Rahul and Kartik quit their jobs to develop a web-based application. After a while they reached a point where their own fund was not enough to cover up the expansion plan for the next level and thus contemplated idea of getting their startup funded. Their web-application was liked by few of IT VCs. But then the problem started, being satisfied with the functional part of their product, VCs asked them to provide their operating margin pattern, sales pattern, break-even horizon, the business entity profile, shareholding pattern and host of other details. Rahul and Kartik got caught unprepared as they had never given a thought about finances of the Startup they founded. Their only focus was to create a great web-application. Whenever funding was required, they used to do it from their savings or used to ask their parents.
Startups need to keep an eye on points enumerated below:
Choose business entity which suits you best – Keep Business Separate
The most common mistake founders of Startups commit is to mix their personal finances with that of their businesses. This results in erosion of their personal finances and also shows screwed financials for the Startup. The business should be carried out under a distinct business entity, facilitating measurability of the financial performance of the business.
The startups should select the business entity which suits best taking into consideration nature of business, objectivity of the founders, scale of operations, degree of control desired by the owner, amount of capital required and sources of funding.
Startups should look to form sole proprietorship or general partnership only if they plan to run medium scale operations covering a particular geographic area or are planning to fund their start-up fully from their own funds. Otherwise, a private limited company or a limited liability partnership should be preferred.
Here, it is pertinent to note that, investors prefer a private limited company form of business for investing for concept of limited liability and also because of operational transparency.
Account all expenses and revenue – Proper Accounting
Startups should employ effective accounting methodology to account all expenses, revenue and other financial transactions of the business in order to build trust in minds of investors and other stakeholders with regard to true and fair view of financial affairs of the business.
Moreover it develops a sense of confidence among customers and suppliers to deal with the business and also helps to enhance credibility in banks and financial institutions with regard to sanctioning financial assistance.
Another point which is worth mentioning here is that proper accounting facilities budget comparisons. For example, a periodical summary of all known costs, over time, will indicate the revenue necessary to support these costs, which will also suggest the financial viability of the business.
Central as well as state specific approvals should be in place
Businesses are required to obtain number of approvals from central as well as state authorities before they actually commence the business operations. These registrations would normally depend on the nature of business and the state in which the business proposed to be set-up.
These would typically include PAN/TAN registrations, approval from Reserve bank of India, Import Export approval, VAT Registration, The Shops & Establishment Act, Professional tax, Central Excise and Custom Duty, Goods and Service Tax, Employees’ Provident Fund Organization, Trade Licenses and such other registrations.
It is always advisable to get in place these approvals before the commencement of the business as non-compliance would attract strict penalty from the central as well as state government authorities which a small business can not afford. It is obvious to state that adherence to these would entail smooth running of the business.
Periodical Compliances are necessary
Businesses in compliance with requisite provisions of law bestows higher credibility and confidence in the minds of all partners, be it their investors, customers or employees, apart from ensuring smooth business operations and peace of mind.
Startups should not have the perception that tax return is to be filed only when their business makes profit. It is very obvious that the break-even period might run into two financial years. It is mandatory to file tax returns in order to claim and carry forward genuine business losses with objective of setting it off with future profits.
Some basic Income Tax provisions to be complied are filing of tax returns on time, TDS compliances such as deduction, payment and filing of TDS and getting books of accounts audited, if mandates.
Company Law compliances includes filing of necessary forms with the Ministry of Corporate Affairs either on a periodical basis or upon the occurrence of any change in event like change in registered office, alteration of memorandum and articles of association of the company, change in composition of the Board of Directors. These small issues require stringent compliances and any failure may lead to heavy penalties and litigations in future, which may bring the business into standstill.
Founders of Startups find it difficult to focus on issues related to accounting and taxation as they have other critical front office issues to handle as well. The idea is to have a plan to handle day to day accounting and taxation compliances. Startups should look to have their own in-house team taking care of these issues or can outsource to professionals till the time they don’t have the requisite infra-structure to handle themselves.
Proper planning and little bit of focus could have made the transition and expansion plans of Rahul and Kartik smooth.