Tag Archives: Startups

Checklist of applicable sections for a private limited company, under the new Companies Act, 2013

Checklist of applicable sections for a private limited company, under the new Companies Act, 2013.

Author : Geetika Chandel – a Company Secretary; manages Compliances at NovoJuris. She loves making graffitis.

Disclaimer: This is not a legal opinion and should not be construed as one. Please speak with your attorney for any advice.

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India Budget 2013-14 : Impact on Angel Investors and Startups

We had shared this note privately to many of the angels and startups who are raising investment. And then, quite a few interesting conversations emerged. Sharing here for the larger audience.

Here’s the link to the Budget Speech http://indiabudget.nic.in/bspeecha.asp. The references made below are to this Speech.

Angel Investors pooling in money and obtaining SEBI registration as Category I AIF Venture Capital Fund shall be given a pass through benefit from Income Tax perspective.

Two important references in point 95 and point 143.

‘Pass through’ means the legal entity (which has pooled the money) need not pay taxes and the same is taxed in the hands of the LPs.

In May 2012, SEBI repealed the VC Regulations and brought in Alternate Investment Fund Regulations (AIF Regulations). Under AIF there are three categories. Category I AIF is the one relevant for our discussion here, which  invests in start-up or early stage ventures or social ventures or SMEs or infrastructure or other sectors or areas which the government or regulators consider as socially or economically desirable and shall include venture capital funds, SME Funds, social venture funds, infrastructure funds and such other Alternative Investment Funds.

Further, AIF Cat.I has a minimum pool size of Rs. 20 crores and each LP’s ticket size of Rs. 1 crore amongst other requirements.

The point is, Angel Investors will have to meet the SEBI registration requirements in order to obtain the tax benefit.

The Finance Act 2012 brought in an amendment to tax the share premium which is above the fair value of investment by the resident angel investors and not proven satisfactorily to the tax assessing officer.  This amendment is effective 1 April 2013.  The hope was this would be reversed, but no.

Text of Points 95 and 143 of the Budget Speech:

95. Angel investors bring both experience and capital to new ventures.  SEBI will prescribe requirements for angel investor pools by which they can be recognised as Category I AIF venture capital funds.

143.        Venture Capital Funds have been allowed pass through status under the Income-tax Act.  The relevant regulations of SEBI have been replaced by Alternative Investment Fund Regulations.  Hence, I propose to extend, subject to certain conditions, pass through status to category I Alternative Investment Funds registered with SEBI as venture capital funds. Angel Investors who are recognised as category I AIF venture capital funds will also get pass through status.

Incubators

Incubators located within academic institutions and approved by Ministry of Science and Technology or MSME can now raise money from large corporate and the corporate get the benefit of its CSR obligation (Corporate Social Responsibility).  The CSR obligation is proposed in the Companies Bill 2012, which is passed at Lok Sabha and awaits approval from Rajya Sabha (expected in a couple of months) and the President’s assent for it to be an Act (legislation).

Under the Companies Bill, corporate (private and public) that make an average profit of at least Rs 5 crore  or have a worth exceeding Rs 500 crore, or their turnover exceeds Rs 1,000 crore in the last three years will have to spend 2% of the net profits in CSR.

So, apart from DST and DIT funds the incubators can now also get funding from large corporate. It also appears that there is an approval process required by  the Ministry of Science and Technology or Ministry of MSME

Text of point 76 of the Budget Speech

76. Incubators play an important role in mentoring new businesses which start as a small or medium business.  The new Companies Bill obliges companies to spend 2 percent of average net profits under Corporate Social Responsibility (CSR).  I am glad to announce that the Ministry of Corporate Affairs will notify that funds provided to technology incubators located within academic institutions and approved by the Ministry of Science and Technology or Ministry of MSME will qualify as CSR expenditure.

Exit opportunities:

Company buyback: Company will have to pay 20% tax on such buyback.  There was no tax incidence on company buy-back.

The consideration paid by the company for purchase of its own unlisted shares which is in excess of the sum received by the company at the time of issue of such shares (distributed income) will be charged to tax and the company would be liable to pay additional income-tax @ 20% of the distributed income paid to the shareholder. The additional income-tax payable by the company shall be the final tax on similar lines as dividend distribution tax. The income arising to the shareholders in respect of such buy back by the company would be exempt where the company is liable to pay the additional income-tax on the buy-back of shares.

Listing: The listing process under BSE-SME exchange is further simplified for startup companies.  The Listing norms for the SMEs (at a very high level) are as below.

  1. Net Tangible assets of at least Rs. 1 crore as per the latest audited financial results
  2. Net worth (excluding revaluation reserves) of at least Rs. 1 crore as per the latest audited financial results
  3. Track record of distributable profits in terms of sec. 205 of Companies Act, 1956 for at least two years out of immediately preceding three financial years and each financial year has to be a period of at least 12 months. Extraordinary income will not be considered for the purpose of calculating distributable profits. Other wise, the networth shall be at least Rs 3 Crores.
  4. Other Requirements:  (i) The post-issue paid up capital of the company shall be at least Rs. 1 crores (ii) The company shall mandatorily facilitate trading in demat securities and enter into an agreement with both the depositories (iii) Companies shall mandatorily have a website

The Finance Minister in the Budget provided for listing on the SME exchange without having to make an IPO.

95. Small and medium enterprises, including start-up companies, will be permitted to list on the SME exchange without being required to make an initial public offer (IPO), but the issue will be restricted to informed investors.  This will be in addition to the existing SME platform in which listing can be done through an IPO and with wider investor participation.

FDI versus FII:

There has always been some confusion on FDI and FII and this time around there seems to be (somewhat arbitrary) explanation provided by the FM.  The RBI regulations reference “FDI” limits, so we’ll now need to evaluate if this clarity adds to a whole lot of other confusion.

Text of sub-point under point 95

In order to remove the ambiguity that prevails on what is Foreign Direct Investment (FDI) and what is Foreign Institutional Investment (FII), I propose to follow the international practice and lay down a broad principle that, where an investor has a stake of 10 percent or less in a company, it will be treated as FII and, where an investor has a stake of more than 10 percent, it will be treated as FDI.  A committee will be constituted to examine the application of the principle and to work out the details expeditiously.

Disclaimer: This is not a legal opinion and should not be construed as one. Please speak with your attorney for any advice.

Legal Issues in E-Commerce – Part 3 of the series

In the earlier posts, Part 1 and 2, we examined a few legal issues related to the business side of e-commerce and conducting business electronically. In this post, we are detailing some of typical questions that e-commerce businesses ask us.

Deep-linking, hyper-linking:  Many a time, the website may provide links to third party websites.  If this link is to the home page (hyper-link), it is not considered as copying the website and therefore is not a copyright infringement.  However, some of the websites expressly prohibit or require permission even for hyper-linking. For example, RBI expressly requires their permission before linking, though it is against the customary practices of internet.

Deep-linking (Courts have in some cases defined it as linking beyond the home-page) is treated differently from hyper-linking.  There are many aspects to this.

Websites which earn revenues through advertisements, object to deep-linking, because the user is directed to an internal page, by-passing the advertisements on the home-page, thereby causing loss of revenue. While this point is a business issue, there are wider legal ramifications as well.

In Bixee versus Naukri.com’s case, since the user was led to the internal pages of Naukri, thereby by-passing the home-page which usually has advertisements, Naukri claimed loss of revenue. There was another aspect to this case as well.  Bixee’s business was enabling users of its website to search for jobs on various other websites.  By deep-linking to Naukri.com’s website, Bixee was using Naukri’s database for its business.  Database is protected through copyright and such deep-linking was considered as copyright infringement.

Incorporating webcontent which is copyright protected by framing, is another point that is usually considered as copyright infringement.   

Related to the above, is where deep-linking is used for comparing prices of different products.  For example: if you want to capture that the price of a mobile phone on your website is cheaper than that offered on, say FlipKart, then in some ways it also gets construed as comparative advertising. While there are no established standards in India, unlike in other geographies, at a minimum it is required to ensure that the information / presentation does not

  • principally capitalize on the reputation of the tradename of the competitor.
  • discredit or denigrate the goods, services, marks or name of the competitor.
  • Mislead the customer or create a risk of confusion.

Courts across various jurisdictions are grappling with issues of infringement of intellectual property rights through deep-linking, meta-tagging.

Another important question that is prominently asked in an e-commerce business is Privacy.

Privacy: In India, though we do not have a separate legislation, Supreme Court has always upheld the Right to Privacy under the Fundamental Rights in the Constitution.  Privacy is very closely linked to Data Protection. Information Technology Act (IT Act) provides for some measures of data protection.

IT Act covers instances such as (i) computer trespass, violation of privacy (ii) unauthorized digital copying, downloading and extraction of data, computer database or information, theft of data held or stored in any media (iii) unauthorized transmission of data or program residing within a computer, computer system or  computer network (cookies, spyware, GUID or digital profiling are not legally permissible) (iv) data loss, data corruption (v) computer data/ database disruption, spamming (vi) denial of service attacks, data theft, fraud, forgery (vii) unauthorized access to computer data / computer databases (viii) instances of data theft (passwords, login IDs) and the like. IT Act also covers instances of cyber offences like hacking, tampering computer source documents. There are both civil and criminal liabilities prescribed in the IT Act.

In an e-com business, quite a few personally identifiable information gets collected, individual’s name, address, telephone numbers, profession, family, educational background, banking details.  Passing on this information to interested parties not only leads to intrusion of privacy but also other legal issues. Many do opine that in the era of social networking, privacy is over-rated.  Try asking them a question if they would like to expose their personal credit card number J

The IT Act does not lay down privacy principle like the Data Protection Act of the EU or the Safe Harbor Principle of the US. But following the highest standards of conducting business, the privacy policy of an e-com businesses need to answer atleast,

  1. What are the ‘personally identifiable information’ that would be collected.
  2. How and when would the information be collected (example, registration process, payment process )
  3. What usage/ analytics / tracking methods would be used (Example cookies, web beacons, IP address, log files)
  4. How and when would the ‘personally identifiable information’ be used. (example, sharing with third parties (banks, courier agents, service providers), to send marketing emails/ newsletters, surveys, contests, polls)
  5. Describe the security measures adopted for protecting the information.

Having a privacy policy is not an end by itself, it has to be honored and adhered to by the companies in spirit.

Trust these posts have been useful. Please do share your comments / questions in the comments section below.

Disclaimer:   This is not a legal opinion and should not be construed as one. Please speak with your attorney for any advice.

Working on your start-up in stealth-mode while being employed?

It takes time from ideation to actual execution.  Those who are employed many a time would like to have the cushion of a monthly salary when still perfecting the idea and getting close to execution, so that the bills can be covered while attempting to establish a client base.  However, there are legal issues to be aware of when starting on your own while still being in an employer-employee relationship.

 While most of the below is common sense, it still happens to be top 5 mistakes startup entrepreneurs commit.  Interestingly, I get this question during most startup events.

 The employer-employee relationship has certain well entrenched doctrines, from Intellectual Property laws to labor laws. All IP generated by the employee ‘during the course of employment’ belongs to the employer or the fact that an employee, specially key employees cannot operate a competing business. An employee must not only check the employment agreement and employment policies but be aware of these doctrines.

 Speak with your employer:  I believe it should be your mandatory task, to discuss with your employer on the business you want to pursue (ensure that you do not mis-represent) and check if there are any issues.  Honesty is still the best policy.

Some companies have restrictions / disclosures required on holding board positions or substantial ownership.

It is best to be upfront and transparent, rather than daring a law-suit or losing IP.

Moonlighting:  Some organizations have zero tolerance to moon-lighting, while some are ok as long as it does not hamper productivity, not in the same domain / area of work and not utilize company’s resources.  Even if you are working on your startup on personal time including phone calls / emails and ensure it is a different business from that of your employer, but then if you are tired all the time, it still means that you are not a very productive employee.

Conflict of interest:  Multiplicity of interests clouds the right decision making.  Ethical impropriety is hard to define and the best way to deal it is to avoid it.

Company’s trade secrets belong to the company and can be used during employment only for the benefit of the company. Misappropriation by memory is the most difficult to defend. Adequate disclosures may not be the best plan for mitigation of risk either.

You must have heard before that the IP creation for your startup is like being pregnant (IP creation) while being married to someone else (the employer).  It raises ownership issues and other legal rights.

For example, Free Software Foundation (FSF) explicitly requires its contributors to execute copyright assignment stating that the software belongs to FSF, primarily to avoid contributor’s employer claiming ownership rights later.

Check the employment policy for Cooling off period where an employer may prohibit the employee from pursuing the same/similar business.  The belief is that with the time lag the memory fades or the trade secret the employee had stales.

Many of the points made here can’t be patched up later.  You should not only strip everything that belongs to your employer but also be perceived to be not using anything that belongs to the employer. It costs much less in terms of time and money to get it right at the beginning that trying to sort it out later.

What are your thoughts?

Disclaimer: This is not a legal opinion and should not be construed as one. Please speak with your attorney for any advice.

Choosing an Advisory Board for Startups

We all need a sounding board to bounce off our thoughts and get good advice.  For startups it is a very valuable and powerful management tool, to have an experienced person who has ‘been there and done that’ to actually provide excellent counsel.  Some informal ways would be having friends, previous employer / boss who you would trust to offer advice.  But then, they might not be an expert who understands the landscape you might be operating in.

Who: A person who is experienced in your industry or specific function is beneficial. Depending on the needs of the business, you could have more than one Advisor and create an Advisory Board with diverse and complimentary skills. I also believe that the Advisor is for the CEO rather than ‘for’ the company.

An Advisor is different from a Director on the Board, since it is not a legal position and carries no  decision making powers, legal obligations, rights or duties.

Why: A trust worthy advisor is someone you can lean on for advice or critical feedback.  Choose the right advisor based on your need for the Advisor’s experience, opening doors for sales, building credibility, brand etc.  Think twice when you want to rope in a celebrity Advisor, they are high maintenance.

Engagement: Identify if you need an intense, hands-on help or an occasional discussion.  Also, if is in specific aspects of business or generic advice. This helps in setting expectations with the Advisor and time commitment. However, don’t expect the world of them.  This exercise also helps in deciding whether it has to be a formal engagement.   Ensure they are available and accessible when you really need them, otherwise it is just not worth the effort.

Compensation:  When you expect ad-hoc help, such as providing introductions or providing some quick inputs / opinions, an Advisor may be willing to spend the time in ‘helping’ without any compensation.  For deeper, meaningful engagements please have a discussion on the compensation expectations of the Advisor.

The compensation could be coffee/ dinner, covering their expenses, honorarium cash or equity, or a combination of these.  For a bootstrapping startup, the compensation is usually in the form of sweat equity either allotted in one go or at staggered intervals.   The equity typically ranges  between 2-5%.

How many is too many:  It is really upto you to reap the benefit of the Advisor’s knowledge.  You need to be engaged with the Advisor and that requires energy and effort to spend quality time with the Advisors.

Agreement:  If there are specific performance metrics expected of the Advisor (which is usually not the case) or shareholder duties (typically restrictions on share transfer, drag along) you may want to have an agreement with the Advisor.  In one of the startup, I have seen an Advisor who wanted the shares to be allotted upfront but took offence to signing up an agreement because it then meant he was expected to perform.

What do advisors get out it? They are definitely not in it for the compensation.  It is usually because they are thrilled at sharing their experience, establishing their thought leadership or just the kick of being called an Advisor.

Go ahead, have a carefully chosen counsel(s) that you can trust and lean on in your startup journey.

Disclaimer: This is not a legal opinion and should not be construed as one. Please speak with your attorney for any advice.

Founders’ Agreement

Most founders begin their startup with their friends, colleagues or someone who they have known in the past. The earlier social relationship is now an economic relationship and it is essential to have a strong contractual agreement. There are some pertinent points that you need to discuss with your co-founder(s) and the best time is upfront, when you are freezing on the idea / broad goals and preparing to start.

Some founders actually go shopping for a co-founder. But before you startup, could you also check on the ‘Chemistry’?  Yup! You would have heard about trust, passion, complimentary skills required for the business. They are absolutely important, but without chemistry it just doesn’t seem to work.

Equity Structure:  Do decide about the shareholding and vesting(if a partnership firm, then contribution ratio and profit sharing). This is also related to other aspects such as roles that each co-founder would play, the amount of cash investment, salary to be drawn by co-founders and others. There is no one formula, but generally, the person who has invested cash and also takes a very active role in the company, would obviously get a higher stake compared to the person who just invests.  While on this point, also discuss future financing capabilities of the co-founders, openness to debt-financing and equity dilution scenarios.

Roles and responsibilities:  In a startup, co-founders pretty much do everything between themselves, until they have the initial employees and some organizational structure.  But still, it is necessary to have a sense of who does what and responsibilities. It not only helps in having adequate discipline amidst chaos in the initial period, but also establish commitment and accountability.

The key take-aways from this discussion would be to identify the decision maker, would it be the CEO / Chairman of the Board/ or a majority shareholder.  While it is great to have a consensual approach, it is imperative to have one person who will have the final say. Closely observing how the decision evolves from this discussion gives you a lot of insight. Be tactful when you discuss designations, some are hung-up over a designation!

The other interesting dimension that it helps is in identifying each co-founder’s personal goals – a profitable venture, a life-style business or exit at high valuation.

It is a good time to think through the authorization for operating the bank account as well.

Broad contours of the business: Most startups evolve over time.  While it is hard to foresee the future requirements, you can check-out your co-founders flexibility / rigidity on a given idea and execution. I have seen a startup team disintegrate because the co-founders came together to build a product company and the market realities (cash flow constraints) forced the company to ‘also’ do services, which consumed a large portion of the startup team’s bandwidth.

Salary:  Till the time the business earns revenues, the co-founders need to sustain themselves.  Expecting a salary during the very early stages is hard. However, a discussion on the compensation structure, including performance based incentive in the form of sweat equity/ ESOP, though sensitive is crucial.  It becomes a touchy point especially if one of them has invested more than the other. But, a candid discussion reduces the heart-burn later.

When things go wrong:  You should discuss on the ‘give-up’ strategy; that all the intellectual property developed by the startup will belong to the company; that a co-founder will not continue / start / participate in another similar or competing business; that a co-founder can be asked to leave if she is not performing and the modalities; most importantly, how would the shareholding alter if a co-founder left.

A co-founder leaving is emotionally draining, but do mitigate the risk and pain by discussing these points upfront.

A Founders’ Agreement primarily captures the outcome of the above points.  You could either have a separate written agreement or make it a part of the charter documents.

What are your thoughts?

Disclaimer: This is not a legal opinion and should not be construed as one. Please speak with your attorney for any advice.