Entrepreneurs generally await for their idea and product to take some shape before formally registering a company. You should look at these aspects to decide the right time to formally structure your business.
Promoters / founders: When you have multiple promoters, it is important to have a clear understanding of roles and responsibilities among founders. A blurred relationship/ agreement can be expensive and can be very short term. You should look to register the company and also capture the roles, responsibilities, rewards, exit criteria etc. which helps in clear understanding and long term relationship among founders.
Funding: When business needs funding to grow scale and operations, founders approach professional investors (beyond family, friends and fools). Investors insist on a structured business as it is secured for them in terms of management, roles definition, due diligence, wealth sharing, flow of information etc. and giving better control over the business they invest in. Many times, if the idea/potential is very big, investors do commit to invest money but they release funds once the company is registered.
Intellectual Property: There is a great amount of IP that is created in initial phases. This includes shaping the idea to creating a product/ service. At some point the promoters feel a need to register the IP. If there is no company then it may be done in individual capacity. Later when you form a company, the IP needs to be transferred as this is an important asset any business will like to have (also the investors to business checks for the IP rights). It may be a good idea to incorporate the company before registering the IP so that it can straight be done in company’s name rather than promoter and then transferring at a later point. It is also possible that a founder may leave the company before assigning the IP to company and it may be challenging & a long shot to get this done (more difficult if the promoter quits in wrong terms).
Third party contracts and hiring employees: When you start business, you hire/ avail services of lot of third parties. This requires a proper services/ delivery agreement (including proper NDA) to be executed with them. If company incorporation is done later, all these agreements may need to be redone under the new company which can turn cumbersome and can also cause substantial delays.
When you start hiring employees, they also look at what kind of company you are. Your business entity also reflects your current size, branding, scale and comfort factor in minds of all stakeholders. Many times it is very challenging to get right resources in non-registered companies.
Branding: Companies invest a lot to create a great brand and it is done over a period of time. Unregistered businesses may have to re-strategize the whole branding exercise (might be expensive process, depending on case to case) when move to a more structured form of doing business.
An important factor to consider is the comfort level of various stakeholders. Many customers have that fear in mind about fly-by-night operators. A Pvt. Ltd. company or an LLP has a process to follow before exiting business. The Government ensures that no cheating or debts remain in the company before winding up these businesses. This gives a great sense of assurance and relief in common public and they are very comfortable trusting these companies rather than unregistered business. Depending on your business needs and which category of market segment you are targeting, you should take a call about what business type you should go for.
Protection against liability: Many businesses have limited avenues where a consumer or another stakeholder may sue them for any losses (e.g. a local kirana shop). If you are operating in an industry (e.g. IT), which have potential to impact bigger changes and going global, it is very important to limit your personal liabilities. It may be a good idea to move to limited liability business entity before hitting a large market segment.
Moonlighting: Many founders start businesses while working on a full time job. Once the business gains some traction, they move full time in it. Most of the companies typically have this clause where an employee is not allowed to work on any other idea/ project or company without approval from them. If done wisely, a registered limited liability business may help reduce this future risk on your business.
Setting up a company is a big leap and a token of more commitment and seriousness to your business. It comes with initial set up costs, regular filings of taxes and meeting various compliances, which if not met properly could be expensive. There may be more aspects to consider and its best to consult a Chartered Accountant or an Expert and get their opinion on when is the right time to incorporate and what business type you should register.
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[Guest article contributed by eLagaan, a CA firm that offers end to end CA, CS, Business Legal & Payroll services for businesses. It specialises in formulating investor friendly structures & terms, staying compliant, setting up best practices desired by founders, investors & employees. This facilitates businesses to grow & scale with ease and stay fundable, saleable and compliant. ]