Shutting Down a Startup – A Step by Step Guide

When and Why to Shut Down a Startup?

While the startup journey can be exhilarating, as with any business venture, there may come a time when the path forward is a dead-end. Causes such as unsustainable business models, unforeseen market shifts, funding challenges, or a change in vision can impact the lifespan of a startup, leading to the difficult decision to shut down the business.  

Similar to setting up an enterprise, closing a business requires careful planning and execution, taking into account the applicable laws. This article aims to provide a quick reference guide to navigate the shutting down of an enterprise in compliance with the legal and regulatory framework in India. 

Shutting Down a Startup -Step by Step Process

The shutting down of an enterprise is a complex and layered process that not only requires strict compliance with the applicable legal framework but also requires structuring such that personal assets are protected and losses during the closure process are minimized.

1. Stakeholder Management

Making the decision to shut down an enterprise requires a thorough evaluation of the company’s financial health and obligations, and consultation with key stakeholders (including shareholders and investors). Investors brought into the company as part of the funding process will typically have exit requirements that are contractually negotiated and recorded in the relevant transaction documents. The closure of the company will accordingly have to take into account any contractually agreed liquidation distribution preference.

2. Labour Law Compliance

Labour disputes in India are largely governed by the Industrial Disputes Act, 1947 (“IDA”). Subject to the applicability of the IDA to the concerned employee, the company will be required to adhere with strict conditions stipulated by IDA in the event of closure^[1] of business. Accordingly, the company will be required to apportion for severance pay and settlement of any outstanding salary or social security contributions that are due and payable by the company. Compliance with the applicable labor laws may also impact the timelines set out for closure of the enterprise. For example, subject to the conditions set out in the IDA, the company may be required to obtain approval for the closure from the competent governmental authority and send prior notice of 60 days intimating employees of the intent of closure. Further, the amount of compensation payable to the employee is also impacted by the circumstances leading to closure.  

3.Financial Management

In the event of closure, it is mandatory that the creditors of the company (both contractual and statutory) are apportioned for. In this regard it is critical to note that the Indian courts have previously held that funds raised through a share subscription agreement bore the nature of a commercial borrowing, making a claim for unachieved exit/buyback admissible under the Insolvency and Bankruptcy Code, 2016^[2]. As such, a clear resolution plan that settles all statutory (including taxation and social security contributions) and contractual liabilities of the company will be required.

4. Closure Option under Company Law – Winding Up

The Registrar of Companies (“ROC”) maintains records of incorporation and closing of companies (considered “juristic persons” in law). As such, closure of an enterprise attracts certain statutory processes dependent on the circumstances leading up to the closure. For companies that are yet to settle all liabilities, and further to the introduction of the Insolvency and Bankruptcy Act, 2016 (“IBC”), the companies can close their businesses under the Companies Act, 2013 (“CA”), through a  winding up petition submitted to the National Company Law Tribunal (“NCLT”). This process requires a special resolution of the shareholders approving the winding up of the company. 
The company (and such other persons as expressly permitted by the CA) will need to file a petition before the NCLT under Section 272 along with specified supporting documentation such as a ‘statement of affairs’ (format prescribed in the law). The petition will be heard by the NCLT, during the process of which the company will be required to advertise the winding up^[3]. Once the winding up is satisfied, the NCLT will pass a dissolution order, which dissolves the existence of the company and strikes off its name from the register of companies. This process is largely left up to the discretion of the NCLT, and the tribunal is empowered to appoint a liquidator for the company (through the IBC) or reject a petition on justifiable grounds. The company would be bound by the order of NCLT to complete the winding up and consequent dissolution.

5. Closure Option under Company Law – Strike Off

For companies that are not carrying on any business for the two preceding financial years or are dormant, an application can be made directly to the ROC for strike off, thereby skipping the winding up process. However, this is subject to the conditions that the company has extinguished all liabilities and obtained approval of 75% of its shareholders for the strike-off. A public notice is required to be issued in this regard, and unless any contrary reason is found, the ROC will thereafter publish the dissolution notice in the Official Gazette and the company will stand dissolved. Startups are able to avail of a fast-track model implemented by the Ministry of Corporate Affairs, which would allow these companies to close their business within 90 days of applying for the strike-off process. This allows companies to achieve closure quickly, save on unnecessary paperwork and filings and avoid prolonged expenses. 

6. Closing Action

While the disposal of assets is often built into the resolution of creditor and statutory dues, it is crucial that the company also take steps to close all bank accounts maintained in its name, ensure that applicable registrations under tax and labor laws be canceled, and complete all closing filings with the ROC and competent tax authorities to record the closure and dissolution of the company. This will ensure that the company’s closure is sanctioned and appropriately recorded by the competent governmental authorities.

Retaining for Future Legal Compliance

Mere closure of the business does not alleviate data security obligations under the law. All sensitive data must be properly backed up, archived, or securely destroyed following data privacy regulations. Essential business records must be maintained for a specific period as required by law and in compliance with the NCLT orders.

Conclusion

Closure of an entity or startup has far-reaching implications, most critically of all, over its employees and its creditors (both contractual and statutory). As such, the legal framework mandates that the employees and creditors are taken care of in the closure process. Typically, where a plan has not been realized for settlement of these obligations, the company enters into the winding up stage, where such liabilities are settled. The final stage of this closure process is the dissolution of the entity itself, – akin to a “death” for the company as a juristic person. However, the framework is designed to ensure that the closure of the enterprise does not absolve the obligations of the company and its officers in charge to settle the outstanding liabilities. 

As more and more entrepreneurs go on to build billion dollar companies, the Indian startup ecosystem has evolved to embrace failure. As PrivateCircle Research claims, “this isn’t just about success, it’s about resilience, learning from failure, and leveraging those experiences to scale greater heights. Serial entrepreneurs come into their second or third ventures with insights, experience and often better access to networks or capital.” This rings true in the trend of venture capitalists and investors looking for founders who have experienced failure and come back stronger, associating the difficult decision to declare a venture a failure as a mark of grit, adaptability and flexibility.

FAQs on Shutting Down a Startup

1. What does it mean to shut down a startup?

Shutting down a startup involves formally closing the business, which includes settling debts, complying with legal requirements, and ensuring proper stakeholder management.

2. What are the primary reasons startups may need to shut down?

Common reasons include unsustainable business models, market shifts, funding challenges, and changes in the founders’ vision or strategy.

3. What are the first steps to take when deciding to shut down a startup?

The first steps include evaluating the company’s financial health, consulting with stakeholders (like investors and employees), and developing a clear plan for the closure process.

4. How should a startup handle its employees during the shutdown?

Compliance with labor laws is crucial. This may include notifying employees, providing severance pay, and settling any outstanding salaries or benefits as per the Industrial Disputes Act, 1947.

5. What legal requirements must be fulfilled to shut down a startup in India?

Legal requirements include filing for winding up or strike-off with the Registrar of Companies (ROC), ensuring compliance with the Companies Act, and settling all statutory and contractual liabilities.

6. What is the difference between winding up and strike-off?

Winding up is a formal process for companies with outstanding liabilities, requiring a petition to the National Company Law Tribunal (NCLT). Strike-off is a quicker process available for dormant companies without liabilities, allowing them to be dissolved directly through the ROC.

7. What financial obligations must a startup fulfill before shutting down?

A startup must settle all outstanding debts, including those owed to creditors, employees, and statutory obligations (such as taxes and social security contributions).

8. What data security measures should be taken during a shutdown?

Companies must ensure sensitive data is backed up, archived, or securely destroyed in compliance with data privacy regulations. Essential business records should be maintained as required by law.

References

[1]  “Closure” defined under Section 2(cc) of the Industrial Disputes Act, 1947 as the “permanent closing down of a place of employment or part thereof”.
[2] https://nclt.gov.in/gen_pdf.php?filepath=/Efile_Document/ncltdoc/casedoc/2709138051512024/04/Order-Challenge/04_order-Challange_004_172804362182744265066ffda65dd44f.pdf
[3] The NCLT winding up process under the earlier provisions required:
Three copies of the winding up petition will be submitted to NCLT in either Form WIN-1 or WIN-2, accompanied by a verifying affidavit in Form WIN-3. Two copies of the statement of affairs (less than 30 days prior to filing petition) will be submitted in Form WIN-4 along with an affidavit of concurrence of statement of affairs in Form WIN-5. NCLT will take the matter up for hearing and issue directions for advertisement. Accordingly, copy of petition is to be served on every contributory of the company and newspaper advertisement to be published in Form WIN-6 (within 15 days).