Should startups funnel their funding and investments into their existing bank accounts, or is it wiser to open a separate one? What are the other mistakes that startups make in India? Sharath Shyamasunder, Founder and CEO of The Startup Zone, with extensive experience working with over 5000 startups, discusses these issues with EFY’s Mukul Yudhveer Singh.
Q. What are the most common mistakes startups make in India?
A. Most startups ignore legal compliance. Many founders, while being highly skilled at tech and products, ignore legal and financial compliance. This usually happens because they are extremely busy with the products and do not keep track of the due dates and compliances involved in the legal processes. Besides the ones that are to be filed with Registrar of Companies (RoC), there are a bunch of forms that startups usually miss.
Q. What does this mean for them?
A. They end up paying a lot of penalties. This often happens in the pre-revenue stages of a startup. In the long run, it also affects their ability to raise funds. Another prevalent problem in the startup industry is attempting to comply with legal and financial laws without having a professional on their team or a reliable compliance partner. This results in these startups spending much time and money on incorrect filings.
Q. Can you give an example of such a mistake?
A. Yes, carrying out financial transactions without understanding whether tax deducted at source (TDS) is applicable or not is the most common mistake made by startups in India. Most startups make that mistake! Similarly, startups miss out on export and import codes or letters of undertaking (LUTs) when carrying out international business.
Q. Is there an example of a startup via which we can understand this better?
A. While I cannot name any startup, one was incorporated in 2012. They had not paid professional tax on behalf of the company and employees employed by them. They ended up paying a huge penalty and interest. The professional tax in Karnataka is ₹200 for salaries above ₹25,000 per month. It is as simple as that. This startup was also on the list of companies that had received notices for non-filing of annual RoC returns. Directors of such companies are disqualified for five years, and the company is struck off suo-moto by the RoC.
Q. Do startups make mistakes on the patent filing side?
A. Patent filing is more of an art and less of a documentation process. Some startups are granted patents for the simplest of solutions they are working on, while others have to struggle to get their patents approved and granted! The three things to remember while applying for a patent include the novelty factor, obviousness factor, and the invention should have inventive steps. Almost all startups make mistakes in all these factors. There are times when startups file patents only for marketing purposes. In such cases, they mention ‘patents pending’ instead of ‘patents granted.’
Q. Are startups aware of the policies that can work in their favour?
A. Unfortunately, many startups are not aware of the policies. For example, in Karnataka, they grant ₹200,000 to startups filing patents. There is a due process, but startups do not know it. Also, many startups do not know how they can benefit from the Startup India registration. They know policies exist, but they do not know the benefits to them.
Q. What other common mistakes are made by startups that irk potential investors?
A. A startup realised it made some mistakes during its due diligence. They were in fundraising discussions when the mistakes they had made came to light. The venture capitalists told the startup they were not investable because of many compliance issues! Some of their biggest mistakes included not legally disclosing the amount raised from friends and family.
Q. What about the fundraising stage? Are startups making mistakes there as well?
A. The most common parts of the due diligence that startups should not overlook before entering fundraising discussions are GST, TDS, labour department clearances, RoC filings, and more. The most fundamental mistake that many startups make while raising investments via the private placement route is not having a separate bank account for maintaining the incoming funds from investors.
Q. But why should they open different accounts? Isn’t that one more thing a startup needs to take care of?
A. Yes, it is. Investors should not deposit the incoming investments into the account that is in use for all financial transactions of the company as per the Companies Act, 2013. Filing the PAS-3 form is mandatory to use the funds. Not doing so is a violation of the Act. This law is clearly defined in the Companies Act. The penalty for such cases is significant!
Q. Is there more to the investments being made?
A. Many startups do not read the term sheet thoroughly. There have been instances where the terms mentioned have favoured the investors heavily. Having a legal team can help identify this.
Q. Are there any other mistakes that startups make after fundraising?
A. Generally, after fundraising, startups do not emphasise maintaining financial data quarterly, half-yearly, or annually. This might sound minor, but it helps a lot when filing RoCs and all other financial obligations. There are also clauses around ‘restricted matters.’ For instance, if there are any share transfers from the founders to anyone, it is the duty of the promoters to inform all such activities to the investor(s). Everything under restricted matters should be handled carefully.
Q. What about mistakes made with supply chain partners?
A. Startups tend to borrow a lot of literature from the internet. Many electronics and IoT startups do this. They should always remember that such literature is not good for their business as there could be IP infringements, royalty clauses, and a lot more associated. Moreover, as IPs are being created by their teams, they should have watertight agreements with all their suppliers, irrespective of the size and nature of work of these suppliers.
Q. What should the startup do when reaching out to potential investors? In such cases, sharing secrets and IPs is generally part of the process.
A. In all such cases, the startup should make it a standard procedure to sign non-disclosure agreements with anyone and everyone with whom they share such secrets. Startups can go to courts and ask for compensation if the NDAs are breached. It has a monetary aspect, but it is mostly what startups want!
Q. Do startups make mistakes in the international expansion phase?
A. They need to understand the legal complexities of the country they want to operate in. Additionally, they need to know the taxation system as well as the IP laws of the region. Patents granted in India may not mean anything in that region as patents are country specific.
Q. Should startups stress about their choice of name for their venture?
A. It does not matter! The company’s name is entirely different from its brand name. For example, Ola functions under the company known as ANI Technologies Private Limited.
