Startup Laws – Importance of Employment Contract and CoFounders Agreement

Not every layoff is legal and during tough times, businesses need to take difficult decision of letting their employees go with a view to target larger business goals.

Originally published here.

However, termination of employees without justification is illegal and employees should always enforce their basic and legal rights.

Off late, startups have been in news for disputes among cofounders or termination of employees without reasonable cause.

Steps to be taken in case of Employment Termination

Unpaid Salary

Sometimes startups and companies terminate the employment of employees without giving notice period or without following proper procedures. In such cases, first step should be to determine what amount of money is unpaid, i.e. calculating salary dues are extremely important as employer is liable to pay full salary corresponding to applicable working days.

Variable Component

Employment contracts and agreements usually comprise variable component in addition to fixed salary compensation. Once unpaid salary is determined, next step would be to calculate exact variable component payable to the employee by the employer. In cases where exact calculations are not possible, approximate amount can also suffice. But startups and employers have no right to withhold such unpaid salary component, be it fixed or variable.


It is common for cofounders and early stage employees to be allotted or promised equity by startups. If that is the case and employment is terminated, it can get tricky to calculate the amount of equity component payable to the terminated employees.

Severance and Unemployment Benefits

Based on terms of employment and local laws, the terminated employees may deserve severance and unemployment benefits. Such benefits usually ensure employees who have been terminated can transition to the next employment smoothly.

Legal Advice – Hiring Employment Lawyer

In case terminated employees don’t get deserved compensation, it is advisable to engage an employment lawyer. In addition, executing cofounders agreement and employment contract is crucial for startups and early stage companies to ensure smooth business operations.

Startup Laws – Legal Considerations for Startups

Determine Nature of Business

Before identifying relevant laws and legal provisions applicable to a startup, it is advisable to determine exact nature of business. This is usually done by following 2 step process, wherein 1st step includes determining the general category of business, i.e. Software/IT, Manufacturing, Sales, Services, Marketing etc.

Subsequently, sub-categories of business should be determined, such as, for example, SaaS (Software as a Service), Mobile Application, Marketplace business, on-demand services etc. Once done, this can help in determining required steps to ensure complete legal compliance for startups.

Deciding Relevant Business Structure

Prior to incorporating a company, it is crucial to determine appropriate legal entity to suffice the exact needs of business. Under Indian laws, startups can select appropriate legal entity by selecting between a private limited company (pvt. Ltd.), one person company (OPC), limited liability partnership (LLP), conventional partnership firm, subsidiary of a foreign company etc.

In case of private limited company, it is advisable to select right amount of paid up capital depending upon priorities of the shareholders (stockholders or promoters or cofounders). Once corporate structure is in place, startups can engage company secretary (CS) and chartered accountants (CAs) for managing regulatory compliance, accounting, book keeping, taxation, including filing of income tax (IT) returns, service tax returns, sales tax returns, professional tax returns etc. Prior to that, startups also need to register their business for tax registrations, including service tax, sales tax, import export license (IEC), VAT etc.

CoFounders Agreement

Structuring equity among cofounders requires drafting of shareholders agreement (SHA) including crucial provisions relating to equity distribution, vesting of shares, lock-in period, voluntary exit of cofounders (shareholders), termination of cofounders (shareholders), rights and responsibilities, investments by cofounders, and the like.

With a view to comply with the legal provisions of the Companies Act, 2013, it is strongly advisable to ensure the incorporation documents of the company (MoA, AOA) are in strict synchronization with the shareholders agreement (SHA).

Startup Growth – Scaling the Business

Every startup aims to reach growth phase quickly and hiring employees form an important step to achieve such growth. While hiring employees, it is extremely important to execute appropriate employment contracts. Companies are also required to ensure labor law compliance and strict enforcement of “Prevention of Sexual Harassment Policy”.

In addition, business growth also includes appropriate IP protection, including patents, trademarks, copyrights, industrial design etc. In case of digital startups embodied as websites and mobile applications, drafting and publishing website terms and conditions, mobile app terms, privacy policy, user agreements, vendor agreements are equally important.

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