Compliance is a word that is resonating in the corporate world in recent times, more so after the debacle of an instant noodles brand last year. The Food Safety and Standards Authority of India (FSSAI) banned them for higher lead and MSG content. The resulting aftermath of distrust and feeling of betrayal amongst the customers shrunk the instant noodle industry from Rs 3,400 crore to Rs 2,000 crore - almost half of the preceding year. It resulted in a net decline of more than 15% on their net sales and dip in profits by more than 40%. The 'Instant Noodle Uproar' qualifies as one of the golden lessons for start-ups to learn.
Start-up founders, motivated by the vision and fuelled by passion of making their business a success usually overlook the rules and regulations laid down by the government to run their segment of business. It is pertinent to take a holistic approach by taking care of all the three aspects of a transaction i.e. Commercial, Financial and Compliance. The fine tuning of products and marketing & sales process extracts the best out of a start-up and the tasks of getting licenses and meeting the rules and regulations laid by the state government are put on the back-burner or passed on to lesser trained personnel. Ignorance or lack of experience is also one of the reasons that the compliance culture is not nurtured but if you are running a business, ignorance can't be your defence. Financial blockades, litigations and finally end of the enterprise are the aftermath of such callousness.
What is compliance?
Simple words put together - Complete alliance of all three aspects of a transaction to ensure that we follow the rules. These rules come from two sources – external and internal. External are the regulatory compliances that are enforced by the law to make sure that the business is adhering to the legal parameters defined by the state. Internal are the standards and policies designed by you to deliver a product or service par excellence.
How non-compliance impacts start-ups
Regulatory laws are broadly the standards, laws and regulations laid down by the government, Central and State, covering four broad parameters i.e.
(a) WHAT is the enterprise doing? (b) How is the enterprise doing that WHAT? (c) WHERE is the enterprise doing that WHAT and (d) WHO is doing that WHAT?
Compliances to be adhered may be due date based, corporate action based and ongoing, and the non-compliance of same have detrimental effects on the future of a start-up. Costs associated with non-compliance are not only fine and penalties but much more. Some non-compliances lead to irreversible impact.
Cost of non-compliance
1. Penalties & fines
The most catastrophic is the penalty or the fine imposed by the regulator. Income Tax, VAT, CST, Service Tax, Companies Act and other non statutes regulating the trade provide for penalties ranging from few hundred rupees to crores E.g. If an enterprise fails to deduct TDS then such amount is disallowed as expense hence enterprise ends up paying 30% (approx) plus interest and penalty equivalent to amount of TDS. Failure to pay VAT or Service Tax may result in penalty, interest and imprisonment upto 6 months. Under the Companies Act, 2013 penalty for non compliance of provisions of allotment of shares may result in penalty upto the amount of funding. Similar provisions exist in Labour Laws and other relevant trade regulations. Indian laws are designed to discourage non-compliance by following the penalty regime. RBI recently imposed an INR 1 crore fine on one of the reputed banks since it violated RBI's instructions to include reporting of data to Central Repository of Information on Large Credits (CRILC). Similarly, telecom operators are frequently on the radar of TRAI, the regulator of telecom industry. In the year July 2014-June 2015, Telecom operators paid a total penalty of around 6 crores for violating the service quality norms.
Penalties don't stop at monetary fines but imprisonment is also one of the offing in case of material and critical non-compliances.. In recent times many e-commerce and other virtual success stories are under constant scanner. RBI, VAT department keeps a constant check on their activities and regulate them regularly. Recently VAT announced that one such corporate owes them INR 82 corers and arrested one of the top officials. It would be better if startups were compliant from the word go. What would have been a penalty would go towards business development.
2. Non-compliance rectification cost
Apart from the fines and penalties, non-compliance rectification cost is the most evil residual effect of being non-compliant in the first place. Hiring additional compliance specialist staff at unfair higher prices, devising and implementing compensation plan if the customers are involved, to get the licenses reinstated and managing the paper work – the cost of all of this is usually 10% higher than if the compliance plan had been in its place right from the inception of the startup.
3. Loss of business
Every business, depending on its activity and nature, has to obtain various licenses and approvals subject to numerous terms and conditions. Failure to comply may result in termination of approval/license. That is, closure of business. The food processing sector is a sunrise sector. In the recent Budget 2017, 100% FDI is permitted in food processing Industry. Between April 2000 and May 2015, FDI in agriculture and food processing in India stood at US$11.51 billion. Thefood sector is regulated by FFSAI. Non compliance leads to termination of approvals and the Instant Noodle Uproar acts as caution for all the aspiring startups in the food sector. Though the most of them are back but only after mammoth efforts of the companies on compliance and the legal front. Similarly, because of RBI regulations few payment gateway companies had to shut their operations in India few years back however only one or two managed to restart its operations subject to RBI restrictions.
No cost can be higher than the cost of closure of business. The Delhi High Court in 2015 directed ED to investigate more than 20 e-commerce companies for violating FDI norms. If found guilty they may be liable to pay fine upto three times of the amount involved and might be forced to change their business model. With the increasing trend of the crowd funding concept in India, rules regarding money laundering and payment settlement have started gaining importance.
4. Loss of funding & goodwill
Any erring startup can't go unnoticed. Everyone is watching with an eagle-eye, speculations are ripe and the start-up is at the receiving end. Lots of face-saving, explanations, query resolutions and future accountabilities are to be worked upon. The customers are unhappy and the investors are lost. And that is when the slip downhill is inevitable. Most of the start-ups fail to raise funds due to their failure in legal Due Diligence. Hence the impacts of non-compliance are sometimes irreparable. Investors as well as customers usually refrain from dealing with non-compliant corporates. Due to numerous incidences of non-compliances and followed by strict regulatory regime and lack of investors, the whole taxi aggregation segment was affected adversely. Enterprises consolidated their operations migrated it to other service providers.
5. Loss of focus by the senior management and the team
Being at the nascent stage of a business, when all the energies, finances and intellect are focused on making the start-up a success, suddenly the top management finds it is mitigating risk and strategising for survival. The regulators often dismiss the top management since they are accountable for the right and ethical functioning of the business. The staff loses the morale to work and wants to come out of the sticky ground of not having made it big yet and additionally caught in the non-compliance controversy. It is advisable to equip the team members with tools and solutions to identify, manage, track and report the relevant compliances. This will enable them to respond to their responsibilities as per best industry practices.
The indispensable compliance function
To build the investors' confidence and brand reputation, to drive the top line growth and protect the bottom line, it's imperative for any start-up to be ready.
Realising the financial and legal implications of being non-compliant, compliance qualifies to be in the top to-do list of all start-up founders. The think tank of a start-up should always consider the following:
Do not launch a half-compliant business. Start-up experts always advise the start-up members to refrain from launching a half-baked idea and waiting for it to mature. Similarly, it's imperative not to launch a half-compliant or non-compliant business.
Include compliance experts in your pilot team. The start-ups should commit themselves sincerely in risk and compliance management. Create a community of internal and external professionals to take charge of compliance. By articulating an effective and efficient Compliance Management System, a thin team can serve the purpose. Less spending can create star functions.
Bring technology to the forefront. Since most of the start-up products and services are technology driven, it should be natural for them to bring in the technology in each of their functions and compliance is no different. A CMS that identifies, reports and, tracks all the applicable laws and regulations with in-build function of skill enhancement can help to manage your expanding business needs and an automated due compliance task manager can increase the efficiency of your team manifolds.
India is the new start-up nation. India had third highest start-ups launched in the world after US and UK in the year 2015. It's time for the start-up to take a serious note of the compliance and the leadership should nurture a culture where compliance is woven in the natural fabric of the organisation. You can touch turbulent waters if compliance is ignored. The most strategic move is to put your compliant foot forward because even if the idea is great, the product is perfect and the sales and marketing team promise the moon, if you have not planned and implemented the compliance mechanism, eventually you will be confronting the debacle that is so unsolicited for.
Target to 'earn' and not only save by timely adhering to compliances!
Disclaimer: This is an effort by Lexcomply.com to contribute towards improving compliance management regime. User is advised not to construe this service as legal opinion and is advisable to take a view of subject experts.
Tags Corporate Law