For many entrepreneurs, the game ends much too early: either there’s a cash crunch or lack of interest from venture capitalists (VCs), maybe poor product traction or dispute between founders. The start-up game, after all, is a difficult and unpredictable one that could end even inside a year or even a few months. It also goes without saying that any of the afore-mentioned difficulties are trouble enough.
So it’s reasonable to ask — and, at Vakilsearch, we often are — whether it makes any sense at all to invest time, effort and money into registering a private limited company. Are there any real benefits to a registration or are many entrepreneurs just fulfilling a childhood dream of being CEO?
After all, a private limited company can cost, after registration, audit and compliance fees, Rs. 40,000 to Rs. 50,000 in the first year, and closing one is a major hassle that can take two years. The answer, of course, is very subjective, depending on several aspects of the business you’re trying to build and the approach you’re taking. Let’s examine this in detail:
If your business will only work with funding, you can stop reading after the answer to this question. This is because VCs will only invest in private limited companies as only it distinguishes between owner and management (the shareholder owns the company, while management runs it). And it will be plenty unprofessional if you haven’t even registered a company before talking to VCs. Moreover, if you start a company and immediately raise money, you could be leading yourself into tax trouble. For example, if you start a company and issue yourself stock at Rs. 20 a share and then raise money weeks later at Rs. 150 a share, the tax department may want to tax the difference. This is one reason you should do it months in advance.
Credibility matters in business, as you would guess. If you’re talking to a VC, a bank or even a respected leader in your sector, or looking for early press courage, the company registration would be a testament to your interest in growing a large organisation. Running as a sole proprietor would give that you’re unsure of whether it will work out and efiling your VAT returns yourself.
In many businesses (finance or e-commerce), a private limited company is necessary from the very beginning. For example, to sell mutual funds on your portal, you must have register a body corporate (i.e. a company or LLP). Similarly, getting a payment gateway is a lot easier if you are a private limited company. So if your business requires it, you should waste no time in getting a private limited company and just start the process. For the many sectors that don’t require a registration, a private limited is not necessary early on.
If you don’t register a separate entity with a legal status of its own (basically a company or LLP), you are exposing yourself to unlimited liability. This means that, in case a creditor comes asking for money, and the business has none, he/she can see to it that your private possessions are sold to recover the money. Therefore, if you’ve started operations, have employees, are shipping products, etc, it makes sense to start a company. If, however, you’re still building an app and will be for the next two years, you are unlikely to be at any risk of liability and can postpone registration.
If you’re not building the next Facebook, you’re going to have a tough time hiring. Without the money to pay fat salaries, you’ll find it difficult to get top talent to work for you. The only way to succeed at hiring is to give early employees a piece of the company via ESOPs. And, obviously, you can only give a piece if there is a company in the first place. On the other hand, if you are simply building the business with a co-founder initially, a partnership agreement will do.
A company registration costs around Rs. 15,000, but you’ll need to spend another Rs. 15,000 on compliance and at least Rs. 10,000 on audit and accounting fees in the first year of business. If this is a sizeable chunk of the money you wish to invest in your business early on, you may want to wait a while (if you can) before registering your company.
On the whole, therefore, the answer is no, entrepreneurs aren’t fools to start private limited companies. There’s plenty reason to go through with it, even though it may not be essential.
The above is an authored article by Hrishikesh Datar, CEO of Vakilsearch.com, largest facilitator of legal services, including company registration in India.
[Top Image – Shutterstock]
Like this content? Sign up for our daily newsletter to get latest updates.
Your email address will not be published.
Notify me of follow-up comments by email.
Notify me of new posts by email.
This site uses Akismet to reduce spam. Learn how your comment data is processed.
We Dont Spam !