When should you incorporate / organize your start-up business?

A very common question I get from entrepreneurs involves the timing of actually incorporating or organizing (depending on whether a corporation or LLC is formed) a formal business entity through which to conduct business.  There are lots of factors to consider. Last year I read an interesting “decision matrix” by Ryan Reynolds, which takes into consideration factors such as:

  • The number of founders.
  • The degree of risk of experiencing some sort of lawsuit.
  • Whether your start-up is seeking outside fundings.
  • Whether and what sorts of contracts you are signing.

I tend to agree with this these factors for the most part – at least as a way to quantify the need (for those people that like to quantify things before making a decision).   Typically, though, I will recommend that a business incorporate or form an LLC as early in the process as possible (assuming the cost is not prohibitive – and it shouldn’t be so long as you find counsel that can help you do so for a reasonable fee).  For entrepreneurs that are serious about their business endeavor, forming a business entity is usually the first step toward making things “official.”  When someone goes through the process of organizing an LLC, opening a bank account, retaining an attorney, retaining an accountant…etc…what was once an abstract business plan or hobby becomes more tangible…and a platform is created from which to focus and launch the business (not to mention the obvious legal advantages such as limited liability that are discussed elsewhere on this blog).   What it really boils down to is this – when you are serious about starting up and executing a new business, that is when you should seriously consider spending the time and money to incorporate or organize a formal business entity (corporation of LLC).

What about Tech Startups that run lean?

I do deal with a ton of tech startups, and in the past few years, those guys have sort of flipped the script on the startup model by spending lots of time developing an application way before even thinking about formalizing the business entity.  Sometimes this can be ok – but problems can arise when you have, for example, 2 founder-types and 2 developer-types.  With no written agreements in place, and everyone involved working on a shoestring (or no) budget, how do the 4 “partners” know everyone will be on board with an operating agreement or founders vesting agreement once something is on the table?  What if the “partners” can’t come to an agreement on equity levels and vesting schedules?  Good luck trying to find investment capital if there is a founders dispute.

Drop Dead Time

Assuming your startup and its founders are all in perfect harmony on equity and vesting issues, the drop dead date for incorporating your business should be BEFORE you start dealing with 3rd parties (vendors, customers, investors, landlords…etc).  Don’t make the mistake of signing contracts without having set up a formal business entity – if you do – that means YOU are on the hook for any liabilities or obligations created by those contracts.

Categorized: Starting a Business

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