New businesses raising funds shouldn’t wait until they begin pitching investors to register themselves as a company. It could lead to delays and tax trouble, too.
There is perhaps no conversation start-ups ignore more than they do ones on legal and compliance. This is not entirely without reason, given the slowness of government processes. Although the Ministry of Corporate Affairs (MCA) is working hard to reduce the pains of starting and running a business, you can’t wait for it to change before you start understanding how the law operates. After all, if you don’t go to them, they’ll one day come looking for you.
Among the first requirements for a business is some kind of registration. Your options are private limited company, one-person company, limited liability partnership, general partnership and sole proprietorship. Of these five, the last two are outdated because of unlimited liability, which means that owners are personally liable for debts of the business. By registering under one of the first three, however, founders limit their liabilities toward the business to the amount they have invested. For example, let’s say a new e-commerce player gets hacked, leading customer data to be compromised. In case the operator is not registered as a company, any penalty would have to be paid by the founders themselves, whereas if it was already registered as a company, the money would only be recovered from the company.
Therefore, if your business has liabilities or there is the possibility of liabilities, register it with the MCA.
Start-ups often realise at the very last moment that they need to register their business if they want funding from a VC. But if you want to seem professional, you need to incorporate. And in this case, you don’t even have the luxury of choice. You can only register a private limited company, as it’s the only one of your three options that easily accommodates external funding and gives investors a seat on the board. The OPC structure would not allow another shareholder (it’s a one-person company, after all), while an LLP only allows partners (as opposed to shareholders). Failing to have this registration in place might seem undisciplined to investors. Moreover, as the process takes 15 to 30 days to complete, the funding process would be stuck.
Therefore, if you’re looking for investment, be sure to register your business as a private limited before you approach VCs.
Another reason putting off business registration until the very end is a bad idea is that it could land you into tax trouble. How? Well, let’s say you registered your company two weeks to a month before approaching a VC, issuing stock at Rs. 10 a share. But you raise money from a VC at a higher valuation, say, Rs. 100 a share. Do you think the Income Tax Department would simply let this be? They might not notice, but they could also treat the difference as compensation to the founders.
Therefore, you may want to register your business as a company a few months before you begin pitching Vcs.