With better access to funding, evolving technology space and increasing demand within the domestic market, the Indian start-up ecosystem has been rapidly progressing and the “Start-up India, Stand up India” initiative has provided a huge impetus to its growth by effectuating many favourable regulatory and policy changes. In addition to the technology space, which has seen an eruption in the emergence of start-ups, start-ups are cropping up in various other sectors and industry segments as well. The start-up India initiative has encouraged many budding entrepreneurs to register their entities through the Start-up India Platform and avail the many benefits and schemes being made available to them through the Start-up Action Plan.
In the wake of this start-up boom, some of the biggest issues faced by entrepreneurs are:
- Retention of core team and/or co-founders,
- Too much to be done in the little time available,
- Managing third-party relationships including the government.
The common thread amongst all these is managing legal relationships and ensuring boundaries and expectations are clarified. The same is done through legal documentation at an early stage along with setting up of processes and identifying responsibilities. In light of the above, outsourcing the legal function becomes essential for start-ups. This article sets out the potential areas of assistance to an entrepreneur that a legal advisor may be able to provide.
Prior to commencing operations, entrepreneurs must decide upon the most viable (operationally and financially) business structure for them. Business structures available to entrepreneurs in India are as follows:
- Sole proprietorship (is not required to be registered).
- Partnership Firm registered under Indian Partnership Act, 1932.
- Limited Liability Partnership registered under Limited Liability Partnership Act 2008.
- One Person Company registered under Companies Act, 2013.
- Private Limited Company registered under Companies Act, 2013.
- Public Limited Company registered under Companies Act, 2013.
- Society registered under Societies Registration Act, 1860.
- Public Trust (No central legislation in India. However, some states have enacted state legislations. For e.g.: Maharashtra Public Trusts Act, 1950.)
- Private Trust registered under Indian Trusts Act, 1882.
- Company registered under Section 8 of the Companies Act, 2013.
Each structure has its own costs, compliances, asset protection and risk management options to consider. Many start-ups adopt a company structure, due to its flexibility and attraction to investors. However, it is recommended that start-ups seek legal and tax advisory from consultants prior to crystallising upon a structure.
Start-ups should start out with a solid and concise contractual foundation and execute legally enforceable contracts with persons and entities they wish to do business with. This goes a long way in safeguarding the rights of the entrepreneurs and will not only help resolve any disputes and problems that may arise between the parties at a later stage, but will also help the entrepreneur take an informed decision about legal actions that may need to be taken to redress the issue early on.
Some of the documents required by start-ups in their early stages, that will not only help them run their business smoothly, but also provide a strong safety net to protect against future disputes, are provided below:
Consultant Agreements: An agreement to be executed with a consultant whose services are being sought by the start-up. This agreement may be entered into with each of the consultants, including both individuals and entities, providing services with certain requisite skills and industry standard expertise to the start-up as independent contractors instead of being employed by the entity. This agreement lays down the terms and conditions of the consultancy services required by the start-up.
Inter-se Agreement or Founder Agreement: When two or more individuals seek to join hands to start a start-up entity, it is important that these co-founders or partners enter into an Inter-se Agreement or Founder Agreement. This agreement lays down important aspects such as percentage of ownership, decision-making, duties etc. and will provide a hierarchy of power and position for each partner in the start-up to prevent legal pitfalls at a later stage.
Lease or Leave and License Agreement: Start-ups require space for their business operations and as per their requirements and commercial feasibility in terms of applicable stamp duty etc., entrepreneurs can either lease or take properties on leave and license basis for their business purposes.
Vendor Agreements / Service Provider Agreements: A clear agreement with a vendor may pre-empt several conflicts pertaining to the duties and obligations of the parties and improve conflict resolution by setting out detailed processes for the same. Even in the event of a dispute it shall help start-up entities substantiate its claim in a court of law.
Confidentiality and Non-Disclosure Agreement: An agreement which may be an extension to the Vendor Agreement / Service Provider Agreement or may even be a stand-alone document. A very essential document for start-ups. During the initial stages, start-ups should be weary of disclosing confidential information of the entity to any other person they wish to do business with. The confidentiality and non-disclosure agreement would ideally lay down the boundaries of the information which should not be disclosed.
Employment Agreement or Letter of Appointment (with a detailed Confidential Information and Invention Assignment Agreement, if required): A detailed and clear employment agreement is essential to ensure that employees understand their roles and responsibilities in the business entity. Employment agreement having clear provisions pertaining to the non-compete and the non-solicit obligations of the employees are the need of the day for start-ups.
Confidential Information and Invention Assignment Agreement – This agreement may be an extension to the Employment Agreement or may even be a stand-alone document. The agreement details how the business entity's confidential information is to be handled by the employee and enables the entity to secure its rights in the work/creations of the employee. It is essential that start-ups execute this agreement with the IT employees of their entity.
Employee Handbook with a detailed Prevention of Sexual Harassment Policy: Every start-up must have an employee handbook containing the entity's policies and procedures required to be followed by all employees of the entity as a condition of their employment. The Sexual Harassment of Women at Workplace (Prevention, Prohibition and Redressal) Act, 2013 and Sexual Harassment to Women at Workplace (Prevention, Prohibition and Redressal) Rules, 2013 framed thereunder, mandate for the provision of a Prevention of Sexual Harassment Policy at every workplace with employs more than 10 employees.
Employment Stock Option Scheme (ESOP): An employee stock option is usually offered by an entity to its employees pursuant to which a pre-determined number of shares in the entity shall become vested to the employee at pre-ascertained date/s. Providing an ESOP option to the employees enables entities to attract and retain performing employees.
Intellectual Property Assignment Agreement: An agreement by which founders can transfer to the business entity, their Intellectual property rights over the products/services required to run the business.
Term Sheet: A document which sets forth the key terms and conditions of the in-principle agreement with regards to the investment proposed to be made by the investors into the founders' entity. The Term Sheet serves as a foundation for the parties to, at a later stage, enter into a detailed and binding agreement such as the Share Subscription and Shareholders Agreement.
Share Subscription and Shareholders Agreement: The Share Subscription and Shareholders Agreement essentially crystallizes the rights and the obligations of the shareholders of the start-up entity, vis-à-vis the entity and each other. A detailed Share Subscription and Shareholders Agreement supports a smooth functioning of the start-up entity.
The agreement details the understanding between each shareholder and the start-up entity and regulates the transfer and sale of the entity's shares to the shareholder. It determines, amongst other things, number of shares to be purchased, price per share and modes of payments (cash, IP, convertible notes, share options or other forms or combinations of consideration). Further it also contains the understanding pertaining to the management of the entity and board matters, liquidation preference, exit options of the shareholder, non-compete and non-solicit obligations if any etc.
Please also see our previous post on Representations and Warranties in the M&A context. We will be doingdetailed posts on this topic soon.
In sum and substance
Seeking assistance early on with the above documentation sets the standards for the future while setting clear boundaries within which parties are expected to act. Decision making becomes easier as the contours of the relationship are thought up early on, freeing the entrepreneurs to focus on their core business functions.
Originally Published 21 December 2016
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.