#4 Choosing the Right Legal Structure for your Startup

Choose right Legal Structure for your business – Company | LLP | OPC | NGO

Usually, it happens that in the rush for growing your business, you end up ignoring some common legal issues that cost you heavy on time and money. Here are some common mistakes that can be avoided:

1. Ambiguity in terms of agreement – An element of ambiguity in the terms of agreement between multiple shareholders may lead to consequences like co-founders leaving the organisation, differences on the rights and responsibilities, etc.
   1. Unclear terms between different stakeholders or shareholders within a company which can lead to significant challenges such as (i) Co-founders leaving the company This also happens when the co-founders do not have a really watertight agreement between them which clearly sets forth their.
   2. Rights and obligations in the company including who really controls the company and who calls the shots 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.
   1. Infringing of trademarks which is another common area for issues in the startup ecosystem. These kind of trademark related cases can cause(i)Reputational damage to companies that lead to(ii)Monetary penalties and(iii)Distract the key founders from daily operations significantlySo how do you really resolve that? That’s by thinking of your brand name upfront and making sure that you have protections in place and making sure that your brand name does not violate the third party’s IPR. Continuing with the list of legal mistakes, another thing you should be careful about as a founder is the
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 up on 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.
   1. Creation and maintenance of terms of use and privacy policy on your website. A Terms of Use Agreement is meant to set forth the terms and conditions for people visiting your website and a Privacy Policy page specifies the way you use website data of the user

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 really 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.

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.
   1. Inexperienced legal counsel within your startup

When you reach a certain scale and commercially you realize that the appointment of legal firms does no longer make sense, then it is recommendable to hire an individual that can help you out in multiple situations, someone with some level of experience to rely on.

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.
   1. Forming a wrong legal entity which can ultimately lead to

(i)Higher taxation and

(ii) Increased liability, wherein you, at the worst case, even be obliged to put your personal assets such as your house, car and various other assets at risk in the event of a dispute or lawsuit or simply being unable to satisfy debts/liabilities of the entity through which you are conducting business.

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

Now, when it comes to deciding on which legal structure to choose for your business, you should consider certain basic points: 

a)Your company’s Tax liability – where the idea is to constantly seek opportunities to minimize tax

b)Risk of personal liability: Your personal liability, where you save yourself from risking your personal assets.

c)Preference of  Investor: 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

d)Record Keeping Obligation: The level of record-keeping obligations, where certain forms of entities’ require significant amount of personal collaterals

e)Cost of Formation: The cost related to creation of the entity, since certain entity forms are more expensive to register than others. And lastly 

f)Future Gole of Business: Your Future Business goals of the business, say, in terms of scaling up or diversifying, where some forms offer more advantages than others

Starting with sole proprietorship, if you ever wondered what kind of legal structure stationary shops, small bakery shops or people who are into small-scale businesses have, the right answer to this is most likely the Sole Proprietorship. Most of these businesses operate as sole proprietorship, generally meant for moderate level risk businesses that are low on financial resources. 

Under this form, you have 

a)Sole ownership of the business, with 

b)Full rights to take every decision on behalf of the entity

In addition to that, you require the

a)Least level of compliance and record-keeping, be it pertaining to the number of registrations you have to make or the norms to meet

As a drawback, you have

a)Unlimited liability, where you would be held responsible for paying up out of your own pocket in case if the business assets are unable to meet the liability

Next, this entity structure

a)Lacks credibility in terms of raising funds from the investors

Finally, there are

a)No provision to add partners here

b)So as the name suggests, sole proprietorship is where you are the sole guy calling the shots and it’s only you running the business and hence the introduction to sole proprietorship lay emphasis on the fact that it is only meant for moderate to small-scale businesses which require a family running it informally where it is only one person running the business.

Partnership

The primary motive behind doing so could be the

1.Low formation cost and

2.Profits which can be shared either as per their capital contribution ratio or any other terms that the partners may mutually agree and set forth in the

3.Partnership deed

Like Sole proprietorship, the liability in a general partnership is also

1. Unlimited which can extend to the personal assets of the partners as well as the liabilities of the other partners of the firm

Under this form, the number of partners can start anywhere from

1. 2 and can go up to 20 partners

Process of Partnership Registration

1.Creating and signing a partnership deed

Then, whether you want to 

2. Register the deed with any regulatory authority, which is the registrar of firms is entirely at the discretions of the partners

Know About Private limited Company 

Pvt Ltd Company Registration Checklist – Required Documents

Know about OPC (One Person Company)

Know about LLP (Limited Liabilities Partnership)