Introduction
The startup ecosystem in India has experienced a tremendous surge over the past decade, positioning the country as one of the largest and fastest-growing hubs for startups globally [1]. With over 1,00,000 registered startups as of 2023,[2] the Indian government has actively promoted entrepreneurial ventures through initiatives like "Startup India," aimed at nurturing innovation, entrepreneurship, and job creation. However, despite these advancements, the process of incorporating startups in India continues to face several challenges, largely due to the complexities of the regulatory framework.[3]
Regulations governing startup incorporation include compliance with numerous laws related to taxation, employment, environmental clearances, and other sector-specific norms. Entrepreneurs frequently encounter roadblocks such as lengthy procedural requirements, unclear documentation processes, and delays in obtaining necessary approvals. The existence of multiple regulatory bodies, often with overlapping jurisdictions, further complicates the process. [4]These challenges not only lead to increased costs but also cause significant delays in the establishment of new ventures, discouraging potential entrepreneurs from pursuing their ideas.
In comparison to global startup ecosystems like those of the United States and Singapore, India still lags in terms of ease of incorporating new businesses. Countries with startup-friendly environments tend to have simplified regulatory processes, single-window clearance systems, and robust digital platforms, enabling faster and more efficient business incorporation.
This project explores the impact of India’s regulatory framework on the ease of incorporating startups and seeks to identify the major barriers faced by entrepreneurs. It also aims to assess the effectiveness of government interventions, such as the "Startup India" initiative, in alleviating these challenges.
What is a Startup?
A startup refers to a newly established business, typically in its early stages, with a focus on developing a unique product or service and bringing it to the market. Startups are generally characterized by innovation, scalability, and the potential for rapid growth.[5] Unlike traditional businesses, startups often operate in uncertain environments, experimenting with new ideas, and leveraging technology to address market gaps.
The Department for Promotion of Industry and Internal Trade (DPIIT), under the Government of India’s Startup India initiative, provides a legal definition of a startup to identify businesses eligible for certain benefits and exemptions.[6] According to the DPIIT:
Incorporation/Registration: A startup must be incorporated as either a private limited company (under the Companies Act, 2013), a partnership firm (under the Partnership Act, 1932), or a limited liability partnership (LLP) (under the Limited Liability Partnership Act, 2008). The entity should not have completed 10 years since its incorporation.
Turnover Criteria: The entity’s annual turnover should not exceed INR 100 crore in any preceding financial year.
Innovation and Scalability: The startup should be working towards innovation, development, or improvement of products, services, or processes, or it should have a scalable business model that has the potential for employment generation and wealth creation.
Not a Reconstruction: The entity should not have been formed by splitting up or reconstructing an already existing business.
Recognition as Startups
Different business structures come with specific rules regarding registration, taxes, and licensing. Laws such as the Companies Act, 2013, the Partnership Act, 1932, and the Limited Liability Partnership Act, 2008, outline the registration process for various types of businesses.
When choosing a business structure, an entrepreneur consider their goals, available capital, and the purpose of the startup. For example, a sole proprietorship might be the best choice for someone starting a small business alone without wanting to register it. On the other hand, if business partners plan to seek foreign venture capital without Reserve Bank of India approval (if eligible), an LLP might be the right option.[7]
Similarly for the startup under the Startup India initiative certain procedure is there that a company who seeks to register it as startup has to follow.
Make an Online Application
Anyone who wants to recognise as startup can register their business by visiting the online portal set up by DPIIT namely Startup India website and National Single Window System (NSWS).[8] After logging in the or creating an account, you will need to provide details related to your venture and make application.[9]
Application
The application made shall be accompanied by the copy of Certificate of Incorporation or Registration and a write-up about the nature of business highlighting how it is working towards innovation, development or improvement of products or processes or services, or its scalability in terms of employment generation or wealth creation.[10]
Recognition
When the DPIIT after calling all the documents and information thinks that the company is eligible it will recognize it as startup.[11]
Await the Registration Certificate
Once the detailed submitted by the company is verified, a certificated of registration will be emailed to the founder of such startup.
In is to be noted that during the registration process, founders need to gather certain documents, including the startup's Incorporation or Registration Certificate, PAN number, proof of funding (if applicable), an authorisation letter from the company's authorised representative, a proof of concept (such as a pitch deck, website link, or video), and details of any patents or trademarks, if applicable. Any awards or recognitions the startup has received should also be included.[12]
Compliances with respect to the Type of Company?
Startups in India are required to comply with various regulatory and legal requirements across different domains to ensure smooth operation, avoid penalties, and leverage available government incentives. The compliance obligations depend on the nature of the business, sector, size, and the legal structure (e.g., private limited company, LLP, or partnership). [13]Here is a detailed breakdown of the key regulatory compliances that startups in India must adhere to:
Startups registered under the Companies Act, 2013
Such startup which are registered under the companies act are required to meet several mandatory compliances. Among these is the obligation to hold an Annual General Meeting (AGM) once a year, with a maximum gap of 15 months between successive AGMs.[14] This meeting is essential for approving financial statements, appointing auditors, and declaring dividends.
In addition to the AGM, startups must conduct Board Meetings, with the first one occurring within 30 days of incorporation. Subsequently, at least four board meetings are required annually, ensuring that the gap between any two meetings does not exceed 120 days.[15] Various forms must be submitted to the Registrar of Companies (RoC). For instance, Form ADT-1 must be filed for the appointment of auditors during the first AGM, and those auditors serve until the sixth AGM.[16] Afterward, they hold office until the conclusion of every sixth AGM. Additionally, startups must file Form MGT-7 annually, detailing the company’s return,[17] and Form AOC-2 for submitting board’s report.[18]
Directors must prepare a Director’s Report, which provides a detailed overview of the company’s operations, net profits, and dividends. Furthermore, Form MBP-1 is used by directors to disclose any interests in other entities.[19] Certain registers must be maintained, such as the minutes of board and general meetings, as well as statutory registers and records like books of accounts and registers of directors’ attendance at meetings, in accordance with Section 44AA of the Companies Act.
Startups registered under the Limited Liability Partnership (LLP) Act, 2008
For such startups registered as LLP, compliance begins with the filing of Form 11—an annual return that summarizes the LLP’s partners and any changes in management.[20] This must be done within 60 days of the financial year-end. Additionally, LLPs must submit a Statement of Account & Insolvency using Form 8, which is divided into two parts: Part A includes the solvency statement, while Part B outlines the income and expenditure account. Form 8 must be filed within 30 days of the six-month closure of the financial year. [21]Apart from annual filings, LLPs are also required to handle event-based compliances, such as filing changes in designated partners, LLP agreements, and name changes with the Ministry of Corporate Affairs (MCA) within stipulated time frames.
Partnerships registered under Section 59 of the Partnership Act, 1932
Such startups that are registered as Partnership must register the partnership firm within one year of incorporation.[22] Additionally, partnerships must notify the Registrar (as defined in Section 2(c-1) of the Partnership Act) if the firm ceases operations or relocates, within 90 days of such changes.[23] Partners and employees are also liable for professional tax in line with respective state laws. In certain cases, state regulations may also require the firm to contribute to the Labour Welfare Fund (LWF).
Other Compliances
Apart from the compliance that are generally followed by the company depending on the type of company its promoters seeks it to be, there are various other regulatory compliance.
Compliances with the Labour and tax-related laws
Startups must also comply with labor laws and tax-related regulations. These include statutes such as the Payment of Gratuity Act,[24] Contract Labour (Regulation and Abolition) Act,[25] Employees’ Provident Funds and Miscellaneous Provisions Act, 1952[26], and the Maternity Benefit Act,[27] among others. Environmental law compliance is also mandatory for specific industries. In terms of employee welfare, startups need to establish certain policies, such as the Prevention of Sexual Harassment (POSH) at Workplace Policy, and draft an Employee Handbook to govern working conditions and internal procedures.
Additionally, startups recognized by the Department for Promotion of Industry and Internal Trade (DPIIT) can benefit from tax exemptions under Section 80-IAC of the Income Tax Act, 1961, allowing them to claim a deduction of 100% of profits for three years.[28] These entities are also exempt from angel tax under Section 56 of the same Act.
Industry Specific Compliances
Startups must also adhere to industry-specific compliances. For example, entities receiving Foreign Direct Investment (FDI) must comply with the Foreign Exchange Management Act, 1999 (FEMA). Similarly, startups engaged in import-export activities must follow customs laws, while those dealing with hazardous substances must meet environmental regulations. Real Estate Regulatory Authority (RERA) approvals are required for startups operating in the real estate sector. For mergers and acquisitions or transactions that could significantly impact competition, Competition Law approvals may also be necessary.
Legal Document
Another important aspect is legal documentation. Many emerging startups overlook formalizing essential legal agreements, which can lead to issues during disputes or funding rounds. Therefore, startups must prioritize drafting incorporation documents like the Founder’s Agreement, Shareholder’s Agreement, Memorandum of Association, and Articles of Association. Equally important is establishing formal contracts with suppliers, vendors, and employees, such as Vendor Agreements, Employment Agreements, and Service Agreements.[29]
Startups may also need to obtain various licenses, depending on the nature of the business. One common license required is the Shop and Establishment License, which applies to all premises where a trade, business, or profession is conducted.
Intellectual Property Protection
Lastly, intellectual property protection is crucial. Startups must register their Copyrights, Patents, and Trademarks to protect their intellectual property and avoid infringement issues. This includes safeguarding domain names and taking steps to combat counterfeiting and piracy. Developing an intellectual property strategy and conducting IP audits are also critical steps in maintaining strong protection over a startup’s intellectual assets.[30]
Financial and Investment compliances
At the early stages, it is critical for startups looking to secure foreign investments to clearly understand the permissible routes under the Foreign Direct Investment (FDI) policy—whether through the automatic route or the government approval route—based on the specific sector in which they operate. Adhering to regulations set by the Securities and Exchange Board of India (SEBI) is equally vital, especially those concerning angel investments, venture capital funding, and crowdfunding. Startups must ensure that their investment agreements are structured in compliance with applicable securities laws to avoid legal pitfalls.
Furthermore, it is essential for a startup to meet all disclosure requirements and compliance obligations mandated by SEBI and other governing authorities.
National Single Window System
The National Single Window System (NSWS) is formed by the govt of India to build a strong eco-system of startups in India and ease the cumbersome regulatory compliances. The NSWS was launched in 2020, and it is still under development. However, it has already made a significant impact on the ease of doing business in India. According to the World Bank's Doing Business report, India has improved its ranking by 29 places, to 63rd position, largely due to the introduction of the NSWS.[31]
Startups typically face multiple legal, regulatory, and procedural hurdles when trying to establish themselves, including obtaining permits, licenses, and registrations from various government departments at both the central and state levels. The NSWS, by consolidating these processes into a unified platform, plays a crucial role in addressing these challenges and making it easier to incorporate and grow startups in India[32].
The incorporation of startups in India requires compliance with multiple laws such as the Companies Act, 2013, Goods and Services Tax (GST) Act, labor laws, environmental laws, and sector-specific regulations. Previously, startups had to navigate different government portals and departments to obtain the necessary approvals. The NSWS consolidates this into a single digital window, reducing the complexity of the process.[33]
For instance, a startup may need to register with the Registrar of Companies (ROC), apply for GST registration, obtain approvals from the Ministry of Corporate Affairs (MCA), and comply with state-specific laws. Through NSWS, these steps are centralized, significantly reducing the time and effort needed to incorporate.
The NSWS integrates services from central ministries such as the Ministry of Corporate Affairs, Department for Promotion of Industry and Internal Trade (DPIIT), and state governments. Startups, depending on their sector, may require approvals for foreign direct investment (FDI), environmental clearances, intellectual property registration, or sector-specific licenses. With NSWS, startups can apply for these approvals in one go, avoiding the need to interact with different departments separately.[34]
One of the key objectives of NSWS is to improve the ease of doing business by saving time and reducing compliance costs for startups. Previously, delays in obtaining approvals due to bureaucratic hurdles could slow down the incorporation process, sometimes taking months. [35]With the automated and digital processes on NSWS, startups can receive approvals in a more efficient manner.
Startups recognized by the Department for Promotion of Industry and Internal Trade (DPIIT) under the Startup India initiative are eligible for various benefits, such as tax exemptions and reduced compliance burdens. Through NSWS, startups can apply for DPIIT recognition easily, thereby accessing these benefits without having to navigate multiple portals. The DPIIT recognition through NSWS also helps startups take advantage of government schemes, incentives, and easier access to funding.
Impact of Regulatory Framework on Incorporating Startups
The startup ecosystem in India has witnessed remarkable growth over the past decade, positioning the country as one of the leading hubs for innovation and entrepreneurship. This growth can be attributed, in part, to the evolving regulatory framework that aims to simplify the process of incorporating startups and foster a conducive environment for business.[36] These regulatory measures have impacted the startup eco-system of India. Some of the positive impacts are as follows:
Simplification of Incorporation Process: One of the most significant impacts of the regulatory framework has been the simplification of the incorporation process. The introduction of the 'Startup India' initiative in 2016 has streamlined various procedures, allowing startups to register their businesses with minimal documentation and fewer regulatory requirements. The e-filing system and online registration platforms have reduced the time and cost associated with incorporation, enabling entrepreneurs to focus more on their core business activities.
Tax Incentives and Benefits: The regulatory framework has introduced several tax benefits to encourage investment in startups. For instance, the government offers tax exemptions on profits for eligible startups for the first three years, as well as exemptions on investments made by angel investors. These incentives significantly enhance the financial viability of startups, making it easier for them to attract capital and scale their operations.
Access to Funding: The establishment of regulatory bodies like the Small Industries Development Bank of India (SIDBI) and the Fund of Funds for Startups (FFS) has created avenues for funding. These institutions provide financial support to startups, thereby facilitating their growth and sustainability. Moreover, the regulatory framework promotes crowdfunding and alternative financing options, allowing startups to access a broader base of investors.
Regulatory Sandbox Initiatives: To encourage innovation, especially in sectors like fintech and health tech, the regulatory framework has introduced the concept of regulatory sandboxes. These allow startups to test their products and services in a controlled environment, reducing regulatory burdens during the initial stages of development. This approach fosters innovation and allows startups to refine their business models before entering the broader market.[37]
Challenges in the Regulatory Framework
Complexity in Compliance: Despite efforts to simplify the incorporation process, startups often face challenges in complying with various regulations. The multitude of laws governing businesses in India, such as the Companies Act, Income Tax Act, and Goods and Services Tax (GST), can be overwhelming for new entrepreneurs. Navigating these regulations requires significant legal and financial expertise, which may not be readily available to all startups.
Inconsistent Implementation: The implementation of regulations can vary significantly across states and local jurisdictions. This inconsistency can create confusion and lead to additional compliance costs for startups operating in multiple locations. For instance, differing interpretations of the same regulation can result in unequal treatment of businesses, hindering fair competition.
Access to Resources and Support: While the government has made strides in creating a supportive ecosystem, access to resources and mentorship remains a challenge for many startups, particularly those in tier II and III cities. The lack of incubators, accelerators, and professional networks can limit the potential for startups to thrive in these regions. Moreover, startups often require guidance on navigating the regulatory landscape, which may not be readily available.
Conclusion
The regulatory framework in India has made notable progress in improving the ease of incorporating startups, particularly through initiatives like the Startup India Scheme, tax incentives, and the simplification of procedures under the Companies Act, 2013. These reforms have been instrumental in reducing the time and cost involved in setting up a business. The introduction of online portals such as the MCA (Ministry of Corporate Affairs) website, and forms like SPICe+, has significantly streamlined the process, encouraging more entrepreneurs to formalize their ventures.
However, despite these advancements, certain aspects of the regulatory environment continue to pose challenges, particularly for early-stage startups. Complex sector-specific regulations, such as those governing Foreign Direct Investment (FDI), as well as compliance requirements set by regulatory bodies like SEBI, often create obstacles. Startups must navigate a maze of legal provisions, disclosure requirements, and compliance obligations, which can be overwhelming for companies with limited resources. These challenges are particularly pronounced in sectors like finance, healthcare, and real estate, where regulatory oversight is more stringent.
To further enhance the startup ecosystem in India, several improvements can be suggested. First, streamlining FDI approval procedures across sectors would reduce delays and encourage foreign investment in Indian startups. Simplifying the approval process, especially for sectors with high growth potential, would boost the inflow of international capital. Second, offering clearer guidelines for industries with strict regulations, such as healthcare and financial services, would help startups in these sectors manage compliance more efficiently. By reducing the ambiguity surrounding regulatory requirements, the government can mitigate compliance-related delays and penalties.
Additionally, expanding tax incentives to cover a broader range of startups, especially those in mid-growth stages, would help sustain financial stability during the critical scaling phase. Furthermore, increased government-led awareness programs are essential to educate entrepreneurs about the various compliance obligations and benefits available to them.
[1] Department for Promotion of Industry and Internal Trade, ‘Introduction and 8-Year Factbook’ <Prabhaav | 8-Year Factbook | Startup India> accessed on 6 October 2024.
[2] Ibid.
[3] Invest India, ‘The Role of Government Initiatives in Boosting Startups’ (Invest India, 26 March 2024) < The Role of Government Initiatives in Boosting Startups (investindia.gov.in)> accessed on 6 October 2024.
[4] Corrida Legal, ‘Navigating Legal Challenges: A Comprehensive Overview of Startup Compliance in India’ (Mondaq, 26 September 2023) <Navigating Legal Challenges: A Comprehensive Overview of Startup Compliance In India - Corporate and Company Law - Corporate/Commercial Law - India (mondaq.com)> accessed on 10 October 2024.
[5] Rebecca Baldridge and Benjamin Curry, ‘What Is A Startup? The Ultimate Guide (Forbes Advisor, 3 June 2024) <What Is A Startup? The Ultimate Guide – Forbes Advisor> accessed on 7 October 2024.
[6] Department for Promotion of Industry and Internal Trade, Notification 127 (E)
[7] Lionel Chen, ‘Choosing a business structure: Which one is right for your small business?’ (Wave, 11 January 2024) < Choosing a business structure: which one is right for your small business? (waveapps.com)> accessed on 7 October 2024.
[8] Notification 1(a), Department for Promotion of Industry and Internal Trade, Notification G.S.R 127 (E).
[9] Ibid.
[10] Notification 2(ii), Department for Promotion of Industry and Internal Trade, Notification G.S.R 127 (E).
[11] Notification 2(iii), Department for Promotion of Industry and Internal Trade, Notification G.S.R 127 (E).
[12] Corrida Legal, ‘Navigating Legal Challenges: A Comprehensive Overview of Startup Compliance in India’ (Mondaq, 26 September 2023) <Navigating Legal Challenges: A Comprehensive Overview of Startup Compliance In India - Corporate and Company Law - Corporate/Commercial Law - India (mondaq.com)> accessed on 10 October 2024.
[13] Legal Referencer, ‘Legal Compliance for Startups in India- A Step-By-Step Guide’ (Legal reference, 26 May 2023) <LEGAL COMPLIANCE FOR STARTUPS IN INDIA- A Step-by-Step Guide - LEGAL REFERENCER> accessed on 8 October 2024.
[14] The Companies Act, 2013 (18 of 2013) s 96.
[15] The Companies Act, 2013 (18 of 2013) s 173.
[16] The Companies (Audit and Auditors) Rules, 2014 r 4.
[17] The Companies (Management and Administration) Rules, 2014 r 11.
[18] The Companies (Accounts) Rules, 2014 r 8.
[19] The Companies (Meetings of Board and its Powers) Rules, 2014 r 9.
[20] LLP Rules, 2009 r 25.
[21] LLP Rules, 2009 r 24.
[22] The Partnership Act, 1932 (9 of 1932) s 58 (1A).
[23] The Partnership Act, 1932 (9 of 1932) s 61.
[24] Payment of Gratuity Act, 1972 (39 of 72).
[25] Contract Labour (Regulation and Abolition) Act, 1970 (37 of 1970).
[26] Employees’ Provident Funds and Miscellaneous Provisions Act, 1952 (19 of 1952).
[27] Maternity Benefit Act, 1961 (53 of 1961).
[28] DPIIT, ‘DPIIT Startup Recognition & Tax Exemption’ <Startup Recognition & Tax Exemption (startupindia.gov.in)> accessed on 10 October 2024.
[29] ‘Essential Legal Documents for Startup’ (Filing India) <Essential Legal Documents For Startup A Comprehensive Guide (indiafilings.com)> accessed on 10 October 2024.
[30] Ibid.
[31] ‘Ease of Doing Business rankings’ <Scores (doingbusiness.org) > accessed on 8 October 2024.
[32] ‘Legal Challenges of Startups in India: Navigating the Ecosystem’ (Free Law, 2 August 2024) <Legal Challenges of Startups in India: Navigating the Ecosystem - Legal Articles - Free Law> accessed on 10 October 2024.
[33] Sreedevi Pillai, ‘Legal Aspects of Startups in India’ (King Stubb & Kasiva, 20 July 2023) < Legal Aspects of Startups in India | Insights & Compliance (ksandk.com)> accessed on 10 October 2024.
[34] ‘How does NSWS help you?’ <India’s National Single Window System for Business Approvals | NSWS> accessed on 11 October 2024.
[35] Ibid.
[36] Alka Jain, ‘From 2014 to 2023: How the startup ecosystem is thriving in India despite all odds? Explained’ (Mint, 18 January 2024) <From 2014 to 2023: How the startup ecosystem is thriving in India? Explained | Mint (livemint.com)> accessed on 10 October 2024.
[37] ShaShidhar K.J. ‘Regulatory Sandboxes: Decoding India’s Attempt to Regulate Fintech Disruption’ <https://www.orfonline.org/wp-content/uploads/2020/05/ORF_Issue_Brief_361_Fintech.pdf> accessed on 10 October 2024.