It is often hard for young companies to visualise the number of laws which their existence and operations attract. Ironically, as the scale of their operations increases, legal compliance becomes more relevant and also more difficult to organise. The difficulty is in part because the laws are designed to discourage delayed compliance—this is invariably not time and cost-efficient due to the mounting penalties and procedural difficulties encountered. Practically as well as legally therefore, it is advisable for young companies to address legal compliance (‘housekeeping’) requirements rather than find oneself in a situation where one has to retrospectively ‘correct’ prior non-compliances. Young companies (and old) are increasingly realising that it is more cost and time-efficient to ensure legal ‘housekeeping’ is achieved sooner rather than later, and well before a potential investment.
Good housekeeping in particular is of value before (and not during) the due diligence process for an outside investment. Besides, non-compliances are implicitly priced in outside investments by way of, for example, stronger indemnities for the investor in investment agreements and in a higher perception of the corporate culture generally- which is then reflected (not expressly computed) in the economic value of the company securities, as well as quality and price of outside investment.
For various reasons, private limited company still remains the most popular form of incorporation for young companies. Even as young organisations grow, many often change to public status only just before their initial public offering and this is to comply with a securities law requirement. Indian corporate, labour and other laws, unfortunately, do not have significant relaxations in compliance standards for small or young private limited companies.
Following are just a few key housekeeping suggestions:
‘Labour’ is a misnomer as some of the laws equally apply to white-collar employees. These are probably the highest enforced legislations in India due to the demographic these laws intend to protect. A few important compliance areas are mentioned below:
The definition of ‘employees’ and ‘workers’ varies in each of the laws above. Given the onerous nature of labour laws and a strict enforcement ethic, the market has evolved structures (not all of which have been tested in court) for managing non-compliance risks-most commonly by structuring employment contracts in a certain way or by other sub-contracting structures typically involving a third party provider.
Mandatory procedures, for both board and shareholder meetings, are critical. This is prone to be overlooked in early stages because of the comfort of “it is all among friends/family”. Later, in a contentious context- or in an investment due diligence process- such lapses can prove to have serious consequences. For instance, a corporate action (for example issue of shares or esops, and buy-backs) can be later avoided i.e. read in invisible ink or at least disputed, if made outside of mandatory procedures. Illustrations of such procedures are:
This article is intended to provide a flavor of good housekeeping and its strategic importance to young companies. Besides the areas covered here, there are other registrations required such as under the shops and establishments acts (which vary across states) which is generic across industries, industry-based registrations and compliances, tax aspects as well as compliances with foreign exchange laws. In foreign exchange laws, as a general rule, the primary compliance responsibility (such as filings after receiving investment/allotting shares to non-residents) rests with the Indian entity and not the foreign counter-party.
For the various reasons set out here, it is advisable for young companies to fine-tune housekeeping early. Another implication of historical non-compliances is disclosures in the ‘Risk Factors’ section draft red herring prospectus, red herring prospectus and prospectus. Finally, post-Satyam and due to other factors, the business climate in India is rapidly shifting from the glorification of ‘jugaad’ (getting away by quick-fix means) or the indulgence of ‘chalta hai’ (complacency)—to greater respect for professionally managed companies. This is also often reflected in a higher market premium for companies which maintain best practices because better investors are more willing to pay a better price for a stake in better-managed companies.
Good compliance, among other benefits (and besides being a legal requirement) attracts good investors and over the medium and long term has all the advantage with being associated with good quality does.
(Srishti Ojha is Partner & Mugdha Sharma is an Associate at Verist Law.)