Founding a company is never easy. Each decision you make can materially impact how your company grows. Making good decisions starts from the very beginning—and one of the earliest decisions founders wrestle with is when to incorporate. What are the indicators that now is the right time? What are the downsides of waiting too long? Is it possible to incorporate too early?
Key takeaways:
-
Incorporating will protect the founding team from personal liability and help secure the company’s intellectual property (IP).
-
A few key signs it may be the time to consider incorporating include if your company is entering into business contracts, developing IP, or looking to fundraise.
-
That said, you can avoid extra costs by waiting until your founding team is solidified. Changing equity structures down the line if founders leave or join can take up time and money.
-
Carta Incorporation Resources makes it easy to determine how best to take this important step.
Signs it’s time to incorporate
Generally speaking, incorporating early in your company’s life can have a lot of benefits—including protecting the founding team from personal liability, securing the company’s intellectual property (IP), and enabling the ability to raise venture capital.
When each of these benefits might come into play can depend on the particulars of your company, including what stage your company’s in. We’ll dig into examples of each below.
Starting to conduct business with other entities
One of the main reasons for legally forming a company around your idea and team is to protect against personal liability. Founders want their assets shielded against potential losses in the business. A sign that it’s the right time to do this could be that the company is starting to engage in activity with other companies; signing contracts, selling products, bringing on contractors, and the like, says Tyler Hollenbeck, partner at DLA Piper.
“You don’t have personal liability protection until you’ve incorporated. The way I think about that in a practical sense, is if you’ve got to go sign a contract soon for commercial purposes, then you need to incorporate before you do that. Otherwise you’re taking on liability in a personal capacity. Unless and until you have a contract to sign with someone else, there’s likely not any personal liability to protect because there’s no liability out there.”
Protecting the intellectual property of your company
Another benefit of incorporating is protecting the company’s intellectual property. Startups and their teams can often be fluid, with directions and responsibilities changing frequently. It’s not uncommon to see old partners come back years down the line to sue for “contributions” they may have made in the early days (we’ve all seen “The Social Network”).
By incorporating the company and formalizing the assignment of IP to the company, a startup is able to protect itself from future potential litigation issues if a founder were to leave.
Time to fundraise/accelerate
For many startups, it will be necessary to raise multiple rounds of investment to enable the scale they’re looking for. To do so, the vast majority of investors will require you to legally form the company before they consider investing. There are also important tax implications for formalizing the ownership of the company before fundraising or receiving a term sheet. If you foresee the need to start fundraising talks in the near future, it’s typically best to get ahead of incorporating the company before starting these conversations.
This will also be the case if you are considering joining a startup accelerator program. These organizations specialize in speeding up the scaling of an early-stage startup through access to mentors, funding, partnerships, etc. Many of the top companies of today are graduates of these types of programs (Airbnb, Stripe, SendGrid, Remitly, for example). If you are considering applying to any of these programs, you should also consider incorporating sooner rather than later.
Signs it may be too early to incorporate
Many articles out there will tell founders the importance of incorporating sooner rather than later. And, in many cases, that’s sound advice. Lawyers are looking to minimize the legal risks faced by their clients. There are, however, situations where it might be advantageous for the team to wait to take that step.
Minimizing time and money risk
While incorporating helps guard founders against legal risk, the act of incorporating has implications for founders beyond just the legal scope, namely time and money. If there’s anything that entrepreneurs are typically short of, it’s those two things. Anything that saves time and money is a godsend, and anything that drains those things needs careful consideration.
“Assuming that the founding team is stable (i.e. there is trust that no one will leave the founding team or there is only one founder), I typically tell my clients that they should wait for a forcing function to incorporate. Either you’re starting to draw up contracts with other businesses or you’re reading to fundraise,” says Tyler. “If neither is the case, then it can be advantageous to wait. Companies in the very early stages often find new co-founders they’d like to bring on board in tax-optimized ways or otherwise reallocate roles and responsibilities among the existing founders. In those scenarios, it can be easy to double both the cost and time invested in the formation if things need to be rejiggered down the road.”
Incorporating means formalizing the team members’ ownership of the venture—which is great, as long as the team stays the same. But, as we know, startups change frequently, with some team members leaving and new ones joining in the early days. Even if the equity held by founders is subject to vesting, each time someone leaves or joins the founding team, new legal work will be created to ensure the equity is properly distributed, a process that will take up both time and money. On the other hand, incorporating and making sure that all IP has been formally assigned to the company before any founder leaves can save time and money in the future, especially if they leave on bad terms.
Incorporating your company allows you to limit your personal liability and protect your startup’s IP. Common signs that it may be the right time to incorporate include starting to do business with other companies, developing IP, selling products, or the desire to formalize team member’s ownership of the venture. Incorporating as a C-corp is also frequently required by venture investors, so it’s best to get ahead of that if you plan on fundraising soon.
Most lawyers will advise clients to incorporate as early as possible, but there can be extra costs by doing so. If you aren’t starting to do business with other companies, and don’t have any reasons to think your IP could be at risk if team members depart, then waiting until the founding team is fully filled out could save entrepreneurs time and money in the end.
Ready to take the next step? Check out Carta Incorporation Resources, a tool to help guide you through which type of incorporation may best suit your business. Once you’re incorporated, you can sign up for Carta Launch, our free fundraising and equity management platform for early-stage startups.
