The drawbacks of ignoring important legal documents in a start-up

The drawbacks of ignoring important legal documents in a start-up

Successful startups are ones that are driven by passionate entrepreneurs who are focused on building unique solutions that deliver customer delight. While it is very important to have a strong focus on customers and the market, it is equally critical to have a good understanding of the basic laws, rules, and regulations that are applicable for the smooth running of the business.


Important Legal Basics

• Formalizing the business structure and the agreement between the founders: The first thing to start is to be clear about the essence and form of the company. Founders will need to incorporate the business as a specific business type – sole proprietorship, private limited, public limited, partnership, limited liability partnership, etc. At the very beginning, it is very important to have this transparency, because this will be central to the overall vision and priorities of the company, both in the short and long term. That type of company comes with its own set of legal requirements and regulations, and before implementing the company, companies should pay careful attention to these.

• Applying for business licenses: Licenses are integral to running any business. Depending on the nature and size of the business, several licenses are applicable in India. Knowing the applicable licenses for your start-up and obtaining them is always the best way to start a business.The lack of relevant licenses can lead to costly lawsuits and unwanted legal battles. Business licenses are the legal documents that enable a business to function when the business registration is the formal method of registering a company with the formal registrar (along with relevant information). The common license applicable to all undertakings is the Shop and Establishment Act, which extends to all premises where trade, company, or occupation takes place.Other business licenses vary from industry to industry.For instance, an e-commerce company may require additional licenses like VAT registration, Service Tax Registration, Professional Tax, etc. while a restaurant may require licenses like Food Safety License, Certificate of 
Environmental Clearance, Prevention of Food Adulteration Act, Health Trade License, etc along with the above-mentioned licenses.

• Understanding taxation and accounting laws: Taxes are part and parcel of every business. There is a wide range of taxes, such as federal taxes, state taxes, and even local taxes, which may be unique to some businesses. Specific market and operating sectors draw various taxes and understanding this will prove useful in advance.As regards business accounting, keeping and auditing proper record books from time to time is a reasonable practice to ensure that applicable accounting and tax laws are adhered to.Given the small size of the business, many start-ups initially do not pay close attention to accounting requirements. This condition cannot however be overlooked for as long as it can lead to significant differences in accounting.

•Adhering to labor laws: Adhering to labor laws are integral to every organization, small or big. When you are established as a company and have hired people to work for your organization, you are subject to several labor laws regardless of the size of the organization. Laws with regards to minimum wages, gratuity, PF payment, weekly holidays, maternity benefits, sexual harassment, payment of bonus among others will need to be complied with. It is best to consult a legal counsel to assess the laws applicable to your start-up and ensure that your startup is compliant with the required labor laws. Start-ups also often hire consultants or freelancers in addition to full-time staff, hence employee policies should cover all employment details with regards to employees both full-time and part-time.Having a well-designed employee policy can be a major differentiator for start-ups. A friendly strategy for workers may be the secret to recruiting and retaining good talent. Employee policies may also prove to be the point of departure to improve employee morale and increase productivity.

• Ensuring intellectual property protection: Intellectual property is today the secret sauce for most businesses, particularly tech-centric businesses. Among other items, software, algorithms, and research results are among the most valuable intellectual property owned by organizations.Start-ups can leverage the ‘Scheme for Start-ups Intellectual Property Protection’(SIPP) under the Start-up India initiative. The scheme was set up to nurture and mentor innovative and emerging technologies among start-ups and help in the protection and commercialization of intellectual property. Facilitators have been impaneled by the Controller General for Patents, Trademarks, and Layout for the successful implementation of the scheme.


Legal Mistakes that Start-ups make

Startups are particularly vulnerable to legal problems related to many different fields, such as protecting their intellectual property, having the correct terms and conditions, and various types of contracts for jobs. Co-founders often feel that they only need to get their legal agreements later, once legal issues have already arisen.Unfortunately, though, not only will it be too late by the time this occurs but it is also almost certain that it would cost the company more money to resolve the legal problems than it would have been if they had the correct legal agreements in the first place.

Following are some of the legal mistakes Start-ups make:

• Neglecting basics: Any start-up needs to have the necessary legal documents in place from as early on in the company as possible. This means having shareholders agreements, co-founders agreements, and any other necessary agreements needed to launch the company.It is easy for start-ups to fall into the trap of not having a legal system in place, either because they are unaware that it is obligatory, or because they are not willing to spend the money that is required. 

• Ignoring the registration process: A key legal document that sets the foundation of their company involves how and under which structure their business is registered, specifically the Memorandum of Association, thereby setting out how their business is going to operate in the future. If they want to incorporate their business it is important to do it as early as possible.

• To not protect Intellectual Property Rights: Protecting intellectual property is probably one of the first things that start-ups think of.However, if a patent has not yet been obtained, it is best not to disclose information about your invention and hence keep your intellectual property as a trade secret. Anything that is open knowledge is a fair game to use by the general public. Therefore, if you do not have valid trademarks or patents in place within your company, your employees and your co-founders would be bound by a non-disclosure agreement.

• To not hire the right legal counsel: Many start-ups, unfortunately, tend to hire lawyers who do not have the necessary experience or expertise when it comes to dealing with entrepreneurs and new businesses. Besides, start-ups will often try to save money in the legal department. Not investing in the right legal counsel will lead to inadequately drafted documents, mistakes, and an unsatisfactory and incomplete understanding of what is needed for the company to operate safely within the bounds of the law. 

• To ignore agreements into writing: Although oral and electronic agreements are legally binding, if an agreement were to be in writing, this would prevent a lot of hassle and avoid ‘he said she said’ scenarios therefore only relying on word of mouth. In the long run, it would be cheaper for all the parties involved to put their agreements into writing. That would mean virtually no lawsuits or court appearances. When one of the parties concerned violated the deal, the implications and consequences will be straightforward and unchallenged.

• Fail to comply with business tax laws: Start-ups need to make sure they know what kind of taxes their company may be subject to. This is an important legal issue, as it is vital for you as a company to be fully informed on any VAT policies and other tax policies. Furthermore, you need to know how and when to pay your taxes as a company. Failure to have the right tax structures will lead to endless needless legal problems down the road.

• They think that legal problems can be solved at a later date: This is very risky to believe that legal issues will be solved at a later date. For several reasons, this is risky, such as the simple fact that not resolving the problems quickly would only make them bigger, because many of the legal issues that start-ups that face have time limits because deadlines.


References :-

1. Richard Harroch, ‘10 big legal mistakes made by startups’ (Forbes, 03 October 2013) <> accessed 17 June 2020
2. Shrijay Seth, ‘Why do Start-ups fail? 5 legal aspects startups overlook’ (Razorpay, 25 November 2019) <>
3. Matthew Faustman, ‘The top 7 legal documents for every start-up’ (India, 11 January 2016)
4. Marci Martin, ‘A guide to handling a Business Lawsuit’ (Business News Daily, 18 May 2018) <>