Incorporating a startup isn’t for everyone – some people incorporate right after they come up with an idea, while others wait until they have an investor willing to wire funds. These are the most common factors startups consider to determine what’s best for them.
Multiple Founders
The intellectual property your co-founders create should be owned by the company if you have co-founders. Founders who create significant intellectual property often decide to incorporate their startups.
Furthermore, incorporation is the first step to dividing equity among the founders. Co-founders may want to finalize their equity split and ensure everyone’s shares will vest before moving forward if they’re working together. Startup incorporation helps businesses secure investment by providing a formal structure.
Fundraising
Startup investors require that your startup is incorporated before they will invest in it, as mentioned above. Incorporate as soon as possible if you have lined up investors. Investors may view your startup more professionally if you incorporate before fundraising. Early-stage startup investors, however, don’t need to worry about it much. For investors who are less familiar with early-stage startups, it might be a factor to consider.
To minimize the delay between the time an investor commits to investing and when you receive their funding, it may still be a good idea to incorporate prior to fundraising. Investing decisions can change over time, so the more time elapses, the greater the likelihood.
The fair market value of founders’ shares may increase if they purchase their shares right before a financing due to the upcoming funding. To avoid any possible concerns about the fair market value, startup attorneys recommend incorporation as soon as possible. Although some startup attorneys believe the fair market value of founder shares is likely to remain at or near par value even after a financing has taken place, others disagree.
It is the founders’ intellectual property that is owned by the corporation, not a corporation that is empty. This is why startup attorneys advise investors not to invest in an empty corporation. Until the founders purchase shares and designate themselves as officers, the corporation is not run by them. Moreover, the founders’ intellectual property won’t belong to the corporation until they transfer it, usually when they purchase their shares.
Hiring
For equity compensation, you may find it useful to form a corporation if you’re hiring employees, consultants, or advisors. The prospect of working for a business that does not yet have a legal entity may unnerve some employees. The last thing startups need to do in order to pay their employees and consultants is to set up payroll and state tax registrations. While you could do this without incorporating, you’ll probably have to start over if you want to incorporate.
Having Customers
The risk of liability increases once your startup has customers. Founders who haven’t incorporated may be personally liable if the company fails. If someone sues you and wins, you could lose your savings, home, etc. Due to this, many startups incorporate before launching their first product or after acquiring some customers.
Entering Into Agreements
Corporations can be bound by legal agreements (such as those with employees or consultants), so it is recommended to incorporate if you plan on entering into legal agreements with others. Having this in place will help you to avoid personal liability if the agreement is ever disputed. Additionally, incorporated startups may be treated as more serious companies by service providers and other businesses.
Unusual Liability Risks
Before starting a business or entering into legal agreements, startups won’t incur much liability. Research and development aspects of your startup may be more risky from a liability perspective than others. Suppose, for instance, that your startup builds rockets and runs the risk of injuring others during research and development. Hence, you may want to incorporate sooner rather than later in this situation.
Name Availability
In order to protect the name they’ve picked for their startup from being taken by someone else, some founders decide to incorporate sooner rather than later. The name doesn’t have to be perfect, since you can always choose another one if necessary. Delaware also allows you to reserve a corporate name for 120 days for a fee, but this complicates incorporation.
Current Employment
Depending on the circumstances, your employer may be allowed to claim intellectual property developed while you were working for them. Different factors can determine whether you retain ownership of your IP, including state laws, IP nature, IP development, and your employer’s contractual obligation. Consulting an experienced attorney is the best way to determine whether this will be an issue.
To avoid overlapping paperwork between your corporation’s paperwork and that of your former employer, some startup attorneys recommend waiting until the founders leave their current employers before incorporating. If your startup is founded on intellectual property that was previously owned by a former employer, investors or acquirers will be less likely to question whether they have rights to your startup’s IP. A claim is more likely to succeed if the date of incorporation is later than the date the IP was developed. Even so, waiting to incorporate does not alter the validity of the claim.
Startup lawyers generally recommend that anyone working on an entrepreneurial venture while employed elsewhere not use their employer’s resources, equipment, or time (including office space, electricity, internet, etc).
