CHAPTER 7

1
LEGAL CONSIDERATIONS
FOR A STARTUP

LEARNING OUTCOMES
By the end of this chapter, students will be able to:
 Learning about Entity Types and how to choose an ideal entity type with
an overview of registration process.
 Understanding the intricacies of Startup Equity Split among co-founders
and how does Equity Vesting works.
 The new age needs of ESOP Planning and reading about some best
practices by Global and Indian Startups
 Learning How to Draft a Co-founder Agreement.
 Understanding Intellectual Property Rights (IPRs) available to Startups
(Patent, Copyright and Trademark)

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 7.2 ENTREPRENEURSHIP & START-UP ECOSYSTEM

CHAPTER OVERVIEW

How to Select the Best

Suited Entity Type
Entity Types Available
Factors to Consider while
Opting an Entity Form
Legal Considerations for a

The Basics of Split

Equity Split
Science of Equity Vesting
Startup

Importance of ESOP
Planning
ESOP Planning
Best Practices
Co-Founder Agreement
Patents, Copyrights and
Trademarks
Intellectual Property Rights
Registering a Patent in
India

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 LEGAL CONSIDERATIONS FOR A STARTUP 7.3

Startups, characterized by innovation, agility, and rapid growth, often operate in dynamic and
competitive environments where success can hinge on various factors, including legal compliance.
Maintaining legal compliance is crucial for startups for several compelling reasons.
Adhering to legal requirements helps startups build credibility and trust with stakeholders. Whether
it's investors, customers, or partners, demonstrating a commitment to compliance signals reliability
and professionalism, enhancing the startup's reputation and attractiveness to potential collaborators
and investors.
Further, legal compliance mitigates the risk of costly fines, penalties, or legal disputes. Startups,
especially those in highly regulated industries like finance, healthcare, or technology, face numerous
legal obligations, ranging from intellectual property protection to data privacy laws. Failing to comply
with these regulations can result in severe consequences, including lawsuits, financial losses, or
even the closure of the business. By staying compliant, startups safeguard themselves against such
risks, ensuring continuity and sustainability.
Interestingly, legal compliance fosters a culture of accountability and integrity within the
organization. It encourages startups to adopt robust governance practices, maintain accurate
records, and uphold ethical standards in their operations. This not only promotes transparency and
efficiency but also instills confidence among employees, investors and customers, fostering long-
term relationships and loyalty.
Most importantly, complete adherence to legal requirements facilitates access to funding and capital.
Investors and financial institutions often conduct thorough due diligence before committing capital
to startups. Compliance with laws and regulations instills confidence in investors, reducing perceived
risks and making it easier for startups to secure financing, whether through venture capital, loans,
or crowdfunding. Generally when VC s fund any start ups they do all kinds of due diligence, legal,
asset, financial, tax, etc to cover all aspects before investing in a company.
For startups with global aspirations, being legally compliant enables them to navigate international
markets and expand their operations globally. In an increasingly interconnected world, startups often
face cross-border legal complexities, including international trade laws, taxation, and regulatory
requirements. Ensuring compliance with relevant laws not only facilitates market entry but also
mitigates the risk of legal barriers or regulatory hurdles that could impede expansion efforts.

By prioritizing compliance from the outset, startups can position themselves for success, resilience,
and long-term viability in the market.

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 7.4 ENTREPRENEURSHIP & START-UP ECOSYSTEM

7.1 CHOOSING AN IDEAL ENTITY TYPE AND OVERVIEW OF

REGISTRATION PROCESS
Selecting the right entity type is of paramount importance to startups as it lays the foundation for
their entire business structure and operations. Each entity type offers distinct advantages and
disadvantages in terms of liability, taxation, governance, and operational flexibility. For instance,
choosing a sole proprietorship or partnership exposes founders to unlimited personal liability, risking
their personal assets in case of legal issues or debts. Conversely, forming a corporation or limited
liability company (LLC) provides owners with limited liability protection, shielding their personal
assets from business liabilities. Moreover, the entity type significantly impacts taxation, with different
structures subject to varying tax rates, deductions, and compliance requirements.
Additionally, the chosen entity type influences operational aspects such as ownership structure,
fundraising options, and governance mechanisms. Therefore, startups must carefully evaluate their
business goals, risk tolerance, growth plans, and regulatory environment to select the most suitable
entity type that aligns with their objectives and facilitates long-term success and sustainability.
Some of the most commonly referred entity types in India are as follows;

Sole Proprietorship

Partnership

One Person Company

Public Limited Company

Limited Liability Partnership

MSME

1. Sole Proprietorship: Like elsewhere, a sole proprietorship in India is the simplest form of
business entity, owned and operated by a single individual. It requires minimal registration
and compliance formalities, but the owner bears unlimited personal liability for the business's
debts and obligations.
2. Partnership: Partnerships in India can be formed as either general partnerships or limited
liability partnerships (LLPs). General partnerships are governed by the Indian Partnership
Act, 1932, and involve two or more individuals sharing profits and losses according to their

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 LEGAL CONSIDERATIONS FOR A STARTUP 7.5

agreement. LLPs offer limited liability protection to partners while retaining the tax flexibility
of a traditional partnership.

3. Private Limited Company (Pvt Ltd): A private limited company is the most common and
preferred choice for startups in India. It's a separate legal entity with limited liability for its
shareholders. It requires a minimum of two directors and two shareholders, with a maximum
of 200 shareholders. Private limited companies are regulated by the Companies Act, 2013.
4. One Person Company (OPC): Introduced in 2013 under the Companies Act, an OPC allows
a single entrepreneur to operate a company with limited liability. The sole member of the
company acts as both the shareholder and director. This structure provides the benefits of a
company while allowing single-person ownership.
5. Public Limited Company: Public limited companies are suitable for larger businesses
planning to raise capital from the public through the sale of shares on a stock exchange. They
have stricter regulatory requirements and are governed by the Companies Act, 2013.
6. Limited Liability Partnership (LLP): LLPs offer the benefits of limited liability to their
partners while allowing them to actively manage the business. They are suitable for
businesses where partners want to have direct involvement in operations while limiting
personal liability.
7. Small Business Enterprise (Micro, Small, and Medium Enterprises - MSMEs): MSMEs
are defined based on their investment in plant and machinery or equipment. They can be
registered under various legal structures mentioned above, but the government provides
certain benefits and incentives to entities classified as MSMEs.
Some Startup attractive entity types in foreign countries especially United States are:
♦ C Corporation: This types of corporations are independent legal entities owned by
shareholders. They offer limited liability protection and can attract investment through the
sale of stock. However, they are subject to double taxation, where both the corporation's
profits and dividends to shareholders are taxed.

♦ S Corporation: This types of corporations are similar to C corporations but have a special
tax status that allows them to pass corporate income, losses, deductions, and credits
through to their shareholders for federal tax purposes. They have limitations on ownership
and are often favored by smaller businesses.
♦ Benefit Corporation (B Corp): This types of Corps are for-profit companies that are
committed to making a positive impact on society, the environment, and stakeholders while

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 7.6 ENTREPRENEURSHIP & START-UP ECOSYSTEM

also pursuing profit. They are legally required to consider the impact of their decisions on
multiple stakeholders, not just shareholders.

7.1.1 How to Select the Right Entity Type

When choosing an entity for a startup, several critical factors must be considered to ensure the most
suitable choice for the business's needs and goals. By carefully considering key factors, startups
can make an informed decision when choosing the most appropriate entity type to support their
growth, protect their interests, and achieve their business objectives.
Key factors that Startups may want to consider while opting the most suitable form of entity for their
business are;
♦ Formation Formalities
♦ Liabilities attached to an Entity Form
♦ Expansion Aspirations
♦ Taxation of an Entity
♦ Social Media and E Commerce Transactions
♦ Closure and Exit

Closure Formation
and Exit Formalities

Social
Media and Liabilities
E attached to
Commerce an Entity
Transactio Form
ns

Taxation of Expansion
an Entity Aspirations

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 LEGAL CONSIDERATIONS FOR A STARTUP 7.7

Let us understand each of the factors and what sub-factors to be consider by entrepreneurs;
1. Formation Formalities : Starting a business involves different steps depending on the type
chosen. For a small business like a sole proprietorship, not much paperwork is needed. Just
the necessary licenses or permits must be obtained. If starting with someone else, like a
partnership, it's advisable to have a written agreement outlining aspects such as profit-
sharing and responsibilities. Limited liability companies (LLCs) and Private/Public limited
companies require more paperwork. For company forms of business founders must file
paperwork with the government, detailing aspects such as leadership structure and business
activities.
Filing with the government is necessary, specifying details like leadership and the company's
activities. Nonprofit organizations also need government registration and approval for tax-
exempt status. Each type of business has its own paperwork and regulations to follow, so it's
important to understand the requirements for a proper start. Compliance with regulations
ensures the company's legal recognition and protection for its owners.
2. Liabilities attached to an Entity Form: In a sole proprietorship, the business owner is
personally responsible for all debts and legal obligations. This means if the business can't
pay its bills or faces a lawsuit, the owner's personal assets like savings or property could be
at risk.
Partnerships have similar risks, where each partner is personally liable for the business's
debts and actions. This means if one partner makes a mistake or the business can't pay its
debts, all partners could be held responsible, putting their personal assets in jeopardy. This
is called principle of agency.
Limited liability companies (LLCs) provide a level of protection for owners. While owners
(called members) can lose the money they invest in the company, their personal assets are
usually protected from business debts and lawsuits. However, this protection can vary
depending on the circumstances, such as personal guarantees or negligence.

In corporations, shareholders' liability is typically limited to the amount they've invested in the
company. This means if the corporation can't pay its debts or faces legal action, shareholders
generally aren't personally responsible, protecting their personal assets from business
liabilities.
3. Expansion Aspirations: When it comes to expansion plans, certain entity forms offer more
flexibility and scalability than others. Limited liability companies (LLCs) and corporations are

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 7.8 ENTREPRENEURSHIP & START-UP ECOSYSTEM

often best suited for expansion due to their ability to attract outside investment, add new
owners or shareholders, and operate in multiple locations.

LLCs offer the advantage of pass-through taxation while providing limited liability protection
to owners, making them an attractive option for expanding businesses. They can easily add
new members or investors without disrupting the existing structure, allowing for seamless
growth.
Company forms of business have the advantage of issuing different classes of stock, which
can attract investors and raise capital for expansion. Additionally, they have a well-
established framework for governance and can easily transfer ownership through the sale of
stock.
On the other hand, sole proprietorships and partnerships may face limitations when it comes
to expansion. Sole proprietors bear unlimited personal liability for business debts, which can
be risky when expanding operations. Partnerships may face challenges in adding new
partners or raising capital due to the shared liability among partners.

While each entity type has its advantages and disadvantages, LLCs and company forms are
generally better suited for expansion plans due to their flexibility, scalability, and ability to
attract investment.
4. Taxation of an Entity: In the Indian context, different forms of entities offer varying tax
implications, making some more favorable for tax planning than others. Limited liability
companies (LLCs) and corporations tend to be more advantageous for tax planning due to
their flexibility in structuring and tax treatment.
LLCs in India are treated as pass-through entities for tax purposes, meaning profits and
losses are passed on to the members who report them on their personal tax returns. This can
offer tax advantages, especially for businesses with multiple owners, as it avoids double
taxation on corporate profits.
Companies, particularly private limited companies, benefit from lower corporate tax rates in
India. Additionally, certain tax deductions and incentives are available to corporations, such
as deductions for business expenses and tax credits for specific activities.
On the other hand, sole proprietorships and partnerships may not be as favorable for tax
planning in India. Sole proprietors are taxed at individual income tax rates, and partnerships
are subject to the same pass-through taxation as LLCs but may face limitations in claiming
certain deductions or incentives available to corporations.

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 LEGAL CONSIDERATIONS FOR A STARTUP 7.9

Overall, LLCs and corporations are generally better suited for tax planning in India due to
their flexibility in tax structuring and potential tax benefits. However, the specific tax
advantages and considerations may vary depending on the individual circumstances of the
business. Consulting with tax professionals can help entrepreneurs navigate the complexities
of tax planning and choose the most tax-efficient entity forms for their needs.
5. Social Media and E Commerce Transactions: In the economic age of social media and
digital transactions, certain entity forms are better suited to handle the unique challenges and
opportunities presented by the online landscape. Limited liability companies (LLCs) and
corporations typically fare better in this context due to their formalized structures and ability
to adapt to digital transactions.
LLCs offer a flexible management structure that can easily accommodate digital operations
and transactions. With the rise of e-commerce and online businesses, LLCs provide limited
liability protection to owners while allowing for pass-through taxation, making them an
attractive option for startups and small businesses operating in the digital space.
Companies, particularly those structured as private limited companies, are also well-suited
for digital transactions. They offer a formalized governance framework that instills confidence
in customers and investors, facilitating online transactions and e-commerce activities.
Additionally, corporations can issue stock and attract investment more easily, providing
capital for digital expansion and innovation.
On the other hand, sole proprietorships and partnerships may face challenges in the digital
realm. Sole proprietors bear unlimited personal liability for business debts, which can be risky
in the online environment where cyber threats and legal issues are prevalent. Partnerships
may also encounter difficulties in scaling digital operations and attracting online customers
without the formalized structure and credibility of corporations.
6. Closure and Exit: LLCs provide flexibility in terms of closure, allowing members to dissolve
the company through a formal process outlined in the operating agreement or as prescribed
by state law. Investors in LLCs have the option to sell their ownership interests or transfer
them to others, facilitating exit strategies while ensuring continuity for the business.
Companies, especially those structured as private limited companies, offer distinct
advantages for investor exits. Shareholders can easily sell their shares on secondary markets
or through private transactions, providing liquidity and flexibility for investors looking to exit
their investment. Additionally, corporations have well-established procedures for dissolution

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 7.10 ENTREPRENEURSHIP & START-UP ECOSYSTEM

and winding up, ensuring a smooth closure process that protects the interests of shareholders
and creditors.

Sole proprietors bear personal liability for business debts, making closure more complicated
and potentially exposing personal assets to creditors. Partnerships may encounter difficulties
in reaching consensus among partners and distributing assets during dissolution. Consulting
with legal and financial professionals can provide valuable guidance in this regard.

7.1.2 Registration Process for Startups

In India, startups can register themselves as Limited Liability Partnerships (LLPs) and Private
Limited Companies (Pvt Ltd) with the Ministry of Corporate Affairs (MCA), Government of India. Brief
steps to register under each type of entity are as follows;
Limited Liability Partnership (LLP)
♦ Visit the MCA portal (www.mca.gov.in) and create an account.

♦ Obtain a Digital Signature Certificate (DSC) for the designated partners.

♦ Obtain a Director Identification Number (DIN) for all partners.
♦ Reserve a name for the LLP using the 'RUN-LLP' service on the MCA portal.

♦ Prepare and file Form LLP-1 (Incorporation Document and Subscriber's Statement) along
with the necessary documents such as LLP Agreement, address proof, and identity proof
of partners.

♦ Pay the required registration fees online.

♦ After approval, the LLP incorporation certificate will be issued.
Private Limited Company (Pvt Ltd)
♦ Obtain Digital Signature Certificates (DSC) for all proposed directors.
♦ Apply for Director Identification Number (DIN) for all proposed directors.
♦ Reserve a unique name for the company using the 'RUN' (Reserve Unique Name) service
on the MCA portal.
♦ Prepare and file Form SPICe (Simplified Proforma for Incorporating Company
Electronically) along with the necessary documents such as Memorandum of Association
(MoA), Articles of Association (AoA), address proof, and identity proof of directors.

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 LEGAL CONSIDERATIONS FOR A STARTUP 7.11

♦ Pay the prescribed registration fees online.

♦ After scrutiny and approval, the Certificate of Incorporation will be issued.

7.1.3 Good to have Registrations for Startups in India

For startups in India, several registrations are considered beneficial to ensure legal compliance,
access to benefits, and protection of intellectual property. Let us read about some good-to-have
registrations.
♦ GST Registration: Goods and Services Tax (GST) registration is mandatory for
businesses with an annual turnover exceeding a certain threshold. Registering for GST
enables startups to avail input tax credits, claim tax refunds, and comply with indirect tax
laws.
♦ MSME Registration: Registering under the Micro, Small, and Medium Enterprises (MSME)
Development Act can avail benefits such as priority sector lending, tax rebates, subsidies,
and assistance for technology upgradation. This registration is particularly beneficial for
startups seeking financial assistance and government contracts.
♦ Trademark Registration: Registering trademarks for the startup's brand name, logo, or
product names can provide legal protection against unauthorized use and infringement. It
helps in building brand recognition and goodwill in the market.
♦ PAN and TAN Registration: Permanent Account Number (PAN) and Tax Deduction and
Collection Account Number (TAN) registrations are essential for startups to comply with
income tax regulations, file tax returns, and carry out financial transactions.
♦ FSSAI Registration: If the startup is involved in food business activities, obtaining
registration or a license from the Food Safety and Standards Authority of India (FSSAI) is
mandatory. It ensures compliance with food safety standards and regulations.
♦ Professional Tax Registration: Depending on the state in which the startup operates,
registering for professional tax is mandatory for employers. It involves deducting tax from
employees' salaries and remitting it to the state government.
♦ ESI and EPF Registration: Registering under the Employees' State Insurance (ESI) Act
and the Employees' Provident Fund (EPF) Act is necessary for startups employing a certain
number of employees. It provides social security benefits such as medical care, disability,
maternity, and retirement benefits to employees.

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 7.12 ENTREPRENEURSHIP & START-UP ECOSYSTEM

♦ Startup India Recognition: Startups meeting the eligibility criteria can register under the
Startup India initiative to avail various benefits, including tax exemptions, self-certification
compliance, and access to government schemes and funding programs.
While these registrations are not mandatory for all startups, obtaining them can provide various
advantages in terms of compliance, credibility, protection, and access to benefits and incentives.
Startups should assess their specific requirements and consult with legal and financial advisors to
determine the registrations most suitable for their business.

Trademark PAN and TAN

GST Registration MSME Registration
Registration Registration

Professional Tax ESI and EPF Startup India

FSSAI Registration
Registration Registration Recognition

7.2 STARTUP EQUITY SPLIT AMONG CO-FOUNDERS AND

EQUITY VESTING
Startup equity split among co-founders refers to the allocation of ownership or equity in a new
venture among its founding team members. This allocation is crucial as it determines each co-
founder's stake in the company and governs their rights, responsibilities, and rewards as the
business grows.
To execute a fair and effective equity split, founders should follow a structured process.
♦ Assess Contributions: Begin by assessing the contributions of each co-founder, including
their time, expertise, skills, and financial investments. Consider factors such as the initial
idea, product development, market research, fundraising efforts, and operational tasks.
♦ Value Proposition: Evaluate the unique value proposition that each co-founder brings to
the startup. This could include domain expertise, technical skills, industry connections,
leadership qualities, or business acumen. Assign weights to these contributions based on
their significance to the venture's success. For example value brought by an ex senior
banker maybe very relevant to a wallet or fintech start up

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 LEGAL CONSIDERATIONS FOR A STARTUP 7.13

♦ Negotiation and Discussion: Engage in open and transparent discussions with co-
founders to negotiate the equity split. Consider factors such as risk tolerance, long-term
commitment, and future contributions to the company. Encourage constructive dialogue
and strive for consensus to build trust and alignment among team members.
♦ Utilize Equity Splitting Tools: Utilize equity splitting tools or methodologies such as the
"Slicing Pie" model, which dynamically adjusts equity allocations based on individual
contributions over time. These tools help founders quantify and allocate equity fairly,
considering the evolving nature of startup ventures.

♦ Formalize Agreements: Once consensus is reached, formalize the equity split through
legal agreements such as a founders' agreement, shareholder agreement, or operating
agreement. Clearly document each co-founder's ownership percentage, rights, vesting
schedules, and dispute resolution mechanisms to prevent misunderstandings or conflicts
in the future.

7.2.1 Importance of Startup Equity Split

Talent Investor
Incentives Retention
Attraction Confidence

♦ Incentives: A well-structured equity split aligns the interests of co-founders with the long-
term success of the startup. It motivates team members to work collaboratively towards
common goals and creates a sense of ownership and accountability.
♦ Retention: Equity ownership incentivizes co-founders to remain committed to the venture
and contribute their best efforts to its growth and development. It reduces the likelihood of
founder turnover and fosters continuity in leadership.
♦ Talent Attraction: A fair equity split enhances the startup's ability to attract top talent and
key employees by offering equity-based compensation packages. It serves as a valuable
recruiting tool, especially for early-stage startups with limited financial resources.
♦ Investor Confidence: Investors scrutinize the equity structure of startups before making
investment decisions. A clear and equitable distribution of ownership instills confidence in
investors, demonstrating a cohesive founding team and mitigating concerns about internal
conflicts or disputes.

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 7.14 ENTREPRENEURSHIP & START-UP ECOSYSTEM

7.2.2 Things to Consider while deciding Equity Split

Founders should be careful of several considerations when allocating equity.
♦ Future Dilution: Anticipate future equity dilution from fundraising rounds, employee stock
options, and incentive plans. Reserve a portion of equity for future issuance to maintain
founder ownership levels and avoid excessive dilution.
♦ Vesting: Implement vesting schedules and cliff periods to ensure that co-founders earn
their equity over time and remain committed to the startup. Vesting schedules typically span
over several years, with a one-year cliff period before any equity vests.
♦ Exit Scenarios: Consider various exit scenarios such as acquisitions, IPOs, or buyouts
and how the equity split will impact each scenario. Define procedures for handling equity
in case of founder departures, disagreements, or company dissolution.
♦ Legal and Tax Implications: Seek legal and tax advice to understand the implications of
the equity split on personal taxation, capital gains, and compliance with regulatory
requirements. Ensure that equity allocations comply with applicable laws and regulations
to avoid legal disputes or liabilities.

Startup equity split is a critical decision that requires careful consideration, transparency, and
alignment among co-founders. By following a structured process, founders can create a fair and
equitable ownership structure that incentivizes collaboration, fosters commitment, and enhances the
startup's growth prospects.

7.2.3 Equity Vesting

Equity
Vesting

Equity vesting is a system designed to incentivize founders or employees of a startup over time. It
ensures that everyone involved contributes to the company's success for a sustained period.

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 LEGAL CONSIDERATIONS FOR A STARTUP 7.15

In this system, individuals receive ownership in the form of shares or equity, but they don't get all of
it right away. Instead, ownership is granted gradually over a predetermined period known as the
vesting period.
During this period, individuals earn their shares incrementally, often on a monthly or yearly basis.
This gradual accumulation of ownership reflects their ongoing commitment and contribution to the
company.
However, if someone leaves the company before their shares are fully vested, they may forfeit some
or all of their ownership. This provision is in place to prevent individuals from benefiting from the
company's success without fulfilling their obligations.
Equity vesting aligns the interests and motivations of founders and employees, encouraging long-
term commitment and collaboration. It also helps maintain stability in the company's ownership
structure by ensuring that ownership is earned and retained based on ongoing contribution and
loyalty.
Equity vesting operates as a form of deferred compensation, offering a way for individuals to earn
ownership in a startup gradually. This approach serves several key purposes beyond incentivizing
long-term commitment.
♦ Firstly, it helps mitigate the risk associated with early-stage ventures. Startups often face
uncertainties and challenges, and not all individuals may be willing or able to weather these
storms. By tying ownership to continued service, equity vesting encourages founders and
employees to remain dedicated and engaged, even in the face of adversity.
♦ Second, equity vesting fosters a sense of teamwork and shared purpose. When everyone
has a stake in the company's success, there's a collective effort to overcome obstacles and
achieve common goals. This collaborative mindset can strengthen the startup's culture,
promote innovation, and enhance overall performance.
♦ Equity vesting also serves as a tool for talent retention. In the competitive landscape of
startups, attracting and retaining skilled individuals is paramount. Offering equity with a
vesting schedule not only attracts top talent but also incentivizes them to stay with the
company for the long haul, reducing turnover and preserving institutional knowledge.
♦ Lastly, equity vesting can facilitate smooth transitions in the event of personnel changes.
If a co-founder or key employee decides to leave the company, vesting ensures that their
departure doesn't disrupt the ownership structure or impede the company's operations.
Instead, unvested shares may be reallocated to remaining team members or returned to
the company's equity pool for future use.

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 7.16 ENTREPRENEURSHIP & START-UP ECOSYSTEM

7.3 ESOP PLANNING AND OTHER BEST PRACTICES

Employee Stock Ownership Plans (ESOPs) are a powerful tool for startups to attract, retain, and
motivate talent by offering employees a stake in the company's success. ESOPs are a form of
employee benefit plan that grants employees the right to purchase shares of the company's stock at
a predetermined price. These shares typically vest over a specified period, incentivizing employees
to stay with the company and contribute to its growth. ESOPs can be an effective way for startups
to compensate employees when cash flow is limited and provide them with a sense of ownership
and alignment with the company's goals.
ESOPs offer 3-fold Talent benefit to founders;

♦ Attraction
♦ Retention
♦ Motivation

7.3.1 Things to Consider When Implementing ESOPs

♦ Legal and Regulatory Compliance: Startups must ensure compliance with applicable
laws and regulations when establishing an ESOP. This includes consulting with legal and
financial advisors to navigate complex tax implications, securities laws, and regulatory
requirements.
♦ Equity Allocation: Founders must carefully determine how much equity to allocate to the
ESOP and how it will be distributed among employees. Balancing the need to attract and
retain talent with preserving ownership dilution is crucial.
♦ Vesting Schedule: Establishing a fair and transparent vesting schedule is essential to
incentivize employee retention and performance. Typically, ESOP shares vest over a multi-
year period, with a portion becoming available each year to encourage long-term
commitment.
♦ Valuation: Startups must accurately value their shares to determine the exercise price of
ESOP options and avoid any discrepancies or disputes down the line. This may involve
engaging external valuation experts to assess the company's worth.
♦ Communication and Education: Transparent communication and education about the
ESOP are essential to ensure employees understand its value and how it works. Startups
should provide clear information about eligibility, vesting schedules, taxation, and potential
risks.

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 LEGAL CONSIDERATIONS FOR A STARTUP 7.17

7.3.2 ESOP Success Examples and Best Practices for Startups

Some big companies have been the torch bearer of ESOPs for employees and have transformed
the entire talent attraction industry with their ESOP success stories. Let us read about some of them;

♦ Flipkart: The Indian e-commerce giant, Flipkart, attributed much of its early success to its
innovative ESOP program, which incentivized employees to work hard and contributed to
the company's rapid growth. Many early employees became millionaires after Flipkart's
acquisition by Walmart.
♦ Google: Google's generous ESOP program played a significant role in attracting top talent
and fostering a culture of innovation. Many of Google's early employees became wealthy
through stock options, contributing to the company's success and growth into a tech
powerhouse.
♦ Salesforce: Salesforce, a global leader in customer relationship management (CRM)
software, has a robust ESOP program that rewards employees for their hard work and
dedication. The company's stock has soared in value over the years, creating significant
wealth for employees who participated in the ESOP.
7.3.2.1 Best Practices for Founders

Start Early

Celebrate
Transparency
Success
Best ESOP
Practices

Educate Regular
Employees Review

♦ Start Early: Implementing an ESOP early in the startup's lifecycle allows founders to attract
top talent from the outset and foster a culture of ownership and commitment.

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 7.18 ENTREPRENEURSHIP & START-UP ECOSYSTEM

♦ Transparency: Be transparent with employees about the ESOP, including eligibility

criteria, vesting schedules, and potential risks. Open communication builds trust and
ensures employees understand the value of their equity stake.
♦ Regular Review: Regularly review and update the ESOP to align with the company's
growth trajectory, changing needs, and evolving market conditions. Flexibility is key to
ensuring the ESOP remains effective in achieving its objectives.
♦ Educate Employees: Provide ongoing education and support to employees about the
ESOP, including its benefits, taxation, and how to exercise options. Empowering employees
with knowledge enables them to make informed decisions and fully participate in the
program.
♦ Celebrate Success: Recognize and celebrate milestones and achievements with
employees to reinforce the value of their contributions and the impact of the ESOP on the
company's success.

7.4 CO-FOUNDER AND CO-FOUNDER AGREEMENT

A co-founder is an individual who, along with one or more other people, initiates and establishes a
new business venture or startup. Co-founders typically contribute to the creation and development
of the startup by bringing together complementary skills, expertise, resources, and ideas.
A co-founder is indeed important for a startup. Why? One may ask. It is so because of;
♦ Shared Vision and Commitment: Co-founders often share a common vision and passion
for the startup's mission and goals. Their shared commitment and dedication are essential
for overcoming challenges and driving the venture forward.
♦ Diverse Skill Sets: Co-founders bring diverse skills, experiences, and perspectives to the
table, enabling the startup to tackle a wide range of tasks and challenges effectively. This
diversity enhances innovation, problem-solving, and adaptability.
♦ Support and Collaboration: Co-founders provide mutual support and collaboration,
serving as sounding boards, advisors, and partners in decision-making. Their collective
efforts foster a culture of teamwork, creativity, and accountability within the startup.

♦ Risk Sharing: Sharing the responsibilities and risks of entrepreneurship with co-founders
can alleviate the pressures and uncertainties associated with starting a new venture. Co-
founders can provide emotional support and encouragement during difficult times.

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♦ Network and Resources: Co-founders often bring their own networks, connections, and
resources to the startup, including industry contacts, funding opportunities, and potential
customers or clients. Leveraging these networks can accelerate the startup's growth and
success.
♦ Long-Term Stability: A strong co-founder team can contribute to the long-term stability
and sustainability of the startup by providing continuity, leadership, and succession
planning. Co-founders can work together to navigate changes in the business environment
and adapt to evolving market conditions.

♦ Lock in period: Formative years of the start-up life are essential for the success of the
startup. The Co-founder might decide to leave the start-up in these years, and it will cause
a hindrance in the initial growth period of the company. This clause functions as protection,
under which co-founders are restricted from selling their investments or terminating the
agreement.
Checklist for Founders’ Agreements

Questions about Roles & Responsibilities

♦ What are the titles of each founder?
♦ Do you have clearly defined responsibilities for each role?
♦ Have you created limits for roles?
♦ How will you allow for change as founders’ roles change over time?
Questions about Rights & Rewards

♦ Who will decide what?

♦ What is the time limit for decision making?
♦ How will you handle deadlock?

♦ By what method will you reach consensus when making important decisions?
♦ Which decisions can be made by a single person, and which need consensus by both/ all
founders?

♦ Did you separate equity from decision rights?

♦ Who will represent the company on the Board?

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♦ Will founders who don’t have Board representation receive observer rights?
♦ How will you allocate equity?
Questions about Contingencies

♦ Did you include time-based or milestone-based vesting terms?

♦ What happens if a founder leaves or is asked to leave?

♦ If a founder leaves, do other founders have the right to buy unvested shares or do these
go back to the common pool?
♦ What happens if a founder wants to sell part of his or her shares?

♦ How will you handle the acquisition or sale of the company?

♦ Will you create an option pool to attract new hires or give additional grants to the existing
team? If so, how much of the equity will you reserve for that?
Questions about Commitments
♦ How much time will each founder commit to the startup and for what duration? Did you
specify the number of hours that comprise a full-time?
♦ What is each founders’ obligation to the company, in light of future external opportunities
that could conflict with current roles and expectations?
♦ Did you include an IP provision?
♦ What is each founder’s financial obligation to the company?
♦ Did you record any capital contributions by a founder, and terms of usage?
♦ Will founders share networks and connections?

7.4.1 Drafting of Co-founder Agreement

Convincing a co-founder to establish an official co-founder agreement is crucial for clarifying roles,
responsibilities, and expectations while mitigating potential conflicts. Start by emphasizing the
importance of formalizing the partnership to protect everyone's interests and ensure a smooth
operation of the startup. Highlight the benefits of having a written agreement, such as defining equity
ownership, decision-making processes, and mechanisms for dispute resolution.
Emphasize that a co-founder agreement can provide clarity, transparency, and peace of mind for
both parties, laying the groundwork for a successful and sustainable partnership. Share examples

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of successful startups that have benefited from having clear and comprehensive co-founder
agreements in place. Assure your co-founder that the agreement is a proactive step towards building
trust, alignment, and accountability within the team.
Encourage open dialogue, collaboration, and mutual understanding throughout the process to reach
consensus and draft a document that reflects the shared goals and values of the partnership.

A co-founder agreement is a crucial document that outlines the terms, responsibilities, and
expectations between the founders of a startup. It serves as a blueprint for the partnership, clarifying
roles and mitigating potential conflicts. A comprehensive list of areas covered in a co-founder
agreement are as under:
1. Introduction: The agreement should begin with an introduction identifying the parties
involved, the name of the startup, and the purpose of the agreement.
2. Roles and Responsibilities: Clearly define the roles and responsibilities of each co-founder
within the startup. This includes outlining specific duties, areas of expertise, and decision-
making authority.

3. Equity Ownership: Specify the equity ownership of each co-founder, including the
percentage of shares allocated to each individual. Address any vesting schedules, restrictions
on transferability, and mechanisms for adjusting ownership in the event of changes in roles
or contributions.
4. Capital Contributions: Outline any initial capital contributions required from each co-founder
and any subsequent financial obligations. Specify the timing, amount, and form of
contributions, as well as any consequences for failure to meet obligations.
5. Decision Making: Establish a framework for decision-making within the startup, including
procedures for resolving disputes and making major strategic decisions. Consider
mechanisms such as voting rights, supermajority requirements, or the appointment of a
neutral arbiter.
6. Intellectual Property Rights: Address ownership and management of intellectual property
created or contributed to the startup by each co-founder. Specify any restrictions on the use,
transfer, or licensing of intellectual property rights.
7. Confidentiality and Non-Disclosure: Include provisions to protect confidential information
and trade secrets of the startup. Define the scope of confidential information, obligations of
confidentiality, and remedies for breach.

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8. Non-Compete and Non-Solicitation: Specify any restrictions on the ability of co-founders

to engage in competing activities or solicit employees, customers, or suppliers of the startup.
Consider the duration, geographic scope, and exceptions to these provisions.
9. Term and Termination: Define the term of the agreement and any provisions for termination
or dissolution of the partnership. Address scenarios such as voluntary withdrawal of a co-
founder, death or incapacity, or material breach of the agreement.
10. Succession Planning: Plan for the orderly succession of co-founders in the event of
departure, retirement, or other changes in circumstances. Consider mechanisms such as buy-
sell agreements, rights of first refusal, or the appointment of successors.
11. Governing Law and Jurisdiction: Specify the governing law and jurisdiction that will apply
to the interpretation and enforcement of the agreement. This ensures clarity and consistency
in resolving disputes.
12. Miscellaneous Provisions: Include any additional provisions relevant to the specific
circumstances of the startup, such as indemnification, insurance, or assignment of rights and
obligations.
Drafting a comprehensive co-founder agreement is essential for establishing a strong foundation for
the partnership and mitigating potential risks and conflicts. By addressing key topics such as roles
and responsibilities, equity ownership, decision-making, and intellectual property rights, co-founders
can clarify expectations and set the stage for success in their startup journey. Consulting with legal
professionals experienced in startup matters can provide valuable guidance and ensure the
agreement reflects the unique needs and objectives of the founders and their venture.
Apart from above points one should broadly keep in mind following laws may govern the agreement.
In India there are different laws that governs the terms and condition of the Founder’s agreement
are mentioned below:-
♦ Arbitration and Conciliation Act, 1996
♦ The Indian Contract Act,1872

♦ Companies Act,2013
♦ The Indian Partnership Act, 1932
♦ LLP Act, 2008 Limited Liability Partnership Act, 2008

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7.5 REGISTERING INTELLECTUAL PROPERTY RIGHTS

(IPRS) (PATENT, COPYRIGHT AND TRADEMARK)
Patents, trademarks, and copyrights are crucial for startups as they provide legal protection for their
intellectual property assets. Patents safeguard innovative products or processes, allowing startups
to capitalize on their inventions and secure a competitive edge. Trademarks protect brand identities,
enabling startups to establish a unique market presence and build customer trust and loyalty.
Copyrights safeguard creative works, such as software, designs, or content, preventing
unauthorized use and ensuring startups can monetize their original creations.
♦ Patent: A patent is a legal protection granted to inventors for their inventions, preventing
others from making, using, or selling the invention without permission for a limited period,
usually 20 years from the filing date.
Example 1: Thomas Edison patented the light bulb in 1880, giving him exclusive rights to
manufacture and sell light bulbs for 20 years, thus allowing him to profit from his invention.
Example 2: A pharmaceutical company may patent a new drug formulation, granting them
exclusive rights to produce and sell the drug, allowing them to recoup research and
development costs and make a profit.
♦ Copyright: Copyright is a legal protection granted to creators of original works, such as
literary, artistic, or musical creations, giving them the exclusive right to reproduce,
distribute, and display their work for a limited period, typically the creator's lifetime plus 70
years.
Example 1: J.K. Rowling holds the copyright to the Harry Potter series, which means she
has the exclusive right to publish and sell books, movies, and merchandise related to the
franchise.
Example 2: A photographer retains copyright to their photographs, allowing them to control
how their images are used, reproduced, or distributed, such as licensing them for
commercial use or selling prints.
♦ Trademark: A trademark is a recognizable sign, design, or expression that distinguishes
products or services of one company from those of others. It protects brand names, logos,
slogans, and symbols, preventing others from using similar marks in a way that could cause
confusion among consumers.

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Example 1: The Nike swoosh logo is a trademark that identifies Nike products, such as
athletic shoes and apparel, and distinguishes them from products of other brands.

Example 2: McDonald's holds trademarks for its golden arches logo, its "I'm loving it"
slogan, and the name "McDonald's," protecting its brand identity and preventing others
from using similar marks in the fast-food industry.

7.5.1 How to Register for Patents in India

A patent is a legal protection granted to inventors for their novel and inventive creations, such as
products, processes, or designs. It provides exclusive rights to the inventor, preventing others from
making, using, selling, or importing the patented invention without permission for a specified period,
typically 20 years from the filing date. Patents incentivize innovation by allowing inventors to profit
from their creations, encourage disclosure of inventions to the public, and promote technological
advancement. They play a crucial role in fostering creativity, protecting intellectual property, and
driving economic growth by providing inventors with a competitive advantage in the marketplace.
Step by Step Guide to Registering a Patent in India
♦ Step 1: Determine Patent Eligibility

Before applying for a patent in India, it's crucial to ensure that your invention meets the
criteria for patentability. This includes novelty, inventive step, and industrial applicability.
Conduct thorough research to confirm that your invention qualifies for patent protection.
♦ Step 2: Conduct a Patent Search
Perform a comprehensive search to verify that your invention is unique and not already
patented by someone else. This step is essential to avoid potential conflicts and ensure the
originality of your invention.
♦ Step 3: Prepare Patent Application
Draft a detailed patent application describing your invention in clear and precise terms.
Include drawings, diagrams, or any other visual aids necessary to illustrate the invention
effectively. It's advisable to seek assistance from a patent attorney or agent experienced
in patent drafting to ensure the application meets the required standards.

♦ Step 4: File the Application

Submit your patent application to the Indian Patent Office (IPO) through the prescribed
channels. You can file the application online via the IPO website or in person at one of the

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IPO branches. Ensure that all required documents and fees are submitted accurately and
on time.

♦ Step 5: Examination and Publication

Upon receipt of your application, the IPO will conduct an examination to assess its
compliance with patentability requirements. If the application meets the necessary criteria,
it will be published in the Indian Patent Journal, making the details of your invention
available to the public.
♦ Step 6: Request for Examination
If you opted for a patent application without a request for examination initially, you must
submit a separate request within the specified timeframe (usually within 48 months from
the filing date) to initiate the examination process.

♦ Step 7: Examination Process

During the examination process, the IPO will review your application in detail. They may
issue office actions or objections if any discrepancies or deficiencies are identified.
Respond promptly to address these concerns and ensure that your application meets the
necessary standards.
♦ Step 8: Grant of Patent
If the IPO is satisfied with your application and all objections are resolved satisfactorily,
they will grant the patent and issue a patent certificate. This certificate confirms your
exclusive rights to the invention for a specified period, typically 20 years from the filing
date.
♦ Step 9: Maintenance and Renewal
To maintain the validity of your patent, you must pay the prescribed maintenance fees as
required by the IPO. Failure to pay these fees may result in the patent lapsing and losing
its protective status.
♦ Step 10: Enforcement

Once your patent is granted, you have the exclusive rights to prevent others from making,
using, selling, or importing your invention in India. You can enforce your patent rights
against infringers through legal action, if necessary, thereby protecting your intellectual
property and preserving your competitive advantage in the market.

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SUMMARY
Choosing the right entity type and navigating the registration process is foundational for startups,
influencing liability, taxation, and operational flexibility. Equally critical is establishing equity split
among co-founders, ensuring fairness through vesting schedules. Employee stock ownership plans
(ESOPs) further incentivize and retain talent, necessitating clear eligibility criteria and
communication strategies. Crafting a comprehensive co-founder agreement is imperative,
addressing equity ownership, decision-making, and dispute resolution. Additionally, registering
intellectual property rights (IPRs) such as patents, copyrights, and trademarks safeguards
innovations and brand identity. This involves thorough searches, meticulous application preparation,
and compliance with legal requirements. By prioritizing these aspects, startups lay solid groundwork,
fostering growth, innovation, and long-term success while mitigating risks and conflicts.

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TEST YOUR KNOWLEDGE

Multiple Choice Questions (MCQs)

1. Falguni Ventures, a VC firm, was advising KalaKaar Social Media app founders on offering
ESOPs to its early employees. The founders were not convinced enough as they felt their
profits would dilute once the app explodes to virality. Which of the following talent metrics
would be unfavorable to the sentiment of Falguni Ventures regarding ESOPs?
(a) Dilution
(b) Attraction
(c) Retention
(d) Motivation

2. Sameer and Karan, the co-founders of WahhChef, a home appliances startup, were
evaluating the unique value proposition that each co-founder brings to the startup. What could
this evaluation be best used for?
(a) Preparing the Term Sheet
(b) Making the Pitch Deck
(c) Deciding the Equity Split
(d) Registering their Startup under Startup India
3. Dharti Bottles, an eco-friendly bottles startup, wanted to get its technology patented. As a
startup advisor to the founders, guide them as to what should be the first step in getting a
patent?
(a) Conduct a Patent Search
(b) Prepare Patent Application

(c) Request for Examination

(d) Determine Patent Eligibility
4. “This registration is particularly beneficial for startups seeking financial assistance and
government contracts”, said Dharam, one of the most sort after business consultants of

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Hyderabad. Which registration from the following options below is he specifically talking
about?

(a) GST Registration

(b) MSME Registration
(c) Trademark Registration

(d) FSSAI Registration

5. Nashta On Wheels, a doorstep breakfast delivery startup, was thinking about which entity
form of business should be formed. Which of the following aspects should they consider while
taking this decision?
(a) Asset Allocation attached to an Entity Form
(b) Global Macro Economic Factors
(c) Social Media and E Commerce Transactions
(d) Ease of Marketing

Answers to Multiple Choice Questions (MCQs)

1. (a) 2. (c) 3. (d) 4. (b) 5. (c)

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