Startup & Company Law

Why structure is the first big decision

Your entity choice shapes how you raise money, how you are taxed, and how much compliance you carry. Most venture-backed Indian startups incorporate as a private limited company under the Companies Act 2013, because investors buy equity shares and that is only possible in a company with share capital.

The three common options

• Private Limited Company: Separate legal person, limited liability, can issue equity and ESOPs, and is the only structure VCs and angels will fund. It needs at least two directors and two shareholders (s.149, s.3). Compliance is the heaviest of the three.
• LLP (Limited Liability Partnership): Governed by the LLP Act 2008. Lighter compliance and flexible profit-sharing, good for bootstrapped services or consulting firms. But you cannot issue shares or ESOPs, so external equity funding is impractical.
• One Person Company (OPC): A company with a single member (s.2(62)). Useful for a solo founder who wants limited liability, but it must convert to a private limited company once it crosses turnover or capital thresholds, and it cannot easily take on co-founders or investors.

Practical guidance

If you intend to raise institutional money, start as a private limited company even though the compliance is higher — converting an LLP later is slow and costly. Reserve your name through the MCA's SPICe+ form, and keep the registered office documents (rent agreement, utility bill, NOC) ready, as these trip up many first-time founders.

Common mistakes

• Picking an LLP to save on compliance, then discovering investors will not fund it.
• Using a residential address without a proper NOC, causing RoC queries.
• Forgetting that an OPC needs a nominee director named at incorporation.

Takeaway: If funding is anywhere on your roadmap, a private limited company is almost always the right starting structure — choose for where you are going, not just where you are today.

Why a founders' agreement matters

Equity disputes between co-founders are one of the most common reasons early startups implode. A founders' agreement records who owns what, who does what, and what happens if someone leaves. It is signed before or just after incorporation, while goodwill is high and the split still feels fair. Lekha's Founders' Agreement template gives you a structured starting point.

Splitting equity fairly

Resist the reflex to split 50:50 just to avoid an awkward conversation. Weigh idea origination, full-time commitment, capital contributed, domain expertise, and who carries the most risk. A modest imbalance that reflects reality is healthier than an equal split that breeds resentment later.

• Roles and decision rights: Define titles, areas of ownership, and which decisions need unanimous agreement.
• Commitment: State whether each founder is full-time, and what salary (if any) is drawn.
• Exit terms: Spell out what happens to a departing founder's shares — this is where vesting (next module) does the heavy lifting.

The link to the company's documents

A founders' agreement is a contract between founders; it should be reflected in the company's Articles of Association and later in the Shareholders' Agreement so the terms are enforceable against the company and new investors.

Common mistakes

• No written agreement at all — relying on friendship.
• Allotting all shares upfront with no vesting, so a founder who quits in month three keeps a huge stake.
• Ignoring intellectual property assignment (covered next), leaving the company without clear ownership of its own code or brand.

Takeaway: Have the hard equity conversation early, write it down, and make sure the split reflects contribution and commitment — not just a desire to keep the peace.

What vesting does

Vesting means founders earn their shares over time rather than owning them outright from day one. The standard pattern is four-year vesting with a one-year cliff: nothing vests until you complete twelve months, then a quarter vests at once, and the rest accrues monthly or quarterly thereafter. This protects the cap table if a co-founder leaves early.

How vesting is implemented in India

Because shares are usually allotted upfront, vesting is typically enforced through a reverse vesting / buy-back mechanism: the company (or other founders) can repurchase the unvested portion at nominal value if a founder departs. These terms sit in the founders' agreement and are mirrored in the Shareholders' Agreement. Any buy-back must comply with the Companies Act 2013 share buy-back provisions (s.68) or be structured as a transfer to other founders.

Founder IP assignment

Investors will check that the company — not the individual founders — owns its core intellectual property. Each founder should sign an IP assignment transferring code, designs, trademarks, and inventions created for the venture to the company. Without this, a founder could theoretically walk away owning the product.

• Assign all pre-incorporation work product to the company once it is formed.
• Register key trademarks and, where relevant, ensure domain names sit in the company's name.
• Have employees and contractors sign IP assignment clauses too.

Common mistakes

• No cliff, so a founder who leaves at month two still keeps vested-feeling equity.
• Forgetting reverse-vesting enforcement, making vesting unenforceable in practice.
• Leaving IP in a founder's personal name, which spooks investors during diligence.

Takeaway: Vesting with a one-year cliff plus clean IP assignment to the company are the two safeguards that make your cap table and your product defensible when investors look closely.

What a term sheet is

A term sheet is a mostly non-binding summary of the proposed investment terms — the headline economics and control rights — that precedes the definitive agreements. Getting these terms right matters because they set the template the lawyers then draft into binding contracts. Lekha's Term Sheet template lays out the standard clauses.

Valuation: pre-money vs post-money

Pre-money valuation is what the company is worth before the new money goes in; post-money adds the investment. Founder dilution is calculated on the post-money figure, so always confirm which number is being quoted. A larger ESOP pool created pre-money also dilutes founders, not investors — watch for that.

Liquidation preference

This decides who gets paid first in a sale or wind-up. A 1x non-participating preference (investor takes the higher of their money back or their as-converted share) is founder-friendly and now common in India. Participating preferences (money back and a share of the rest) are more aggressive and can badly skew returns in a modest exit.

Anti-dilution

Anti-dilution protects investors if you later raise at a lower price (a "down round"). Broad-based weighted average is the reasonable, widely accepted form; full ratchet is harsh and re-prices all earlier shares to the new low price, heavily diluting founders.

• Clarify board composition and any investor veto rights early.
• Note which clauses are binding (usually exclusivity and confidentiality) versus indicative.

Common mistakes

• Optimising for headline valuation while ignoring a participating preference that quietly costs more.
• Agreeing to full-ratchet anti-dilution without understanding the downside.

Takeaway: Valuation grabs attention, but liquidation preference and anti-dilution often decide what founders actually walk away with — negotiate the whole structure, not just the number.

From term sheet to binding contracts

Once a term sheet is signed, two definitive documents do the real work: the Share Subscription Agreement (SSA) and the Shareholders' Agreement (SHA). The SSA governs the investment itself; the SHA governs how shareholders behave going forward.

What the SSA covers

The SSA sets out how many shares the investor subscribes to, at what price, the conditions precedent (clean cap table, board approvals, due diligence sign-off), the founders' representations and warranties, and indemnities if those reps turn out to be wrong. Allotment is then done by board resolution and an SH-7 / PAS-3 filing with the RoC.

Key SHA terms to understand

• Reserved matters: Decisions (issuing shares, taking debt, changing the business, senior hires) that need investor consent regardless of board majority.
• ROFR / ROFO: Right of First Refusal or First Offer — existing shareholders get the first chance to buy shares someone wants to sell.
• Drag-along: Lets a majority force minority holders to join a sale, so a buyer can acquire 100%.
• Tag-along: Lets minority holders join a sale on the same terms, so they are not left behind when founders exit.

India-specific points

SHA terms are only enforceable against the company if they are also written into the Articles of Association (a settled principle under the Companies Act). So alter your AoA to mirror reserved matters and transfer restrictions — otherwise the clauses may bind only the signatories, not the company.

Common mistakes

• Signing an SHA without reflecting its restrictions in the AoA.
• Agreeing to sweeping reserved matters that paralyse day-to-day operations.
• Overlooking drag-along thresholds that could force a sale founders dislike.

Takeaway: The SSA buys the shares; the SHA governs the relationship. Read the reserved matters, transfer rights, and drag/tag clauses carefully, and mirror them in your Articles to make them stick.

What an ESOP pool is

An Employee Stock Option Plan (ESOP) reserves a slice of equity — typically 5–15% — to grant as options to employees, who can later buy shares at a fixed exercise price. It is the main tool early startups use to attract talent they cannot fully pay in cash. Lekha's ESOP Plan template sets out the scheme document.

The legal framework

For a private company, ESOPs are issued under Section 62(1)(b) of the Companies Act 2013, read with the Companies (Share Capital and Debentures) Rules 2014, and approved by a special resolution of shareholders. For listed companies, the SEBI (Share Based Employee Benefits and Sweat Equity) Regulations 2021 apply. Promoters and directors holding more than 10% generally cannot receive options in a private company plan.

Grant mechanics

• Pool creation: Shareholders approve the pool size and plan terms by special resolution.
• Grant: The board issues a grant letter to each employee stating the number of options, exercise price, and vesting schedule.
• Vesting: Options vest over time (a minimum one-year gap between grant and first vesting is required), often four years with a one-year cliff.
• Exercise: Vested options become shares when the employee pays the exercise price; tax arises at exercise as a perquisite, and again on eventual sale as capital gains.

Common mistakes

• Granting options without the special resolution and proper plan document.
• Forgetting the mandatory minimum one-year vesting gap.
• Not explaining the two tax points to employees, who are then surprised at exercise.

Takeaway: An ESOP is powerful but procedural — approve the pool by special resolution under s.62, document each grant properly, and be transparent with employees about vesting and the tax at exercise.

Why board governance matters

A company acts through its board of directors, and most operational decisions are made by board resolutions. Getting the mechanics right keeps decisions valid and keeps the company out of trouble during diligence. Lekha's Board Resolution template covers the standard format.

Frequency, notice and quorum

• Frequency (s.173): A company must hold at least four board meetings a year, with no more than 120 days between two consecutive meetings.
• Notice: At least seven days' written notice of each meeting must go to every director (shorter notice is possible in limited circumstances).
• Quorum (s.174): The minimum present is one-third of total directors or two directors, whichever is higher.

Board powers vs shareholder powers

Section 179 lists powers the board exercises by resolution at a meeting — for example, borrowing money, investing funds, issuing securities, and approving financial statements. Some of these can only be passed at a physical or video meeting, not by circulation. Bigger structural decisions (altering the constitution, certain ESOP approvals) need shareholders, not just the board.

Resolutions and minutes

Decisions are recorded as resolutions in the minutes, which must be finalised within 30 days and signed. Listed and many other companies follow Secretarial Standard SS-1 on board meetings issued by ICSI. Well-kept minutes are not box-ticking — they are the evidence that a decision was validly taken.

Common mistakes

• Skipping the 120-day rule between meetings.
• Passing s.179(3) matters by circulation when they require a meeting.
• Letting minutes drift unsigned for months.

Takeaway: Meet at least quarterly, give proper notice, confirm quorum, and record clean resolutions and minutes — this is the backbone of a company that survives investor diligence.

The cap table as single source of truth

A capitalisation (cap) table lists every shareholder, their share class, the number of shares, and their fully-diluted percentage including the ESOP pool and any convertible instruments. After a funding round, an accurate cap table is essential — every future raise, ESOP grant, and exit is calculated from it. Errors compound, so reconcile it after every allotment.

What changes after a raise

• Allotment filings: New shares are allotted by board resolution and reported to the RoC via PAS-3 (return of allotment). Update the register of members and issue share certificates.
• Foreign investment: If an overseas investor participates, the company files Form FC-GPR with the RBI through the FIRMS portal within 30 days of allotment — missing this is a common, penalty-attracting slip.
• Valuation: Pricing for a foreign or fresh issue generally needs a valuation report from a registered valuer or merchant banker.

Ongoing governance after funding

New investors usually bring board seats, reserved matters, and reporting obligations. Hold the AGM on time and keep minutes — Lekha's AGM Minutes template helps — and route investor-consent items through the right resolutions. Keep the statutory registers (members, charges, directors) current, as investors and acquirers inspect these closely.

Common mistakes

• Tracking ownership in a stale spreadsheet that does not match the register of members.
• Missing the 30-day FC-GPR window for foreign investment.
• Forgetting convertible notes or SAFEs when calculating fully-diluted ownership.

Takeaway: Treat the cap table as the company's financial source of truth, file allotment and (where relevant) RBI forms on time, and keep your registers and AGM records current — clean post-funding hygiene pays off at the next round and at exit.