Legal formalities are essential for startups to avoid costly mistakes later. When starting a venture, founders must choose a legal entity like a company, LLP, or partnership and draft key documents. These include a memorandum of association outlining the company's objectives, articles of association establishing rules and procedures, and a founders' agreement clarifying roles and equity splits if multiple founders. During fundraising, a non-binding term sheet sets the basic investment terms before legal agreements are finalized. Common mistakes include not clearly defining exit terms, misunderstanding investment documents, and failing to formalize employment agreements. It is important for founders to work closely with legal counsel well-versed in relevant laws.

1. Legal formalities for Start-ups
Understanding the fine print in legal documents is
essential to avoid costly mistakes later.
If you are embarking on an entrepreneurial
journey or are on the verge of raising your first
round of investment, then here are some legal
formalities that you need to be familiar with.

2. Documentation at the time of
starting up
• An entrepreneur can choose to register his venture as a company, a LLP, or a
partnership. However, most often 'company' is the preferred entity.
• Also, If he is considering venture capital funding as a source of growth capital
in the future, incorporating a company will be necessary given the relative
regulatory and operational flexibility it offers.
• "Assuming that the founder chooses to incorporate a company, he will need to
acquaint himself with the memorandum of association, and the articles of
association of the company," says Ashwini Vittalachar, partner at law firm,
Samvad Partners.

3. 1
• Memorandum of Association, Articles of Association, and Founders' Agreement(in
case of multiple co-founders) are the defining documents for aventure .
• The memorandum of association sets out the main objects and activities of a company.
The founder should identify the core business of the company and ensure that the same
is reflected in the 'main objects clause' of the memorandum of association.
• And , the Articles of Association acts as the rule-book or bylaws of the company. It
contains provisions pertaining to transfer of shares, further allotments, board and
management procedures, Vittalachar adds.
• She further notes that Founders' Agreement is reflective of the intended relationship
among the founders. So, rather than acquainting oneself with the terms of a Founders'
Agreement, a founder must discuss the various aspects of how the multiple founders
propose to own and operate the company. Accordingly, the agreement will need to be
crafted. Typically a founder's agreement will have provisions relating to shareholding
and percentage splits, dilution mechanisms(especially in the context of a fund raising in
future), share transfer restrictions and board seat/ management rights, etc.

4. • Clarity is key, believes Sunil K Goyal, managing director and fund manager, Your
Nest Angel Fund. "Co-founders may ponder between themselves while starting a
venture on aspects such as position and role of each partner, delegation of decision
making, decision making process for major decisions, clarity on initial and
subsequent funding by partners, valuation norms for investments by partners,
sweat equity , rate of interest on loans extended by partners, signatory for banking
operations, norms for profit sharing, salaries, etc., keeping in mind engagement
levels such as full-time or part-time or a sleeping partner, exit valuations between
partners, settlement of accounts on liquidation or exit," he stresses.
• Besides having clarity on role and equity, founders must ensure necessary
registrations/operational licenses are obtained, labour compliances are met with,
intellectual property, if any, are registered, and that contracts are properly
formalized. This is useful not just from a future investment perspective, but also
ensures that the corporate house is in order and that risks are mitigated,
Vittalachar says.
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5. Term sheet: A key legal document
during fund raise
• Once a founder has an interested investor on board, the parties generally enter into a letter of intent
or a term sheet. The term sheet essentially sets out the basic framework of the transaction. While the
same is non-binding in nature (except for certain terms like exclusivity), the term sheet becomes an
extremely important document as this determines how a transaction unfolds. The definitive
agreements signed are broadly based on the provisions contained in the term sheet. This document
also allows the parties to gain exclusivity, and hence becomes important.
• A term sheet is basically a non-binding document. Apart from two or three clauses - like those
relating to exclusivity, confidentiality and governing law - the other provisions in the term sheet do
not constitute a binding contract. The idea of a term sheet is to say that the parties – founders and
investors – have, after discussions, reached a stage where they have a preliminary level of comfort
with each other.
• It's a broad, in-principle agreement relating to the key deal terms, including the valuation, explains
Vijay Sambamurthi , founder and managing partner at law firm Lexygen.
• The term sheet codifies the discussions and includes things the parties have agreed to
informally, not legally. Subsequent to the term sheet, there will be a due diligence process and
the parties will eventually negotiate, agree on, and sign the definitive agreements.

6. • Term sheet is only the beginning of a funding process, according to Goyal."A well-
prepared entrepreneur should be prepared to cut down the lag from term sheet to
money in the bank account.
• It requires having audited accounts, tax filings, RoC compliances, highlights of
major customer and partner agreements, patent filings, and the books of
financial statements of the venture," he says.
• And, assuming that the outcome of the due diligence has been satisfactory , an
investor then proceeds to negotiate the definitive agreements – typically the
shareholders' agreement, share purchase or share subscription agreement
(as applicable), Vittalachar says.
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7. Common mistakes
• Mishandling an exit, when the engagement level becomes part-time or one of the founders becomes a
sleeping partner, is one of the most common mistakes committed by entrepreneurs.
• Up front clarity in the Founders' Agreement can ensure smooth sailing in such times. And, during
rounds of external funding, the founders must retain the management control or the board control
with themselves, understand implications of key terms such as liquidation preference and drag-along
rights of the investors.
• Adding to the point, Vittalachar cautions, "Often, founders undermine the importance of reading and
understanding the fine print.” This is true both in the context of material contracts as well as term
sheets and definitive agreements.
• “Another common mistake is laxity in formalizing employment terms and incentives (including
ESOPs). This becomes difficult to formalize and manage as the numbers increase, and tends to take a
nasty turn, especially in the context of disputes."
• Having a legal counsel to assist on various issues helps address all these problems. According to
Vittalachar , most of the legal issues that a founder battles with are not necessarily “business law”
issues.
• There could be concerns around IP law, taxation, real estate, employment law, litigation, to name a
few. Hence, it is necessary to choose a lawyer who can provide advice relevant to the founder and the
business. But this is often overlooked. The right lawyer can anticipate issues and will guide
entrepreneurs in the right direction.

8. THANK YOU!
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