Direct answer for founders

Related-party transactions are not banned for Indian startups. A founder can rent office space from a relative, pay a founder-linked agency, borrow money from a director, use a group company for shared services, reimburse founder expenses, or buy from an entity where a director has an interest. The problem starts when the company cannot prove who was related, what was supplied, why the pricing was fair, who approved the transaction, how tax was handled, and whether the relationship was disclosed.

This is a founder-level governance issue. In diligence, investors and acquirers do not only ask whether revenue is growing. They ask whether company money has leaked to founder-linked entities, whether founder loans are disguised withdrawals, whether vendor pricing is defensible, whether relatives are on payroll without role clarity, whether board minutes record conflicts, and whether financial statements disclose related-party balances properly.

The legal base begins with the Companies Act, 2013. Section 188 covers related-party transactions: https://www.indiacode.nic.in/show-data?actid=AC_CEN_22_29_00008_201318_1517807327856&orderno=192. Section 184 deals with disclosure of director interest: https://www.indiacode.nic.in/show-data?actid=AC_CEN_22_29_00008_201318_1517807327856&orderno=188. Section 179 recognises the board’s powers, subject to the Act, memorandum, articles and company regulations: https://www.indiacode.nic.in/show-data?actid=AC_CEN_22_29_00008_201318_1517807327856&orderno=183. Founders should also read the company’s articles, shareholder agreement and investor rights documents because those documents may add stricter approval requirements than the Act.

What counts as related-party risk in a startup

Do not start with legal labels. Start with cash and influence. If the person receiving money, giving money, providing services, lending assets, approving invoices or negotiating terms is connected to a founder, director, key employee, investor, relative or group entity, pause and classify it.

The practical test is simple: would an independent board member, auditor or investor understand this payment without needing a private explanation from the founder? If not, document it before the transaction happens.

Why early-stage startups get this wrong

Most early companies do not have enough cash, staff or bargaining power. Founders use personal networks to move fast. A cousin designs the first logo, a founder’s old company lends laptops, a parent gives office space, an investor introduces a consultant, and the founder pays software bills personally for six months. None of this is unusual.

The mistake is letting temporary founder support become permanent informal practice. After two years, the books show credits from founders, unpaid reimbursements, recurring payments to related vendors, unclear advances, related-party balances, personal card expenses, and contracts signed after the work was completed. At that stage, cleanup becomes harder because memories fade and records are scattered.

Step 1: build a related-party register

Create a one-page register before the next payment cycle. It should be maintained by the founder, finance lead or company secretary, and reviewed before board meetings.

This register is not only for compliance. It helps founders see whether too much company value is being routed through connected people.

Step 2: collect director interest disclosures

Section 184 requires directors to disclose concern or interest in companies, bodies corporate, firms or other associations of individuals in prescribed situations. For startups, the annual disclosure is useful but not enough. A director should update the company when a new interest becomes relevant to a transaction.

Founder checklist:

1. Collect MBP-1 style director interest disclosures at the start of the year and whenever there is a material change.
2. Maintain a list of entities where founders or directors hold ownership, directorship, advisory role or control.
3. Ask founders to disclose family-linked entities that may supply to or receive money from the company.
4. Record in board minutes when an interested director does not participate in a conflicted decision where required.
5. Keep disclosures in the diligence folder, not only in a secretarial file.

Investors generally tolerate disclosed conflicts better than surprises. A hidden related-party vendor can damage trust even where the rupee amount is not huge.

Step 3: approve before paying

The approval path depends on the transaction, company type, thresholds, articles, shareholder agreement and investor consent rights. A startup should not assume that every founder-approved payment is fine because the company is private.

Use this practical approval matrix:

If the company has investor documents, check reserved matters. Many shareholder agreements require investor consent for related-party transactions above a limit, founder compensation, loans, guarantees, asset sales or payments outside the approved budget.

Founder loans and advances

Founder loans are common. The danger is poor classification. Money coming from a founder may be share application money, loan, advance, reimbursement support, expense paid on behalf of the company, salary payable adjustment or temporary bridge. Each has different consequences.

Before taking founder money, record:

• Amount and date.
• Whether it is loan, advance or share application money.
• Interest rate, if any.
• Repayment timeline.
• Board approval and lender consent if relevant.
• Whether the founder is resident or non-resident.
• Bank trail and ledger head.
• Tax and Companies Act treatment.

If the founder is non-resident, do not casually move money into the Indian company without FEMA review. If the company intends to issue securities later, the timing and documentation matter.

Founder reimbursements

Reimbursements should not become a substitute for salary or withdrawals. Keep a written reimbursement policy, even if short.

Good reimbursement evidence includes invoice, proof of payment, business purpose, category, approval, GST invoice treatment where relevant, and a clear note where the expense is partly personal. Large or recurring founder reimbursements should be reviewed monthly.

Common red flags:

• Restaurant, travel or subscriptions without business purpose.
• Personal credit-card statements instead of invoices.
• Expenses booked months after they occurred.
• Same founder raising and approving the claim.
• Personal assets bought and used by the company without transfer record.

Vendor deals with founder-linked entities

A related vendor is not automatically a bad vendor. It may be the fastest or best supplier. The question is whether the company can defend the commercial terms.

Before signing:

1. Define scope and deliverables.
2. Compare at least one market quote where practical.
3. Record why this vendor was chosen.
4. Add confidentiality, IP assignment, data protection, GST, TDS and termination clauses.
5. Decide whether the interested founder should step away from approval.
6. Review whether board, shareholder or investor approval is needed.
7. Track output like any other vendor.

Do not pay a founder-linked entity on vague invoices such as “consulting support” or “business development” without measurable deliverables.

Related-party diligence folder

Keep this ready before fundraising:

The Best CS Firm In India approach is to make related-party transactions visible, approved and commercially defensible before they become diligence objections.

Common mistakes founders should avoid

• Assuming related-party rules matter only for large companies.
• Paying founder-linked vendors without written scope.
• Recording founder money as miscellaneous receipts.
• Forgetting tax treatment on rent, consulting fees or reimbursements.
• Not collecting director interest disclosures.
• Allowing the interested founder to be the only approver.
• Keeping related-party balances open for years.
• Not checking investor reserved matters.
• Hiding related-party payments from auditors or investors.
• Cleaning up only after a term sheet arrives.

A 10-day cleanup plan

Sources

• Companies Act, 2013, Section 188 on related-party transactions: https://www.indiacode.nic.in/show-data?actid=AC_CEN_22_29_00008_201318_1517807327856&orderno=192
• Companies Act, 2013, Section 184 on disclosure of interest by directors: https://www.indiacode.nic.in/show-data?actid=AC_CEN_22_29_00008_201318_1517807327856&orderno=188
• Companies Act, 2013, Section 179 on board powers: https://www.indiacode.nic.in/show-data?actid=AC_CEN_22_29_00008_201318_1517807327856&orderno=183
• MCA Companies Act, 2013 reference page: https://www.mca.gov.in/content/mca/global/en/acts-rules/ebooks/acts.html

FAQ Section

Founder / Business Takeaway

Related-party transactions are manageable when founders treat them as governance records, not informal founder favours. The goal is clean approval, clear pricing and no surprises.

Related BSA Resources

• Company Secretarial Compliance: https://www.bhavyasharmaandassociates.com/services/company-secretarial-compliance-startups-2025-delhi/
• Fund Raise Due Diligence: https://www.bhavyasharmaandassociates.com/services/fund-raise-due-diligence-service-for-startups-delhi-bangalore-gurgaon-2025/
• Shareholders Agreement Documentation: https://www.bhavyasharmaandassociates.com/services/shareholders-agreement-investment-documentation-startups-2025-delhi/
• Blog: https://www.bhavyasharmaandassociates.com/blog/