Friday, June 15, 2007

Starting a company in India: The regulatory issues

I'd like to talk about some of the things you need to do if you're starting a company, aiming to get funded and the like. Note that you can get professional help for most of the below; accountants will help you through the process for a fee.

1. The "Private Limited" entity

You could create a proprietorship or a partnership, but if you're looking at investors and venture capital you will want to have a private limited entity. This is a "firm" - a company registered with the Registrar of Companies (ROC), and while it provides limited liability there are much more regulatory issues to deal with. Let me assume you're going ahead with a private limited company.

The way this works:

  • The company is founded with a certain amount of startup capital (we'll talk about that later)
  • Each founder (and angel investors) get "shares" allocated to them for a price they pay
  • These shareholders (called "members") elect a board of directors to represent them at the company. For a startup, you will typically have all working founders and representatives of any outside investors on the board.

2. Getting a "DIN" - a Director Identification Number

Registering a private limited company requires that all directors get themselves registered at the ROC. You should apply for a Director Identification Number (DIN) - you can do so online - by filling out a PDF form and submitting it. A provisional DIN is allocated, after which you need to print the page, sign, get a notarisation from a practicing CA and send it to the MCA office. This costs nothing, except a small amount you may pay for the notarisation.

3. Digital Signatures

All applications for creating private limited companies now require online forms and digital signatures. Details are on the MCA web site - and a number of certifying authorities provide these signatures as USB tokens. The cost ranges from 500 to 2000 per year.

You need just one DIN and one digital signature, even if you are a director in 10 companies. Also note that for the purpose of starting a company, only one director's digital signature is needed.

4. Naming ceremonies

You need to get the name registered first - this is to ensure that your company does what your name indicates.

Download and fill Form 1A (all forms are downloadable ). You can upload this to the MCA site and pay Rs. 500 for the service online. The name then must be approved by the ROC, which is a discretionary and sometimes, unfathomably arbitrary process. Amit Ranjan has a post on his experience.

A good CA can get your name approved with a personal sit-down and explanation.

About these forms: each PDF form has a "Check Form", "Prescrutiny" and "Submit" button. At this point, none of the "submit" buttons work - you have to submit the form manually.

5. Incorporation - Memorandum and Articles of Assocation

You can then get your CA to create your Memorandum of Association (MoA) and Articles of Association. In simple terms - the MoA specifies WHAT your company wants to do. The AoA specifies the framework of organisation (who are the directors, what kind of voting, how will expenses be approved, how many people form a quorum for an AGM etc.) The articles are important in that they should not be one-sided towards specific shareholders (will tick off investors, who'll change them anyway). Most likely your CA will draft one from a standard set of terms that they have earlier passed through the ROC.

These need to be attached with Form 1 (again, downloadable), digitally signed by you and your CA. When you submit, you'll pay fees based on your "authorised capital". This is the amount of money you plan to convert into shares. So for an authorised capital of Rs. 100,000 you can issue 10,000 shares of Rs. 10 each (or 100,000 shares of Rs. 1 each and so on). The "paid up" capital is the money actually converted to shares - so for an authorised capital of one lakh, you can pay up just Rs. 10,000 and divide that 10,000 into shares to founders.

You will pay a certain stamp duty and registration fee for the "authorised capital" - it goes from 4,000 for a 100,000 authorised capital to 26,000 for about 10 lakhs and so on. People may advise you to go for a lower authorised capital to save on this registration cost, and keep any excess capital as a "loan" instead. But this structure may reduce your later compensation when you get investors in, as the loan may be returned and your shareholding moved to a vesting structure, giving you very little value for the money you've put in. Don't lose out on future value for a few thousands today.

Remember, you are both an investor and a "manager" - meaning you have both management and control interests in the company. A new investor can come in and choose to vest the ownership you get as a "manager" but that should not compromise on your holding as an investor. Split the two - in fact, at important points, think independently of decisions as a manager and an investor.

ALong with Form 1, there are two other forms - Form 18 and Form 32, that need to be signed and submitted to the ROC.

6. Opening a bank account

Once your company is "approved" you will get a piece of paper called the "incorporation certificate". When you have this, along with a "common seal" (your CA will get this done) and a printed copy of your MoA and AoA, is you can pop the champagne or the poison of your choice.

But to pay for the champagne, you may want to open a bank account. Banks will ask for the documents and your PAN/TAN number (mentioned below). Account opening can be upto four days and you will be required to fund the "current" account with about Rs. 10,000 or so.

7. Registration with other authorities

  • PAN/TAN number: This is for paying and deducting tax. Can be applied for online. Needs an address proof, for which a copy of the aforementioned Form 18 is ok. You need this to do any tax stuff, or to open a bank account.
  • Bank Account: For a bank account, you need to provide, at the very least, your MoA/AoA, incorporation certificate and PAN/TAN acknowledgement of application. Some banks will ask for more details. Also you can ensure that two signatures are needed for cheques, and get a netbanking ID so all investors can be made aware of the expenditure.

8. Do you need an office?

If you're planning to work from home, don't bother with a few registrations because they will want you to put a signboard with your company name on the outside. Most residential societies will not allow this. Yes you can perhaps get away with bribing the labour inspectors etc. but frankly that's not the "clean" way to do things; if you're in the business to get other investors or to sell the company, you need it as clean as possible.

But if you do need an office or want to hire employees etc. you should get the following registrations:

  • Shops and Establishment : Karnataka has this act where you need to register an office, but other states will have their version as well.
  • Professional tax: A state levied tax on salaries paid out. You need to pay Rs. 2500 in karnataka to register, and depending on salaries paid, pay a certain amount (max. 200 per person/month) to the Professional Tax office.
  • Service Tax and VAT: The Central Excise department wants you to pay tax on pretty much any revenue - VAT is if you sell a product and Service tax, if you render services. Registration is important. Service Tax registration can be delayed till revenues are above Rs. 7 lakh a year.
  • Provident Fund (PF) : For 20 employees or more, this is mandatory. Lots of documentation, but you can get someone to help for about Rs. 5,000 or so.
  • Employee State Insurance (ESI): Applies to Karnataka, but other states do their own number. This is for employees whose income is less than Rs. 7,500 per month, and again, only applies if you cross 20 employees. Get someone to help, it's cheaper.

9. Compliance and Accounting

Post registration, a private limited company needs to maintain records and be compliant with the laws. That would sort of be obvious, but honestly it requires some work on a regular basis.

  • ROC compliance: Involves Maintaining a big fat "statutory register" - no big deal really - ROC filing at key points and maintaining board minutes (using signed minutes is fine, once a quarter is legally required). You can do this yourself or use the services of a Company Secretary (typical charges: Rs. 3000 - 5000 per visit). You might need to revisit this process once a quarter if you are a small startup.
  • Professional Tax, PF/ESI, VAT/Service Tax : For these there are monthly, quarterly and/or annual returns.

    Get a person to help you out in this process - typical costs are about 3-10K per month.
  • Tax Deducted at source (TDS) and Fringe Benefit Tax (FBT): again, monthly and/or quarterly returns, could be done by the same person as above.
  • Accounting: You need someone to maintain books of accounts. If you choose to use an accounting software, you can bring someone in to enter vouchers etc. Typical costs are Rs. 1000 to Rs. 5000 per month. You might not need them every day - once a week might be ok.
  • Tax and Statutory Audits: At the end of the financial year, you will end up needing to file accounts in two places - the ROC and the Income Tax department. The actual numbers will vary because of the great Indian fight between these two departments on what constitutes "depreciation". You'll need a Chartered accountant to "audit" your accounts for the ROC, and someone to help you file the Income Tax returns. Typically the same CA will help with both, and charges vary from 10,000 to 10 lakhs depending on many things including your accent.
  • Inspections: Officers from various departments may visit your office for "inspections". Do not instantly hand them bribes or even meet them as a "CEO" or such hi-fi designations. Let the process run through and you can even negotiate bribes if demanded. Whatever happens, ensure there is paperwork to back it up (like an inspectors report or such).

The entire incorporation process can be done is as less as 15 days, unless you want to start a company named "Infosys Wipro TCS Congress BJP CPI Indian Government Private Limited" in which case the time required is: forever.

While all this may sound daunting, a good CA can help you do this fast. Remember that although a CA will help you through the process, you need to ensure that no corners are being cut, since it is something you will have to explain later when legal and other due diligence is performed. Keep yourself informed about what needs to be done, but outsource it to accountants. While you can delegate this task, you can't absolve yourself of the responsible.

What you want to do is get this done with the least amount of one-time and continuous pain, and get on with the real work.


  • Post incorporation funding: When you incorporate and create a bank account you need to then fund the account with money. Assuming the founders and early investors will put in money, take care to note down the money received, and if required, provide equity shares for the money. For example, if you have asked for an authorised capital of Rs. 500,000 and four founders want to initially put in Rs. 25,000 each, you might issue 2,500 shares of Rs. 10 ("face value") each to the investor, for a total "paid-up" capital of Rs. 100,000. A few months later, some investors might put up a further 100,000 and then you issue fresh shares of the same Rs. 10 face value (but these shares can be sold for higher, like Rs. 50, if you please)

Some other Links:
Startup costs in Bangalore