Launching a startup can be a thrilling and satisfying experience. However, it’s crucial to consider the legal and financial aspects when forming your startup. One of the most important decisions you’ll make is when to incorporate. In this article, we’ll discuss when it makes sense to incorporate your startup.
Although every situation is unique, it’s recommended to work with legal counsel to ensure that you’re taking the best course of action for your startup. If you’re seeking a lawyer, feel free to contact us here.
When You Create Intellectual Property
When launching a company, it’s important to know who owns the intellectual property — you or the company. This is significant because the core assets of most tech startups are generally not physical inventory, manufacturing plants or machinery, but rather intellectual property such as the code base, patents, trademarks, layouts, business plans and execution strategy.
By default, the person who creates intellectual property owns the rights to it. Therefore, if intellectual property is created by an individual before the company is formed, that individual owns it until it is transferred to the company.
This may be obvious, but a company has to exist before it can take ownership of the intellectual property. After the company is incorporated, the intellectual property should be transferred to the company. This transfer can be done through various legal mechanisms like a technology assignment agreement or a license agreement. Once the intellectual property is owned by the company, it becomes a corporate asset that can generate revenue for the business. Until then, it’s the founder’s asset.
Most investors require that the founder has clearly transferred ownership of the intellectual property to the company before investing. They want to ensure that no disputes of ownership emerge down the road that may be incredibly costly for the company.
Incorporating your startup is essential when creating intellectual property. It removes ambiguity of the ownership of your intellectual property and makes it easier to attract investors.
When You Have Co-Founders
Incorporating your startup is essential when there is more than one founder, as it protects your personal assets. Without incorporation, the law considers you a partnership, and you and your co-founder become personally liable for any legal issues or debts incurred by the company. This puts your personal assets, such as your home or car, at risk in the event of a lawsuit or bankruptcy.
Incorporating your startup creates a separate legal entity that can own assets, enter into contracts and be sued without putting your personal assets at risk. Limited liability protection is a significant advantage of incorporation, as it provides peace of mind and protects your personal assets from business-related risks. This protection is especially important when there are co-founders involved, as one founder’s mistake could have severe negative consequences for the other founder.
Additionally, the incorporation process forces co-founders to discuss key issues such as ownership, governance, roles and responsibilities. Essentially, incorporation sets expectations and creates space for the founders to discuss what they individually value and expect from each other and the company. Many startups fail due to interpersonal issues stemming from misaligned expectations because they did not take the opportunity to set clear expectations at incorporation.
When You Launch
When your product goes live, it’s important to consider that for every user who may benefit from the product, there’s also a user that could have issues resulting in legal violations or litigation. If you haven’t incorporated, then those problems very quickly become your personal problems. As a sole proprietor or partnership, you and your co-founders are personally liable for any legal issues or debts incurred by the company. This means that your personal assets, such as your home or car, could be at risk in the event of a lawsuit or bankruptcy.
Incorporating your startup creates a separate legal entity that can own assets, enter into contracts and be sued without putting your personal assets at risk. This is because the corporation is responsible for its own debts and legal issues. Limited liability protection is one of the most significant advantages of incorporating, as it provides peace of mind and protects your personal assets from business-related risks.
Incorporating your startup can also help establish credibility with customers and investors. Incorporation creates a more formal structure for your business, which can make it more attractive to potential customers and investors. Incorporation also signals to potential customers that your business is legitimate and trustworthy. Having a formal business structure can make it easier for customers to trust your product and brand.
So when you launch your product, even if it’s an alpha or beta launch, you’ll want to be incorporated. Incorporating your startup is essential when your product goes live. It provides limited liability protection and establishes credibility.
When You Build Your Team
Incorporating your startup provides limited liability protection, separating personal assets from legal issues or debts incurred by the company. This is especially important when bringing on a team, as it can help protect both you and your employees from financial risks.
Before incorporation, co-founders and team members may be personally liable, with their assets potentially at risk. Incorporating your startup creates a separate legal entity that can own assets, enter into contracts and be sued without putting your team’s personal assets at risk.
Incorporating your startup can also make it easier to attract talent. It creates a more structured setup that helps potential employees understand the ownership and governance of the company. Corporations can also offer employee benefits, such as health insurance and retirement plans.
Most startup employees are looking for equity as part of their compensation package. However, until incorporation, there is no equity to issue. Equity compensation is a popular way to attract and retain talent, offering employees the opportunity to share in the company’s success. By incorporating, you can set aside a portion of the total authorized shares for issuance to employees.
Incorporating your startup is essential when hiring a team. It provides limited liability protection, makes it easier to attract talent and offers flexibility in equity compensation.
When You Are Raising Funding
In simple terms, experienced investors won’t consider investing in a company until it’s formed. Even early-stage investors still require a legal structure for three main reasons. First, investing is about owning a stake in a company, and investors want to participate in its success. They can’t own a part of something that doesn’t exist. Second, investors need to be sure that the company owns the intellectual property, not the founders. Until the company is formed, the founders own the valuable intellectual property. Finally, incorporation signals to investors that the founders are serious and committed to running a professional organization.
By incorporating your startup, you can protect your personal assets, establish credibility and potentially save money on taxes. Incorporation is a critical step in the growth of your startup, and it’s important to ensure that you’re taking the necessary steps to protect your business and yourself.
Incorporating your startup can be a complex process, so it’s important to consult with a legal or financial professional before making any decisions. If you’re looking for legal counsel, feel free to reach out to us here.
If you’ve been convinced that you need to incorporate, but are still unsure about what legal structure is right for you, click here.