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Why You Should Register A Company Before Talking to VCs

There is perhaps no conversation start-ups ignore more than the ones on legal and compliance. This is not entirely without reason, given that the slow pace of government processes is the anti-thesis to the start-up method. Start-ups prefer to work quickly, leaving aside only a few things at the very end. When it comes to legal work, however, this isn’t always the best idea. If you’re currently working on a product or service that will require funding from a VC, read on to find out why you should take the time out to register a private limited company at least a few months in advance.

Why Only Private Limited Company

If you’re looking to raise money, don’t waste time wondering whether a private limited company is a better option than a limited liability partnership (LLP). A VC will only invest in a private limited company as it’s the only structure that distinguishes between shareholders (owners) and management. In all others, such as one-person company, partnership, sole proprietorship or LLP, the owner and management are the same. This would require the VC to be involved in the day-to-day management. As they would prefer not to have these hassles, VCs only invest in a private limited company.

It Takes Time

Now that you’re aware that only a private limited company is a good option, let’s discuss why you need to get started sooner, rather than later. Many entrepreneurs, in our experience, push registration to the very end, just before approaching VCs. But remember, it takes around 15 to 30 days to incorporate a private limited company, and you’ll need another 15 to 30 days to complete the other formalities (issue share certificates, appoint an auditor, etc). It’s rather unprofessional to be in the middle of any of this while talking to VCs.

Tax Trouble

Another reason putting off business registration until the very end is a bad idea is because it could land you into tax trouble. How? Well, let’s say you registered your company two weeks to a month before approaching a VC, issuing stock at Rs. 10 a share. But you raise money from a VC at a higher valuation, say, Rs. 100 a share. Do you think the Income Tax Department would simply let this be? They might not notice, but they could also treat the difference as compensation to the founders. This could unnecessarily lead to a huge payout when you haven’t even earned any actual money yet.

For these reasons, it makes sense to register your business as a company a few months before you begin pitching VCs.

A contribution by Vakilsearch team.

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