Have an idea and want to start up? Typically, your first thoughts will be about the nature of the entity, how much time will it take, how much cost is involved in starting up etc. No, your first step should not be thinking of entity and cost of setting up. There are many things to be taken care of, before you take the big step of incorporating a company.
If you are thinking of starting up while in your existing job and have no intentions to resign anytime soon (since you want to first test the waters), you should review your existing employment contract for restrictive covenants such as non-compete/non-solicit. While a non-compete clause would prohibit you from engaging in a business similar to your current employer’s business, a non-solicit clause would prohibit you from employing your current colleagues in your startup or from approaching the clients/vendors of your current employer. These restrictions can operate both during the term of your employment and after its termination/expiration for a certain fixed period of time. You need to review the scope and duration of such restrictions before you decide to start an organization. Moreover, if you wish to continue in your employment while deciding to pursue your startup ambition on the sides, such restrictions may pose as a roadblock.
Once, you are sure that there are no contractual restrictions, you may commence your startup journey by choosing a name for your organization. You may think, this is as easy as going and looking for a domain name and then buying and owning all the rights to that name. However, that is not the case. Choosing a unique name which no one else has is extremely important. You can check the availability of the name chosen, on the MCA website. You also need to ensure that someone else does not already possess a trademark for the name that you choose. It is very important to choose a unique name. This is because a name which is already in use or similar to an existing name, may lead to trademark disputes. You can read more about how to choose a name here.
Many entities mandatorily require at least two shareholders and directors. Hence, choosing a co-founder is important but not mandatory – if you can’t find the right match – then for now go with a family member or a friend. Once, you have chosen your co-founder, you both need to discuss certain issues such as each person’s contribution, the shareholding pattern, equity investment, role distribution, existing commitments etc. Based on mutual consent, a free and impartial division of duties should be done. In order to capture this mutual understanding and to make it legally binding, it is advisable to enter into a Co-Founders’ Agreement, preferably before incorporation. You should seek legal help to draw up this agreement. You may refer to our Co-Founders’ Checklist to understand what all needs to be included in a Co-Founders’ Agreement. [Download it for free by signing up on http://www.lexstart.com] .
Many prospective founders think that a startup essentially means starting a company. However, this is not true. You can choose to structure your startup as an entity of your choice which can be either be a private limited company, a limited liability partnership, a one-person company or a partnership firm. In fact, you do not even need an entity to start a business. A sole proprietorship is a business which can be started by an individual without incorporating an entity. All you need to do is to choose a name for your business, location of the business and open a current bank account in your business’s name.
Choosing the right entity goes a long way in determining the success of your startup, hence you should weigh the pros and cons of each entity before making a choice. We have discussed the pros and cons of each entity below:
Private Limited Company : A private limited company is beneficial to secure funding as it is easy to issue shares to an investor. It also ensures limited liability. Grant of ESOPs is also an advantage as it ensures flow of good resources. However, there are a lot of compliances associated which raise the cost. Moreover, it is difficult to close down a private limited company.
Partnership Firm : Minimum two people are required to start a partnership firm. It involves less documentation and is easy to start. However, investors are wary to invest as partners may be held personally liable for any fault of the firm.
One Person Company : A one-person company is the best when you want an absolute 100% control over the company. However, the cost of formation and compliances are same as a private limited company. It will be tough to get investors as they cannot be added as partners and hence will have no incentive to provide funding.
Limited Liability Partnership : A LLP has the features of both partnership and a private limited company. Hence, it is easier and cheaper to form while ensuring limited liability. However, one cannot grant ESOPs in a LLP. Sole Proprietorship: A sole proprietorship is easier to form and requires only basic documentation. However, investors may not be willing to invest in a sole proprietorship.
You can read more about how to choose an entity here.
Hence, you should ensure that you have done your homework before you decide to implement your idea of starting up. When you `think’ of starting up, do not just think about the idea, but think through all the aforementioned issues which will make your startup successful in the long run.