When to incorporate your Start-up?
30 minutes before starting to write this article, I got off a call with Arvind Batra, founder of @Eventshigh, an event aggregator. They are building an IP around interest-led discovery of events. Arvind sought me out after listening to me speak at @nextbigwhat Unpluggd event in the last week of May, 2014. Some questions he had were:
- Should they incorporate the company in the US or India?
- Is true that it is easier to raise money from US investors if the company is incorporated in the US, and has a subsidiary in India?
For a while, I went back to when I was starting out for the first time and was weighing myself down with problems that were not yet mine. With experience, I am wiser, and below, I share some of the learnings.
First, know your stage.
We normally don’t pay attention to the difference between a product, a startup, and a company, and use the terms almost interchangeably, but @vijayanands brings out a good distinction.
Knowing the difference, will tell you what (not) to focus on at each stage. Not just that, by describing your endeavor accurately, you also tell at what stage of the business you are in. For example, Abhilash (@abhiscar) and I are currently working on Parallelo and we are at the product stage, meaning we have users, and we are working on the product-market fit*. Before you read further, a Product here means a SaaS product, and my learnings are primarily as a SaaS entrepreneur.
* Edit (Feb 4, 2015) - We achieved this in Jan, 2015
Worry about the problems of that stage.
If you are not charging your users yet
You are probably not charging your users because you haven’t found the product-market fit. Of all times in the life of a business, this is the most stressful because you are in a whirlpool of intense research, fast pivots, and the pressure to ship fast. And you are probably one or two people doing all this, which means time is one luxury you don’t have. Your business requires you to focus on things that matter most at this time. That is converting users into customers. Not incorporation. If you don’t find your product-market fit, you won’t have customers anyway, so why spend time on incorporation?
Incorporating a company takes only a couple of weeks, but keeping on top of compliances after incorporation takes a toll. For example, regardless of whether you are running a successful business, you have to pay Professional tax for the company and file returns for it as long as your company remains incorporated. And if things don’t take off, there is only one thing that you need to know about company closure, that it is a real PAIN IN THE BACKSIDE, even in the US. I've done both, so I know. So come to an understanding with your co-founder about how you both will own the business, and
If you have customers
Congratulations. But ask your CA if you should still incorporate. If you are just about ramping up, you can still hold off incorporation until you hit Rs 10 lacs in revenue in a financial year.
So what happens when you hit this Rs 10 lacs mark? You are required to charge and remit service tax, for which you need to have service tax registration, unless all those revenues are from outside India. If you hit this revenue mark and growing, you may soon be in situations where you have to incorporate anyway (because your client requires it, or you plan to raise equity or debt capital soon), so it may be a good time to incorporate your start-up, and go for the service tax registration in the incorporated entity's name.
For as long as you are a proprietorship concern though, just make sure that you diligently maintain accurate records of all income and expenses, and treat the business different from yourself. If you cannot and you are among those who think Business Governance is the name of a flop movie, Rohan Arinaya, ex-PwC and partner Merican Consultants has some sage advice.
“…We don’t realise, but as entrepreneurs we don’t differentiate between self and profession. The finances and the lives continuously intersect each other. Yes, this shows the level of dedication to your Start-up but what happens in the process is that the business continues to receive a large amount of capital which might not have been otherwise available. Its like having a rich father when in college - its great you can spend the money but the process of learning and mastering the art of managing limited finances should be imbibed at as early a stage as possible.”
If you have employees
You don't need to incorporate just because you are hiring.
When you are still a small unit, your first couple of hires are probably those that you know well and understand Startup risks. See if you can build a trust bond with them and hire them for a proprietary concern to stave off incorporation for the time being. Put your promise of ESOP in writing and execute it when you finally incorporate.
If you are going to raise money
This is when you must incorporate so you can offer shares to your investors for the money they will invest. If the investors are strategic in nature, like that Accelerator you are part of, or a law or design firm that offers their services for equity in your company, see if you can convince them to wait till the time when you have to incorporate.
Find the fastest route to revenue
It may have been clear to you, the objective of this post is not to advise against incorporation (that would be silly of course), but to know when to do it so you can focus on the right things.
The time interval between ideation and an incorporation event (steadily growing revenues, strategic partners who need equity, investor interest etc) could be more than 6 months. So ask your CA what is right for your stage. Now to that other question.
Is it easier to raise money from US investors if the company is incorporated in the US and has a subsidiary in India?
If Rudyard Kipling were to answer this question in his IFesque manner, he'd have said :
When you are a business that customers can’t get enough of, and for you investors cut each other by half, there is no step you’ve taken wrong, or an action amiss 'cause it’s your arse that everyone wants to kiss.
A short answer is the quote below, powerful coming from whom it did:
-- Thanks for reading. I am no company law expert, so if there are any errors, or you think differently, please leave a comment below. While at that,
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