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.

Notes:

  • 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

17 comments:

Anonymous said...

nice information!keep informing...
http://www.mentoringofamerica.com/Mentoring/

SM said...

Very informative.
Related information about starting a company in Bangalore:
starting-a-company-in-bangalore

SM said...

The link in my previous comment does nto seem to work, so posting again.
http://www.techjini.com/blog/2007/06/01/starting-a-company-in-bangalore/

Anonymous said...

Very nicely put. Starting a company seemed non threating as people make it sound.

Gaurav said...

Very good information. Even though the process is long, it is not as bad as I thought. It is good that atleast most of the forms are available online in PDF.

I created an LLC in US, using www.legalzoom.com. I spent about 30 minutes to provide all the info to the site and they did the rest. The whole process took around 10 days, but it was very convenient.

I wonder if it will be a good idea to clone legalzoom in India? A one-stop (online/perhaps offline as well) service that takes care of all these forms and processes. I guess the biggest hurdle would be the bribery. Would the applicant pay the bribes as "misc" charges or the document processing company standardize it and include it in their service fee :)

Anonymous said...

Very useful information... thanks a lot
If you have time can you please talk about the difference b/w partnership company and pvt lmt company...

Vaibhav said...

Just the kind of Info i was looking for.
Cheers,
Vaibhav

jidesh kumar said...

MCA 21 envisages electronic filing of documents and paperless administration and pertains to Registrar of Companies offices as stipulated in the Indian Companies Act, 1956 (the Act). One can get a complete understanding of the MCA 21 from the MCA portal. The key benifits envisioned by the MCA 21 are as under:

(a) On‐line incorporation of companies
(b) Simplified and easy mode of filing of Forms/ Returns
(c) Registration as well as verification of charges anytime and from anywhere
(d) Inspection of public documents of companies anytime from anywhere
(e) Corporate‐centric approach
(f) Building up a centralized database repository of corporates operating in India
(g) Enhanced service level fulfillment and customer relationship building
(h) Total transparency through eGovernance (i) Timely redressal of investor grievances (j) Availability of more time for MCA employees for qualitative analysis of corporate information

All the ROC's have virutally become back offices and several facilitaion centers have been set-up know as Registrar’s Front Offices (RFOs).

Armed with this knowledge, I proceeded to incorporating the company. For MCA21, the following four types of users are identified as users of Digital Signature Certificates (DSCs).
(a) MCA (government) employees ; b) Professionals (Chartered Accountants, Company Secretaries, Cost accountants ) who interact with MCA and companies in the context of the Companies Act, 1956.; (c) Authorized Signatories and Directors of Companies ; (d) Representatives of Banks and Financial Institutions
I had already solicited the help of my collegue Vinod [who works with us ] who also happens to be a CA.


The first step - OBTAIN A DIN /Director Identification Number

Process

An existing Director/ person intending to become a Director are required to make an application to MCA for allotment of a unique identification, namely, Director Identification Number (DIN). It is intended to be a lifetime number. For obtaining DIN, form DIN1, requiring personal details such as name, address, and email ID of the person making an application, is required to be filled in. There is a fee of Rs. 100/ for application for allotment of DIN. On submission of of form DIN1 online, applicant shall be allotted a provisional DIN and then he/ she is required to pay the requisite fees with reference to the provisional DIN obtained. The applicant shall be required to take a printout of the submitted eForm and will have to attach proof identity, proof of residence, proof of father’s name, proof of date of birth and photograph. The applicant shall be required to sign the physical copies of the form and get these documents duly notarzed/ attested by an approved authority. The applicant shall be required to send these documents along with the proof of payment made for DIN application to MCA DIN Cell at Noida. On receipt of these documents, the application will be scrutinised and on approval, the DIN shall become active. The outcome of application (approval / rejection) shall be communicated to the user through email. Also the applicant can enquire the application status by quoting provisional DIN allotted at MCA portal.

Comment:

DIN is a mandatory process for foreign directors too and is required while applying for Form 1A [Name Availability Form]. A provisional DIN number is allotted instantly upon uploading the required information on the MCA portal. Eureka, it works..

The process of obtaining a permanent DIN however takes approximately 4 weeks subject of course to documents being in order. Form DIN-2 needs to be submitted to the MCA along with the approved number of all companies of which they hold a director position. DIN-3 attested by Company Secretary is required to be submitted to the concerned Registrar of Companies (ROC).

The Second step - DSC/ Digital Signature Certificate

The Digital Signature Certificate (DSC) is another requirement that is now required to be accomplished. I suggest that the DSC be applied parallel alongside applying for Name Availability since the process of incorporation can be accomplished that much more faster. The DSC can be obtained from six private agencies authorized by MCA 21 (Ministry of Corporate Affairs 21st century).

For the purpose of using the new electronic filing system under MCA 21 Project the applicant needs to obtain a Class II Digital Signature Certificate. Company directors submit the prescribed application form along with proof of identity and proof of address. Each agency has its own fee structure which ranges from INR 400 to INR 2650.

Comment:

The process was remarkably smooth with the process taking around 2 days, although Vinod did share with me that he had encountered problems previously. If the directors are foreign in origin, valid address proofs in the form of passport duly notarised and photographs would need to be provided. It is advisable therefore that several copies [I had around 5 copies] of the address proof of the directors be notarised since this saves valuable time. A good CA is very necessary to ensure that there are no undue delays.


Step three - Applying for Name Availability


Perceived to be a simple step, this can at several instances be time consuming. It is therefore advisable to go in for professional consultation before one applies for name availability. Clients often feel that their chosen names would be made available to them as a matter of course. This of course is from from reality. There are a few tips to get your name of choice.

Firstly, caution must be exercised that the chosen name is not generic., in the sense the name must not be too general. For example Wipro technologies - while the name Wipro is just fine, the Registrar of Companies (ROC) would take objection to the usage of 'technologies'. This is because the ROC is guided by an internal circular to the effect which has come into effect post incorporation of most MNC's who tend to have generic names.

Secondly, a good CA would always suggest you to check informally at the ROC whether a choice of name would be available. This is quite critical to hasten the process.

Thirdly, in case of a wholly owned subsidiary, if the choice of name bears the name of the parent entity, it is always advisable to obtain an NOC from the parent entity to the effect that it has no objection in the Indian subsidiary using the same name. This is particularly so if the parent entity is a well known name eg., Walmart

Fourthly, it is necessary to provide six names in the order of preference. It is necessary to make an intelligent choice of names since the ROC is likely to grant the second choice if the first does not fit the bill.

Comment:

We were able to obtain the desired name with not much difficulty since we had done our homework of checking with the name with the ROC well in advance. Officially, the ROC accomplishes this taks in 7 days and I must say that more often than not this timeline is often exceeded. It amazes me as to how much can be accomplished with bureaucrats in India with the right connections.


Step four -Memorandum & Articles to be stamped

Once a name is approved, the Memorandum of Association and Articles of Association together with miscellaneous documents have to be filed within six months of the approval. In practice, if the proposed name is available the same is granted within 2 or 3 days.

The application should be accompanied necessarily by the following: (i) Unsigned copies of the Memorandum of Association and Articles of Association. (ii) Payment receipt. Ensure that the copies submitted to the Superintendent of Stamps or to the bank for stamping are unsigned and no promoter or subscriber has written anything on it by hand. The Superintendent returns the copies, one of which is duly stamped, signed and embossed evidencing the payment of the requisite stamp duty. The rate of stamp duty varies from State to State. According to Article 10 and 39 of the Indian Stamp Act,1899, stamp duty payable on memorandum of association and articles of association for a company to be incorporated in Mumbai, Maharashtra is: AOA: Rs. 1000/- for every Rs.500,000/- capital or part thereof subject to a maximum of Rs.50,00,000.00. Stamp duty for the MOA is Rs.200.00 Once the Memorandum and the Articles of Association of the Company have been stamped, the same is required to be signed by the Promoters of the Company including commencing with the name and description, father’s name, address, occupation and the number of shares subscribed for in their own handwriting which is duly witnessed. After signing the documents are to be dated. Declaration form 1: On Rs 100 stamp paper

Comment:

It took us around 2 working days to get the stamping done. The process was however delayed since we had to get the overseas directors to sign off on the Memorandum and Articles.

Final Steps - Documents to be presented to obtain the Incorporation Certificate

After the stamping of the MOA and AOA, 3 copies along with the following documents are required to be scanned and uploaded on the MCA-21 Portal: - The stamped copies of the MOA and AOA - Copy of the Form-32 along with the consent letters of the Directors of the Company, who are appointed therein. - Form-1 - application and declaration for incorporating of a Company and printed on non judicial Stamp paper worth INR 20. - Form 18-evidencing the address proof of the Company. - Form-1A-evidencing the name approval. - Copy of challan evidencing the fee with respect to above mentioned forms. - Power of Attorney from the subscribers in favor of any person for making corrections on their behalf in the documents and papers filed for registration .This must be on nonjudicial stamp paper of INR 100. - Identification of the subscribers by way of copy of driving license, passport, voters identity or ration card. These documents, in addition to their online uploading, are also to be filed in original with the ROC. Once the documents are uploaded and confirmation of payment of fee is received from the Bank by the ROC, it processes the papers in order of their receipt. A software ensures that the queue can not be jumped by ROC. The fees paid to the Registrar for registration are scaled according to the amount of the authorized share capital of a company as stated in its memorandum.

Comment:

The process of issuing a certificate of incorporation normally takes seven working days. Pursuant to incorporation, TAN and other necessary registrations as required can be obtained.


Concluding remarks

In all the process of inorporating of a private limited company in India can be a smooth process if the right tools of approach are adopted. We took around 18 working days to obtain the certificate of incorporation. I must make a special mention that that the government has made an honest attempt to smoothen the rough edges that one encountered in incorporating a company. This is not to say that the present system is fullproof as one can still find old barks of wood at the ROC reminding one that it may take a while before things are up to speed of this digital era.

H/P: +91 9811620150

Jidesh Kumar.M.D
Managing Partner
King, Stubb & Kasiva
Advocates & Attorneys
E-66, 2nd Floor, Kalkaji
New Delhi- 110019
India

Ph : +91 11 - 41032969, 41318190, 41318191
Fax: +91 11 - 41329569
Web: www.ksandk.com
E-mail: info@ksandk.com

Raag Vamdatt said...

Awesome....

Thanks for the step by stp, detailed info on incorporating a company!

Again, awesome!

Anonymous said...

Hi Guys,

I have a doubt regarding the shares during incorporation.
In the MOA if you say Mr. A has Rs. 50,000 worth of shares and Mr. B has Rs 50,000 worth of shares. After the company bank account is opened do Mr. A and Mr. B have to put Rs 50,000 each in the company or can they own shares without putting money in the company??

Deepak Shenoy said...

If you have an MOA saying so then you have to put the money in - otherwise it's an unrealised amount (it can be a "receivable" of sorts, but your auditor will request you put it in)

Anonymous said...

Thanks Deepak. Much appreciated.

Navin Pathak said...

World Bank has created an excellent site, listed below, on this topic.
http://www.doingbusiness.org/ExploreTopics/StartingBusiness/Details.aspx?economyid=89

Navin pathak
www.entryindia.com

HIM said...

A must read for all aspiring Indian Entrepreneurs. Wish I had seen this earlier.

krishna said...

very cool - thanks for the post. just the info I was looking for.

Anonymous said...

Thanks

Anonymous said...

Dear All,
Thanks for sharing the valuable information. Would you please share some of the contact details of the professional auditors whom you are aware of and based in Bangalore? Currently I am based in Tokyo and planning to movie to Bangalore very soon. I am interested in staring a new company and the core business would be insurance. Any suggestions/insights would be highly appreciated.

————
Best Regards,
Vikas