venture needs support of stakeholders - clients, vendors and employees. Having coherent documented systems allows the organisation to present a clear framework of relationships. Clients appreciate the missions, values and functioning methodology of the business. Vendors are aware of the procurement and quality policies. Employees know the venture's expectations and operational framework. Well-structured policies facilitate the evolution of the best principles of corporate governance at the venture. Some of the policies that are relevant for a business to develop are as under.
What are the different types of business entities?
A business may be set up in India in one of the following formats. Each business format is suited for specific uses and has its advantages and limitations. While it is possible to convert a business from one format to the other, it may involve significant time, effort and expense.
A proprietorship is a business entity that is owned and managed by a single person, called a proprietor. This is the simplest form of business and is easy to set up. In India, most independent professionals conduct business as proprietorships - examples are doctors, chartered accountants, lawyers and local shops and outlets. Unlike other forms of business, there is no specific procedure prescribed for setting up of a proprietorship. A proprietorship does not have an income tax identity separate from its owner. The existence of a proprietorship is shown by its registrations in its name. Registrations under the Shops and Establishment Act, the Service Tax Act, under the MSME provisions, etcetera are sufficient as proof of existence of the proprietorship.
One Person Company (OPC)
A One Person Company (OPC) is a recent concept introduced under the Companies Act, 2013. OPC provides a systematic legal framework for an entrepreneur who wishes to launch a venture on his own. OPC has only one shareholder, who should be a citizen of India and resident in India. This shareholder has to nominate another person to become the shareholder of the OPC in case of death or incapacity of the original shareholder. The nominee should also be a citizen of and resident in India. OPCs offer all the advantages of a Company, namely : (a) limited liability, (b) perpetual existence, and (c) independent legal standing. Accordingly, it also is required to comply with the provisions applicable to a Company such as auditing of accounts, filing of annual returns, etcetera. Further, the tax slabs applicable to a Company also apply to OPCs. If the paid up share capital of the OPC exceeds Rupees 50 Lac or the annual turnover of the OPC exceeds Rs. 2 Crore during a year, such OPC is compulsorily required to convert into a private limited company or a public limited company.
A partnership is a business owned jointly by two or more persons who have agreed to share profits of the business. This is among the most common business formats seen in India today. A partnership can have a maximum of 20 partners. The partnership agreement gives the partners complete flexibility to decide on matters such as capital contribution, management of affairs and distribution of profits. Commonly, partnership firms are set up in case of small and mid-sized businesses in which the owners themselves provide specialised services. Examples of partnership firms are legal firms, accounting and auditing firms and engineering firms.
Limited Liability Partnership (LLP)
An LLP is a legal entity which is a hybrid of a partnership (in terms of its constitution) and a company (in terms of protection from unlimited liability). In terms of liability protection, a partner is liable only to the extent of his agreed upon capital contribution. Further, a partner cannot be held personally liable for independent or unauthorized acts of any other partner. However, such independent or unauthorized acts will bind the LLP itself. The operations of an LLP are managed as per the provisions of the LLP Agreement, which is also called the Partnership Deed. [Read more about LLP]
Private Limited Company
A private limited company is a form of business which has its own legal existence separate from that of its owners. It has two attractive features: protection of limited liability to the owners and the ease of transfer of ownership. Unlike other formats, there is a separation of ownership and management of a private limited company. The owners of the company - called as ‘shareholders’ - do not actively participate in the management of the business. The business decisions are taken by a team of people called as ‘Directors’, who are elected by the shareholders from time to time. [Read more about private limited companies]
Public Limited Company
A public limited company is a form of business which is suited to mature businesses. In addition to the advantages of a private limited company, a public limited company permits its shareholders to freely transfer their shares. This form of business is highly regulated, and there are several restrictions which a public limited company has to follow.