What kind of company should I start?

Starting up a business is hard, really, really hard. Your chances of failure are high. You like it to lose both your sleep and your hair. But luckily for you, you're not alone. Welcome to E.T. Startup School, your step-by-step guide to starting, building and consolidating your startup business idea. Your teachers at the E.T. Startup School will be some of India's best known entrepreneurs, VCs and domain experts. So grab a notebook, take close attention. School is about to start. Today's class at E.T. Startup School is called What kind of company should I start? Your teacher is Ganesh Prasad. Ganesh is a partner in the corporate and commercial practice group at Khaitan and company, one of India's leading law firms. With over 20 years of experience, Ganesh specialises in domestic and foreign venture capital and private equity investments in a variety of sectors. You may not know Ganesh, but you definitely know the brands we helped bring to India. Brands like Hubert, WeWork, and booking.com. Ganesh, welcome to E.T. Startup School. First question for you. Many founders typically work on a business idea when they're still in a full-time job. What are the legal implications of this? It all depends primarily on the contractual arrangement that they actually have with their respective employers. Sometimes they have fairly exhaustive employment manuals. With bars, they're from doing any of these things. While they're in employment of this particular company, if there is no bar, if they have done it outside of their employment time from the company's time, so technically, it should be okay. But the IP in which most people have an idea, and it's an expression of an idea which translates into a startup. If they're working on it from a back end, after their time in the company, I think it's sort of okay. However, you still leave a small room for your former employer to sort of come back against you and litigate in case he finds that little challenging. We've seen those cases too. You've seen that as well. What are the chances that an employer, suppose at a full-time job, I worked on a startup on the weekends, I came up with something, I quit my job, I founded my startup. Now, my employer calls me and says, okay, no problem. I just want to stay in your company because you were working for me while you came up with this. Is there a risk of the employer asking for a stake? See, anybody can comment, this is free India. They can ask whatever they want. I have seen some ridiculous claims being made by some employers. The burden of proof then would be really on the employee in question that he did not use the company's resources of his former employer. He did not use the time of the, during which he was actually employed. Of course, Moonlighting today is a larger issue, which I think everyone has been talking about. It really boils down to the employment manual, particular company has robust employment panels where they see that you will dedicate all of your time no matter what it is. Because with COVID, what has happened is the line between what is office and what is home has actually gotten blurred. It's very easy for somebody to make such an argument. But having said that, can you prove it? That will be up to both of them who are boring eventually. But I think people should not really worry about it. I have one thumb rule which I have always advised people to learn. Go ahead, do what you have to. And if there is a brilliant idea and you have sort of done something that can always and that's going to actually create value, and that's going to unlock value in the larger ecosystem. Don't worry about the nitty grittys and the smaller aspects. They will generally fall into place. That's good. So would they take away from this answer, be that all employers should study their employment contracts pretty carefully or sit with a lawyer and go through their employment contract once just to be on the safe side? Yes. The way employment contracts specifically are being designed today. And also because of the hybrid model, what we currently are looking at, post the great resignation if I may add, with the scarcity of employees across sectors. I think it is very important that people actually come up with really robust employment agreements, where in the IP is protected and anything which, if your independence on which side of the table you are, if you are on the side of the employer, the former employer in question, then obviously you will want to make it that much watertight. Okay, Ganesha, zoom that I quit my job. I came up with an idea. It's a reasonably good idea. I've got a co-founder and now I'm going to figure out what kind of company structure should I incorporate. So what kind of structure should a startup founder consider? So if you're saying you've got an idea and that is the expression of an idea and it's just fantastic idea. Nobody has ever thought about it. And this idea is going to revolutionize the industry and this is the girl thing which I guess the whole world was waiting for. Hopefully. Yeah. I think you should just go for a company rather than any other form. You have various other things like a sole proprietorship or an LLP. And I'm not going to get into some of the other companies, my guarantees and all of those things. But you know largely if you are a startup entrepreneur, I think you should just go for a private limited company. Why? Because you can race capital. You can have angel investors. You can have people investing you and eventually that will scale up and you have a you have a ready system which can scale up. I think that is my advice. But if your idea is not so mature and you're still exploring like the exploring what is basically that I would say start slowly be a sole proprietorship. That might be a better option for you than take the burden of compliance because a company has a lot of compliance related filings. In legal terms Ganesh, what is a sole proprietorship and what kind of business should consider this? What kind of startup should consider this? A sole proprietorship is when you basically have just I would say you're the you're the whole and sole of that particular business and everything is run because of you and with maybe very very limited workforce. You do not have a formal structure to that particular entity. It's like a moment of Dukal as well what we call it. That's usually a sole proprietorship. Where will it be relevant if you are possibly a let's say depends again on the vintage of that particular employer. So if somebody who has sort of spent a lot a lot of time now he's on his retirement and but he doesn't want to retire actively but he wants to do some consulting work. So our sole proprietorship is better for him. Next question what is an LLP? What's a limited liability partnership? So a limited liability partnership was basically enacted as a piece of legislation. It came into existence. You know there was earlier the partnership act which defined the relationship between people. Partnership act actually the way it sort of defines under the earlier partnership act was it governs the relationship between a group of people and it had unlimited liability and then comes in the limited liability partnership concept where the liability of the partnership partners are basically limited. Now today if you ask me there is no difference. It's actually very similar. I would rather say to a private limited company and an LLP but the compliance obligation is a lot more in a company but in a limited liability partnership you do not have that level of compliance obligation. Earlier there were certain things about dividend distribution and there were certain tax advantages but I think that has all been plugged and I think given that I would possibly say it is not so attractive to somebody who is not very defined in terms of what they want or what they don't know. They don't know where their company is going to go. It's in high sea and it will all depend on market forces. That is where you go for a company but when you know where you're going then you sort of form a partnership but that partnership is going to have limited liability where the liability of the partners will be limited to the extent of their capital investment. So that is where it is. Is there anything else that founders need to know? about liability, the word liability? Earlier partnership act obviously had personal liability. Now in the current limited liability partnership structures it is limited to the extent of normally and again we lawyers love these the the greatness of the whole thing normally as an honest quote is actually sort of go behind your assets saying that there is apparent fraud or there is something else which you have sought your guilty or as a as a name partner there your liability is limited to the extent of the capital that you have brought in. So that was the actual intent of the NLP city came in. An unlimited liability just to clarify means that my personal assets are liable as well. Yes they go behind your personal assets and they can possibly attach whatever they wanted to. That was what was the earlier concept possible. What kind of business is the best suited for LLP structures? Earlier we would possibly because of the tax advantage which was there we would sort of advise on some of these structures but now and also the ability to raise capital. See if you are going to get a sophisticated investor, you would not want to sit in an LLP, you would want to come in a company. If you want to go about and scale up that particular entity you have either scaling up can happen in terms of you know number of investors number of rounds of investments in a company better rather than an LLP. Usually the way we see it today law firms are LLP's we see consulting firms as LLP's audit firms as LLP's tax firms as LLP. So somebody who is in the consulting role where they know there is a defined structure they know whom to admit they know whom not to admit and they sort of are contractually in control of their existence and their future. Largely are people who should possibly go for LLP's but when you are in high C you don't know whether you are going to sink or you are going to like really go to the shore or maybe you know like it's something which would be the blockbuster idea of yours which would go you know listed or NASDAQ and you know invoice you know all of that the company structure is always the better one. Now tell us what is a private limited company in legal terms you have of course said that this is one of the best structures in case you want to raise money you want to scale for all of those reasons private limited is a good option in legal terms what does a private limited company mean and what does the founder need to know. In an LLP you have a partner you have a designated partner who is basically the guy on whom all liabilities rest the day to day operations rest and the rest of them are not real and not so liable on for day to day operations but in a private limited company there is something known as a perpetual succession does it doesn't matter if one of the shareholder dies is there is always it moves on it's very similar to an LLP largely I would possibly say there is this other element of directors who come in here from partners there is a change directors. Now director liability unfortunately is fairly large and in private companies see you again you're going on charting in high C now if you're going to charting in high C you will also have rough further which means the compliance part as I would possibly put in is a little more and there is the concept of a common seal which I think is a little dated today you know but for certain documents you don't really require a common seal and there are certain there is a lot of compliance when you have to do rounds of capital days. What is the right decision. A common seal I'm sorry to interrupt you is that a legal term. Yes so I'll tell you it's a colonial piece of hangover either as I would love to call it where you basically have a seal like you know Mohor which is adopted by the actual thing which actually embosses the paper on which it is and that becomes the seal adopted by the by the company. So there are certain documents on which it would be a financing document some of them kind of actually insist. There are a couple of them where the common seal is required to be affixed then there is a perpetual continuity the directors are there then the shareholder and then of course the liabilities limited to the extent of the shareholder of each shareholder. Normally again I mean again it comes into the green part of it. There is a concept of lifting of the corporate veil which is usually done in case of apparent fraud where because liability is not associated with the shareholders normally. So I'll just take a step back here. You need to understand the difference between what is control and what is management. Now in a private company usually the management is expected to be run by directors. They can be directors they can be shareholders they can actually hold shares or they may not hold share they can be a professionally run company. Now if for some reason let's say I put two three of my I would say lack of a better word somebody gullible as directors and basically make them do all the nonsense that I want them to controlling them from behind then technically that means that I am the largest shareholder who actually is acting through these directors. There are times when you know if at all there are there is apparent fraud and such like where you know the courts have actually sort of lifted the concept of a corporate veil because normally liabilities sticks only with the directors but sometimes because of mischief played the courts have actually said listen it is not just a director there it was you as a shareholder who was playing them so I'm coming back to you. And there have been instances where a founder has been removed from his or her post right if I'm not mistaken. So under what circumstance can a founder be removed from his or her own company? It's a very good question. We always sort of see there is a contractual part of the story then there is actually the number of shares shareholding what actually constitutes your actual shareholding in a particular company. Now if I'm going to continue if I keep on raising funds and funds and angel invest then there is VC investment there is private equity investment so my 100% of my shareholding keeps dropping to a smaller percentage. Now comes a point when the investor basically has a right because they come and it's like they will ask for the closest pound of flesh closest to the heart of the promoter where sometimes they lose their companies. When can that happen that can happen when they fall below a particular threshold or when they have certain rights which are contractually agreed upon because when they invested in they put in they agreed to the the promoter and question agreed to those rights. So then technically you can remove them from the company but you cannot let me tell you you can remove usually it is a case of you removing them from management as a director. You cannot and if you were to sort of go to the next level where you are effectively squeezing them out or you're basically taking his shares what we call as you call upon his shares because they have defaulted on certain things which are again provisions what you sort of see normally in typical VC investments. You know you're basically like you're signed up your house and you and you signed off your house to bank and you'd be faulted there what happens the bank is basically calling you. Can claw your house away from you. Yeah absolutely. So that's exactly what happens. Normally we see that it's a fairly contentious scene at that point in time you have seen that in a lot of companies right now. You know that's where I guess some of the structures like you know preferential shares which basically convert into a particular you know this was actually a concept of which was which was a Western concept where you which it was from the US Jewish students. We had certain shares which would possibly west in case there is a takeover or for that if somebody is trying to sort of reduce your percentage then you're exercise that particular right saying that listen I'm going to now come back from let's say 10 to 51 or whatever that percentage might be. So there were certain of these rights which were included in Western Jewish students. Now today of course if you are holding certain preference shares or let's say if you are holding a debentures which are convertible into equity shares of a disproportionate nature. Then I think the promoter is actually in good shape but it depends on what you agree. Ganesh, it seems like all startup founders should engage in law firm but I'm fairly certain many of them are cash trapped and cannot engage a fancy firm like Khaytan and company. So what should a young startup firm do in terms of engaging a lawyer or a law firm? Good question. Again, I would say see if you meet a lawyer, usually when you go to a law firm, there are 90% of the people who come to us or to a tier one law firm come recommended through some or other who is a friend or friend of a friend. You'll know them. You'll have some kind of a touch point there. And if that particular touch point is a genuine touch point which is a reliable and which is the source of reference basically somebody who is reliable, normally we have seen two things. One, you give certain shares to the lawyers in the startup and the lawyers basically spend their time and energy in consideration for that particular consideration, stake in such company. So that actually is not you're not really going out of pocket in that sense but you don't have cash, you don't not paying them in cash but it is non cash consideration what you actually sort of end up paying. I would, while there are certain law firms which are actually doing that but not possibly adopted by many of the law firms, some law firms it's a handshake because we are in the business of relationships. We are here for the long run and so what happens it's a golden hand shake in a different form and meaning where you basically say listen I have come to you this is what I can afford at this point in time but the moment I raise my first round of investment that is when you charge me so it's a waterfall mechanism. Wait a minute, I become rich and famous then I'll pay you a property. I'll just take a token. Just to give you some context I have been paid by somebody who could not afford me. I don't want to name them it's a very very large company today in Tirupati Ladus. Tirupati Ladus. I was just asking if it is bottles of vodka or something but I think Tirupati Ladus is a good option. He basically went to Tirupati and he said I pray to the Lord to bless me and to make my venture a great success and all I can afford right now is this amount of money and this as a result. It's volume of Ladus. Yes. I just took the process I said keep the money you'll need it we will see when you sort of become great. Did they eventually end up paying you? Yes. They came back as a good client a very paying client. See that's where I guess it's a call of the lawyer's faith in that particular idea because when we see ideas we see a lot of ideas. We know what will work usually because at the end of the day our roles as lawyers it has changed it has evolved. We now are more like bankers. We know what will work largely what will not work. So sometimes you know if we see the novel team that particular idea we usually sort of like would like to part. We are always we also as lawyers we're not looking just as legal legally or putting some document there. We also want to be part of creation of a enterprise. Okay so that's good to know that a founder can actually pay you with stake and hopefully not with Ladus all the time but they can hire a firm like Khaytan and company if they negotiate the right amount of stake. We don't take stake. I just just to just let you know at this point in time we sort of like just defer it which is safe. Golden handshake and you come back when it ready but there are other firms you're saying there are there are there are you can negotiate a stake exchange for legal services. Yes. Yes. Yes. Connition 2017 a founder named Yogan Dravasupal he went to jail for alleged fraud for apparently not paying back vendor offices or something. What are the legal risks that a startup founder needs to bear off and if I'm a founder under what conditions can actually go to jail. He fraud is fraud. Okay. Whether you're a founder of a startup or whether you're a founder of you know you're a sole proprietor or if I'm just sitting at my home and I basically you know don't pay somebody it's it's basically fraud. But jail seems a bit extreme. Unfortunately fraud is under section 420 which basically is cheating and that is the law of the land. Now what happens it's see usually what happens here is whenever we see disputes and one of the key advice I keep telling people please don't come to lawyers based of your time based of money. And you will come to lawyers in spite of you. Absolutely. Though you know if you're fighting the first thing which I tell people please do not fight just settle it out whatever the hell it is just you know do a handshake and just move on. Cut your losses and move on don't spend money unnecessarily on the proceedings of course. Don't spend money on it's wasteful money. See when you when you engage us as on a fundraise when you engage us when you're going public when you're doing an M&A it's meaningful it's it's a positive influence on the company and positive influence for everybody. But when you're actually going about in fighting because I either have an ego issue or I refuse to sort of you know honor my commitments or I have an integrity issue that sorted amongst yourself do not come to us because it's it's a waste of your time and you we will basically bill you we will the courts will basically they're already settled with time it's the typical what you know there was this movie. Err. Arig Petarig Petarig and yeah. Yeah. Yeah. Yeah. Err. Derby me. So it's one of those things which will end up you will you will basically go up to ladder but you never know when you're going to where you're going to go. All right so interesting advice from a lawyer try and settle with the handshake be amicable if you can avoid doing a lawyer for disputes and going to the courts for disputes avoid it. Yes. Yes. Unless of course unless you have you strongly believe in it that you know you have been wrong and sometimes the the the value is high very very high and that's it. If anything else about the law that has started founder needs to know is there a law primer that every start a founder should go through a basic law primer. Integrity honesty are two things which you need to start with and it has to come from within. It is not something that you know you say that listen I am a very responsible business no it has to come from within and that has to be the mantra on which you operate. If you are able to sort of comply with the letter of the law if you are able to comply with what are the laws that really sort of affect somebody as a entrepreneur. How would I find that out because sometimes the law is written in legally is language. So as an entrepreneur how do I figure out what are the laws that apply to me. So fair enough I would possibly say do you know something that there is not a single company which is existing today and I am telling you this with hand on my heart I have possibly about trying more than two decades of experience and all the poster voice of your of the of startups and everybody else or for that matter who become mature gone public whatever the hell it is. There will be something about the other which is missing. Start up the one advice I give is focus on your business don't worry about the law law will get fixed law is to enable business it is not the other way around number one number two what is what are the laws that you really need to sort of focus on you need to know your employment law which is your labor laws because I think there are liabilities around it. Now of course if depending on the nature of the startup how many people are there what is the strength of the startup in all of that if they become sophisticated the not sophisticated below 20 less than 10 all these kind of things are there it is something which you will need to sort of maintain records it's main compliance you will need to hire somebody who is possibly a lawyer or a consultant or sometimes the chartered accountant also sort of doubles up there and they sort of do this for you. The second more most important thing which I see in the current context is the indirect tax regulations of this country in the name of GST I think there is so much of harassment just just just general harassment by the regulators so make sure that your direct tax and indirect tax books are in order and your house is in order. If you have these three things in order then I think you're good to go don't worry about the rest of course if you're having if it's an idea and you're protecting everything else all of those things in terms of IP protection how you are going to sort of as whether it is it belongs to you the strong employment agreements your employee employee handbooks and manuals and all of that it comes in that whole category of what I call is label law. compliance. Alright. Kanishch, what does startup founders need to know about trademarks, copyright and patents? I recently saw somebody posting online that their clothing design was copied by somebody else, the startup's clothing design. But there's also a law apparently that says items of utility like clothing and furniture cannot actually be copyrighted or patented. So on one hand, you get upset that somebody's copying you or infringing on what you think is your creation. On the other hand, maybe you don't know the law well enough. So what do we need to know as entrepreneurs about trademarks, copyright and patents? Okay. So, trademark is the trademark of your business. You obviously… Quite often we call it a logo as well, if I'm not mistaken. No, yes, of course. You need to sort of get it, if it's an idea worth any salt, then obviously you need to get that right. You need to find your trademark. And unfortunately, the way intellectual property rights are, it's… You have the European office, you have the US office, you have the Indian office, you have the Indian patent office, you have the US patent office, you have the European patent office, you will have to get a patent in each of these places. Yes. Now, in terms of the… See, what happens in terms of copyright itself? It's effectively the expression of all of those quotes that you possibly have made your platform. It could be a design, let's say, what… It's a answer question. What is that you are effectively looking at? I can't patent my design for, let's say, a piece of clothing. You can technically, but you know, if it's a… It's effectively a design. So there is a copyright in that particular design in the way it is stuck in everything with it. So, I would possibly broadly classify that as a piece of intellectual property. If it is so significant that it is actually creating value for you, you should definitely go and protect it. The flip side to that is the moment you sort of make any application to the patent office, whatever novelty you have in any idea, that is actually in public domain. So, you are disclosing it. You are disclosing it. But that also… That means there is reverse engineering which immediately kicks in. Somebody will come there. There is a Chinese company which… Nothing against them, but there is a Chinese innovator, let's be put it that way, who will possibly come there and say, "Hey, listen, if I do the same thing differently like this, this can be achieved." And I can apply for a different patent. So you just change a couple of the parameters and you get the same products. Those things are the risks that you run. Otherwise you sort of keep it as a trade secret in which case, I don't know how long you want to protect it. Okay, India of course is the startup capital of the world with hundreds of startups and unicorns and all of that. The system, the ecosystem is buzzing. But Ganesh, yet we hear of startup founders choosing to incorporate their companies in countries like Singapore or Dubai. Why are they doing this? What are the advantages and disadvantages? Three to four questions, very pertinent valid question. One, I will answer this in two to three portions. One, it's the ease of doing business. Second tax rate. A Singapore company will have lesser tax rates. A UAE company will have lesser tax rates than the kind of taxation that our Indian company is required to sort of put in. If you were to attract financial investors, when they see a Singapore company, when they see somebody who is outside India, not that people don't invest into Indian companies, like there is venture capital, there are private industry companies which are very, very active. But there is this whole comfort level for a lot of the funds. At least this is somebody who is a Western funding their mind. Even if it is in Singapore, it's in their mind a Western fund. A Western company, it's a well run, it's a pro-pervosibly better than coming into India, where if I get into a dispute situation with the promoters, then I don't know what I'm trading on, it's thin ice. And again, we go back to the tarik, tarik, tarik situation rather than sort of like just have certain agreements which are rather robust and which will be respected. Of course, Indian diaspora also, we have sort of cross-dragists of, and our judiciary has been quite strong. It continues to be strong. We possibly are seeing the dispute resolutions at a much faster pace than what used to be earlier, rather long saga. But having said that, that's definitely an advantage. The third one, the sectors itself, the sector in which you're operating. Like I advise a lot on gaming companies. I advise a lot on Bitcoin companies. Now the problem here is the Indian government, government's current view right now. They're going against all of the gaming companies, you know, they're saying that, oh, listen, this is gambling. Now even set principles are being questioned and they get questioned every time. There is police action when you're sort of like having a game like, let's say, a Rami, which is more or less a settled proposition that it is actually a game of skill. There will be somebody who will basically go behind you and say, oh, listen, you're running a gambling den, then this is prohibited and I have the powers to sort of lock you up as a thing. Some of these things actually sort of matter. So, depending on what bit sector you are in and with all of these other parameters keeping in mind, people definitely aren't looking at other jurisdictions. And of course, the lifestyle which possibly, that's a factor as well. Yeah. Okay, Ganesh, final question. This question is about transitions. How easy is it to transition? Suppose I started a sole proprietorship. I want to become an LVP or I want to become a private limited or I incorporate a company in India and I say, okay, after a couple of years, I want to move it to Singapore. How easy or difficult are these transitions? Seeing the more mature company is a more mature sole proprietorship is, the more mature the entity is. It's like, see, you're basically put in the roots of spread. Now we are going to approve it and you're going to put it into Singapore or some of it. What we call as an externalization structure. One, there are tax issues because there is, you know, the first thing is that you have created value here, you're uprooting here and there, you know, it depends on how you're doing it, of course. Whenever you externalize anything, it is best done. Rather, I would not say that it's best done that you start in Singapore or in some of the jurisdiction outside. But whenever you decide to sort of move, do that particular choice early in the ecosystem. Because what's going to happen is, if you do not do so, I would say that the cost of compliance and I would say the cost of, you know, the severance of the umbilical chord between India and, you know, eventually sticking it up is going to be fairly a large number. That's something which is avoidable. Alright. Ganesh Prasad of Khaitan and Company, thank you very much for talking to us at E.T. Startup Schools. So, thank you. Thank you for having me. Pleasure. So, that brings us to almost the end of today's class at E.T. Startup School. 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