Avoiding Legal Troubles: The Necessity of Properly Closing
Down a Failed Company in India
A common and popular notion today is that the success of young
entrepreneurs will be key to India's transformation in the new millennium.
While I completely agree, it doesn't mean that young entrepreneurs are not
failing at all in India. While we say that the success of startups will lead to
India's transformation, we tend to neglect the question: "What about those
startups that get closed down within months of their opening? What's happening
to them?"
According to Entrepreneurial India, a study released by IBM and conducted by the IBM Institute for Business Value (IBV) based on a survey done in collaboration with Oxford Economics in 2017, nine out of ten startups end up failing in India within their first five years. The IBM study is based on interviews with more than 1,300 Indian executives, including startup entrepreneurs, venture capitalists, government leaders, leaders of established companies, and educational institution leaders, to analyze the macro impact of startups on the economic growth of the country.
In reply to a query in Rajya Sabha, the government stated that information regarding the success or failure of startups is not centrally maintained, but privately conducted surveys and studies give us insight into the closure of startups.
Data published by Tracxn states that Indian startups faced a challenging year, with 2,404 of them shuttering in 2022, more than double the 1,012 that had shut shop in the previous year. As of 30th November, 23,773 startups have been recognized by the Department for Promotion of Industry and Internal Trade (DPIIT) in the year 2022. Edtech faced its harshest year, with 25 funded startups in this sector closing their doors.
The reason for exhibiting all these aforementioned statistics is to make entrepreneurs realize that it is important to plan for the failure of a startup as well. When we start a new business, while we are hoping for a jackpot, we might end up with nothing. An orderly shutdown of the startup, if it becomes necessary, will help protect the founder and the investors from potential liabilities.
For instance, a company "ABC" shut its operations in 2018 and hence, stopped filing its financial statements or annual returns. Mr. Gupta, one of the directors at ABC, then started another venture "XYZ" in 2021. However, in 2021 he was approached by the authorities and was informed that he can no longer act as the director of "XYZ." The reason is that since "ABC" has not filed its has not filed financial statements or annual returns for any continuous period of three financial years despite being an incorporated company, the (former) directors of "ABC" are not only disqualified from being directors at "ABC," but also barred from being a director at any other company for five years. As long as a startup is an incorporated company, it needs to abide by the laws of the land. Hence, it becomes extremely important to dissolve it in a legally sound manner. Consider a man who spends tons of money on the recovery of an already dead person instead of doing the last rites and bidding adieu. Sounds ridiculous, right? But that's exactly what not legally winding up an already closed down company is like. This could lead the directors and promoters of the former company to incur expenses, even when they move on to start a new business, e.g., facing difficulty in taking loans from financial institutions. Further, the Company shall also get its name removed from the register of companies and realise all amount due to the company and make provision for the payment or discharge of its liabilities and obligations, failing so the company and the directors may face civil and criminal penalties. The company also shall also resolve prior tax liabilities failing which company and its directors may encounter penalties and stringent actions may be taken against them by the Department. Voluntary closing down the company will also absolve the directors from their continued liability as sets deadlines for anyone who has a claim against the company. Moreover, the company shall also incur fees for default in furnishing return of income.
A startup carries its own legacy in the form of liabilities, assets, unpaid salaries of employees, claims from vendors, etc., and this legacy needs a proper adieu to protect its founders and investors.
Even though opening of business is easy with Indian Government starting various procedures for ease of doing business by different means zero fees of incorporation for new companies having capital up to Rs. 15 Lacs etc., winding up the business would require more effort. One would need to deregister the business, surrender the GST registration, close company bank accounts, and the list goes on. Employee salary dues, creditor's repayments, and vendor repayments would have to be taken care of according to the priority list provided by the law. One thing that will still continue would be the advertisements, the only difference being that this time they would be to sell those capital assets.
Last but not least, it is natural for founders to find it extremely difficult to come to terms with the fact that their startup is on the verge of shutting down. However, it is important for every entrepreneur finding themselves in such a stage of their career to realize that every new beginning comes from another beginning's end. Failure is simply an opportunity to begin again, and this time even more intelligently.
This Article has been Compiled by Nupur Gupta (Analyst).
You can direct your queries or comments to the author at info@factumlegal.com
Disclaimer-
The contents of this article should not be construed as legal opinion. This article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances. We expressly disclaim any financial or other responsibility arising due to any action taken by any person on the basis of this article.
