When Should I Incorporate?
There are many reasons for why you should incorporate your business, including liability protection, investability and asset protection. However, incorporating your business can be a lot of upfront cost and administration if you’re still in the stage of experimenting; it may not be practical to incorporate immediately.
So, when should you incorporate your business? It’s generally better to set up a corporation sooner rather than later, especially to avoid tax complications in the transition. Here are some key events which should trigger you to incorporate:
1. Incorporate before you sign any material contracts which would otherwise expose you to liability
A corporation is a separate legal entity which shields the individuals who run the business from the liabilities of that business. You should incorporate your business before signing any material contracts so that your corporation is a party to (and held liable under) those contracts, as opposed to you personally.
Material contracts are those that have an effect on your business, assets, liabilities, financial conditions, property or operations. For instance, you should incorporate your business before signing any lease agreements, hiring any employees, or taking any bank loans. More on some of these situations below. Generally, such contracts would expose you to liability if you were to default or not perform under the contract.
2. Incorporate before you take any investments
You should incorporate your business before taking any investments so that you can offer limited liability to your investors and signal to your investors that you are serious about the business that you are building. For investors, it’s generally a pre-requisite that you have a corporation to invest in. In fact, most of the investment structures used for financing require a corporation.
But don’t just wait until the last minute. Incorporate well before you’re looking to raise capital, so that you have the time necessary to get everything in good order before you invite investors into the mix.
3. Incorporate before you hire any employees or contractors
You should incorporate your business before you hire any employees or contractors so that you can take steps:
to ensure that the work products of your employees or contractors are owned by the corporation,
to ensure that the corporation is held liable under any employment agreements, contractor agreements and/or employment laws, as opposed to you personally, and
to offer your employees or contractors equity incentives (e.g., stock options) if you so choose.
4. Incorporate before your business assets become too valuable
This is a big one!
You should incorporate your business before your intellectual property or other business assets become too valuable.
Rolling assets into a corporation may have major tax implications and it is generally simpler and cheaper to roll in assets of lower value. If your business assets have substantial value before you incorporate, you will likely need to loop in your accountant or other tax advisor during the incorporation process to ensure the asset transfer strategy is most tax efficient. In addition to higher legal fees to do a transaction like that, you’ll incur high accounting / tax fees as well.
5. Incorporate TO MANAGE CO-FOUNDER RELATIONSHIPS
If you have co-founders, you should consider incorporating much sooner. Co-founder relationships can be complicated, and from what we’ve seen, it’s very common for co-founder relationships to change in the first few years.
Corporate structures are built to manage that kind of complexity. If you get all the right things in place from the start, a co-founder split / dispute can go from a business ending situation to an inconvenience. The longer you wait, the harder it can be to put these things in place. Relationships can change and each co-founder may not be as supportive anymore of what’s necessary.
In any event, work with a lawyer that knows high-growth companies and the structures that are most customarily used. It’s really important that you remain investable when setting up these protections.
6. Incorporate when you know you want to take a serious run at your business
All in all, a corporation sets you up to grow your business.
Regardless of whether the other triggers above have been hit yet, if you know you’re ready to take a serious run at building this business, it’s time to incorporate.
Ink LLP provides legal counsel to high-growth companies and those that build them. Contact one of our lawyers to discuss your business and how our team might be able to help you tackle the challenges of your business and the opportunities for growth.
This information is provided for informational purposes only and is not legal advice.