Startup Law Basics: Forming and Funding a Company in India

In India, a startup is first an ordinary business entity (usually a private limited company under the Companies Act, 2013, or an LLP) and only then a "startup" in the legal sense, which is a status granted by DPIIT under notification G.S.R. 108(E) dated 4 February 2026. That status, together with the Income-tax Act, 2025, decides access to the main legal benefits: a tax holiday, relaxed rules on loss carry forward, deferred tax on employee stock options, and lighter compliance. Funding law has also become simpler, because angel tax on share premium was abolished with effect from 1 April 2025.

This explainer is for B.A. LL.B. and LL.B. students who meet startups in company law and tax papers, and for readers who are thinking of starting something themselves. A final year student in Nagercoil building a legal tech app with two classmates faces exactly these questions: which form to choose, whether the venture qualifies as a startup, and what an investor's money will mean in law.

Which business form should a founder choose?

The law gives founders several vehicles, and the choice affects liability, funding and tax benefits.

• Private limited company under the Companies Act, 2013. This is the usual choice when outside investors are expected, because investors take shares.
• One Person Company. The Startup India FAQs confirm that One Person Companies are eligible for benefits under the Startup India initiative.
• Limited Liability Partnership under the Limited Liability Partnership Act, 2008.
• Partnership firm under the Indian Partnership Act, 1932. For startup recognition the firm must be registered (the Startup Playbook refers to registration under section 59 of the 1932 Act).
• Cooperative society registered under a State or Union Territory cooperative law, or a multi-state cooperative society registered with the Central Registrar. Both are listed in the 2026 notification.

A sole proprietorship is not on the list, so it cannot be recognised as a startup. Keep one more point in mind: the income tax holiday is available only to a private limited company or an LLP, not to a firm or a cooperative.

The reason founders prefer a company is the doctrine of separate legal personality. In Salomon v A Salomon and Co Ltd [1897] AC 22, the House of Lords held that a validly incorporated company is a person distinct from its members, so the members are not personally liable for its debts beyond what the law provides. Indian company law is built on the same foundation, and you should cite Salomon whenever an answer turns on limited liability.

When is a business a "startup" in law?

G.S.R. 108(E), which superseded the earlier notification G.S.R. 127(E) of 19 February 2019, sets four conditions that must all be met:

1. The entity is one of the permitted types listed above.
2. Not more than 10 years have passed since its incorporation or registration.
3. Its turnover has not exceeded Rs. 200 crore in any financial year since incorporation.
4. It works towards innovation, development or improvement of products, processes or services, or has a scalable business model with high potential for employment or wealth creation.

A new category, the deep tech startup, gets 20 years and a Rs. 300 crore turnover limit, if DPIIT is satisfied that the business rests on new scientific or engineering knowledge, spends heavily on research and is creating novel intellectual property. An entity formed by splitting up or reconstructing an existing business is not a startup. The notification also bars a recognised startup from parking funds in assets such as land not used for business, luxury vehicles or jewellery, unless they are part of its core business.

How does a founder obtain DPIIT recognition?

1. Incorporate or register the entity first.
2. Create an account on the National Single Window System (nsws.gov.in), log in, click "Add Approvals", then "Central Approvals".
3. Find "Registration as a Startup", add it to the dashboard, fill in the form and attach the supporting documents the form asks for.
4. Submit. The Startup India FAQs say that for existing entities a certificate is typically issued within 2 working days of successful submission.

The recognition page states that the Ministry charges no fee for the Certificate of Recognition and that DPIIT has not appointed any agency, representative or franchise. The startup must file using its own details, mobile number and email. Anyone in Madurai or Chennai who sells an "official agent" service for recognition is offering something DPIIT does not recognise.

A common mistake is to treat the certificate as the finish line. The Tax Playbook says plainly that recognition does not automatically entitle a startup to the tax incentives. Each one has to be applied for separately.

How does the law treat funding?

Early money usually comes as equity (shares issued at a premium), debt, or a mix, and the term sheet records which. Three legal points matter most in 2026.

• Angel tax is gone. The DPIIT Tax Playbook (May 2026) records that angel tax, which taxed share premium above fair market value in unlisted companies, was abolished with effect from 1 April 2025.
• Sweat equity and ESOPs. According to the Startup Playbook, a startup may issue sweat equity up to 50 per cent of paid-up capital (against 25 per cent for other unlisted companies) for up to ten years from incorporation, and the bar on giving stock options to promoters or directors holding over 10 per cent does not apply for that period.
• Angel funds. Under SEBI's framework, as summarised in the Playbook, angel funds may invest only in startups not connected to a corporate group with turnover above Rs. 300 crore.

Before relying on any of these figures in a real transaction, read the current rule itself, because company and SEBI rules are amended often.

What tax benefits follow recognition?

From 1 April 2026 the Income-tax Act, 2025 replaces the 1961 Act. The old section numbers still appear in textbooks, so learn both.

• Tax holiday: section 140 of the 2025 Act (old section 80-IAC) allows a deduction of profits for any 3 consecutive years out of the first 10 years. The entity must be incorporated on or after 1 April 2016 and before 1 April 2030, its turnover must not exceed Rs. 300 crore in the relevant tax year, and it must hold a certificate of eligible business from the Inter-Ministerial Board (IMB), applied for on the Startup India portal. That certificate is separate from DPIIT recognition.
• Losses: section 119 (old section 79) lets an eligible startup carry forward losses incurred within 10 years of incorporation despite changes in shareholding, as long as every shareholder who held voting shares on the last day of the loss year still holds those shares on the last day of the year of set-off. Percentages can change; what matters is that the same people stay on the register.
• ESOP tax deferral: sections 392 and 289 (old section 192) let the employee pay tax within 14 days of the earliest of three events: expiry of 60 months from the end of the relevant tax year, sale of the shares, or leaving the company.

Take a worked example. Suppose the Nagercoil team incorporates a private limited company in 2026 with each founder holding a third of the voting shares. It makes losses in its first two years. In year three an angel investor buys new shares, and one founder's stake falls from 33 per cent to 25 per cent. The early losses can still be carried forward under section 119, because all three founders still hold their shares. If that founder had sold out entirely, the condition would fail.

Recognised startups may also self-certify compliance under 9 labour laws and, for "White category" industries, 3 environment laws. The self-certification page says no labour inspections will be conducted for 3 to 5 years, except on a credible, written complaint approved by an officer at least one level above the inspector. The page still names the older labour statutes, such as the Industrial Disputes Act, 1947, so check the current position before advising anyone.

How should you write this in an exam?

1. Begin with the entity and the doctrine of separate personality, citing Salomon.
2. Distinguish incorporation (Companies Act or LLP Act) from startup status (G.S.R. 108(E)).
3. State the four conditions of the definition with figures, and mention the deep tech category.
4. Cover funding, noting the abolition of angel tax from 1 April 2025.
5. Give tax benefits using new section numbers with the old ones in brackets.
6. Close with a short critical point, such as the restrictions on investing in non-core assets.

The startup definition comes from a notification and the benefits from statutes and rules, so examiners reward accurate provisions and figures. Students who want practical exposure can work on business law queries through the college legal aid clinic.

Sources

• G.S.R. 108(E), Gazette of India, 4 February 2026: DPIIT notification defining startups and deep tech startups.
• Startup India: DPIIT Startup Recognition: eligibility, NSWS process and fee position.
• DPIIT Tax Playbook for the Startup Ecosystem (May 2026): angel tax, section 140, loss carry forward and ESOP deferral.
• Startup Playbook (April 2026): Companies Act and SEBI relaxations for recognised startups.
• Startup India: FAQs: One Person Company eligibility and processing time.
• Startup India: Self-certification: labour and environment law self-certification.