Should you be a private company or a public one? Should this company be wholly Indian or a joint venture? A legal primer for a newborn firm

Today, every company, whether traditional or starting out afresh, is looking at the question as to in what manner they can create or increase their visibility on the internet. Such is the lure of the Net.

Apart from planning your business strategy, you would need to look at its practical implementation through the laws of the country where you plan to structure your set-up. We have briefly tried to outline the various stages from start to maturity that you would go through.

In this first part of the three-part series, we have tried to capture issues you would need to aware of while planning the inception of your company.

The structure of a dotcom: The first thing you will need to determine is how you want to structure your company. Typically, structuring could be as:

(a) a wholly-owned Indian company.
(b) a Joint Venture between an Indian company and a foreign partner or an Indian company with some foreign investment.
(c) A wholly owned subsidiary of a foreign company.

In cases of foreign investment, depending on the amount and sector in which the investment is proposed, you may need to either file a declaration with the Reserve Bank of India (RBI) or obtain Foreign Investment Promotion Board (FIPB) permission. If the proposed foreign investment is within the sectoral caps laid down in the Foreign Exchange Management Act 1999 (FEMA 1999), then your e-business would require only RBI approval. This is called the "automatic route". However, if the proposed foreign investment does not fall within the permissible sectoral investments, it would require FIPB approval and would fall under the "normal route", where permission is given on a case-to-case basis.

Under FEMA 1999, only if the investment is in B2B (Business-to-Business sector), would you be able to make an investment through the automatic route without needing to obtain the approval of the FIPB.

As of now, the government has allowed foreign equity up to 100% for investment in the B2B sector. This is provided the overseas promoters agree to divest 26% of their holding in favor of the Indian public within a 5-year period. The Ministry of Commerce & Industry Press Note No.7(2000 Series), however specifies that "these companies should engage only in business to business (B2B) e-commerce and not in retail trading, inter alia implying that existing restrictions on Foreign Direct Investment in domestic trading would be applicable to e-commerce as well".

Incorporation: You may start off as a private limited company or a public limited company. Most people though generally prefer the former.

This is primarily because a private limited company offers greater corporate flexibility. It is also far easier to structure and a simpler vehicle through which foreign investment can be channeled. A public limited company in comparison has to comply with many regulations, compliance laws and listing requirements.

To illustrate our point, in the case of ESOP's, a public limited company has to comply with all the requisite Securities and Exchange Board of India (SEBI) guidelines in order to issue Employee Stock Option Plan's. The same procedure would be a relatively simpler one for a private limited company.

Accordingly, it is preferable that any e-business is initially set up as a private limited company, whereby the transfer of its shares are restricted, the number of its members is limited to 50 and the public is prohibited from subscribing to any shares or debentures in the company.

The incorporation procedure would include: -

• Choosing a name for the company and then making an application to the Registrar as to the availability of the name under form No. 1A.

• Filing with the Registrar of Companies (ROC), the Memorandum and Articles of Association of the proposed company, along with details of the registered office and Directors

• At this point there are two types of fees payable:

1. Stamp fees for the Memorandum and Articles of Association, which is Rs.100 for the former and Rs.1000 per 5 Lac rupees worth of capital mentioned for the latter.

2. Fee payable to the ROC. This would follow a predetermined slab structure determined by the authorized capital of the company.

• All documents to be filed must be stamped and filed with the ROC within six months from the date on which the name is cleared

• Private companies may then begin business operations from the date on which the certificate of incorporation issued.

Shareholders agreement: The shareholders agreement is the agreement entered into between the promoters or majority shareholders of the company. Basically, it is an understanding arrived at by the promoters as to the proposed structure and functioning of the company as well as the share subscription and capital structure of the company. It also sets out the proposed activities of the company, appointment of directors, the shareholders rights of pre-emption in case of sale as well as the rights of purchase in case of fresh issue of shares and finally the procedure to be followed at the time of maturity as in the case of an initial public offering. It would also include provisions such as the future course of action to be taken in the eventuality of the failure of the e-company, or an agreed timeframe to start making profits.

Investment agreement: If the investors in your company is a venture capitalist (VC) either a venture capital fund or a venture capital company, the capital contribution of the investor will be embodied in the Investment agreement. A VC investor generally makes investment in an e-business by taking high risks, he would therefore need to secure his investment and this is done through the Investment agreement. The investor generally insists on certain areas being covered in the investment agreement such as the amount of share capital, the rights accruing to the investor, the right to pre-emption, lock-in periods, confidentiality, veto power on key business aspects etc.

Click here for the second part 'The fine art of hiring, partnering and licensing'