Many entrepreneurs are so focused on finalizing their innovative product or service that they procrastinate on the formalities of forming the requisite new company until later. Unfortunately, waiting until later will dramatically increase the risk of losing ownership of the solution they worked so hard to complete in addition to personal and family assets.
Although the specifics vary in all parts of the world, the common parameters I have experienced here in the U.S. for incorporation should provide you at least the key startup entity considerations you need to address in any business environment around the world.
- Isolate your new startup business from your personal accounts. By default, these domains are totally intermingled, which will lead you to manage both poorly. It’s very easy and inexpensive to set up online a Limited Liability Company (LLC) for the startup, which will allow you to track business costs, cash and taxes correctly—no matter what happens.
- Liability for initial setbacks or lawsuits needs to business versus personal. If there is no legal business entity, early vendor or partner failures will jeopardize existing personal assets and any future personal income streams. The business entity has to be in place before a problem appears and is not recoverable by starting the business later.
- Focus on structuring the business brings priority to building a plan early. Building a business plan is a discipline every entrepreneur needs to learn early, required or not. Founders generally need more focus on the market sizing, volume projections, cost details and margin expectations to balance the optimism of their passion for the idea.
- Define a business entity early to manage taxes and intellectual property. An LLC will work just fine for this, but if you know enough to anticipate more than 100 investors or special classes of stock, I recommend incorporating as a Delaware or Nevada C-Corp or S-Corp. Tax status can be assigned separately to match your preferences.
- Founder’s stock may be taxed at time of incorporation. If you wait to incorporate the business until you have a product and customers, which normally has no taxable value until liquidity, it will be taxed at issuance at the current value. This could well mean a large tax bill due from you at the worst possible moment in your business rollout.
- New intellectual property should always be assigned to a business. Patents issued to you before you incorporate the business will not be considered part of the business valuation by investors. Until you have a business, you shouldn’t get a web domain name or social media accounts, since these all should match and are hard to change later.
- Co-founder and equity negotiations work best if you own all the equity. If several co-founders are involved before any company is set up, all will assume they get an equal share later, no matter how little they contribute. Negotiation and equity ownership needs to happen when they join you, and you need the leverage of being the business owner.
- You need a business entity to attract any investor or bank support. In my experience, any startup without a formal business entity defined will be viewed as a hobby, and would never interest investors or potential partners. Also, trends change rapidly these days, so you need to be ready move quickly from idea to a business.
Overall, the formalities of setting up the right business entity in the right timeframe for your new idea are just as critical to your ultimate success as building the right product. The work for both can be done in parallel, or the business setup work should be done first. Successful startups are all about being able to move to success before the market changes or new competitors appear.
For U.S. startups, sole proprietorships and simple partnerships are never recommended. LLCs are the easiest, quickest and least expensive ways to get started. S-Corps (Subchapter S corporations) work best for services solutions, and C-Corps (C-corporation) are the best long-term solutions for product organizations. Upgrading later from one type to the other is not difficult.
If you need help, there are many places you can go online, like BizFilings with state-specific information. If information online only confuses you, make an appointment with your local community SCORE free mentoring office, or your nearest Small Business Development Center (SBDC). For more detailed requirements, it’s always appropriate to hire an attorney to guide you.
The opportunities and the joys of creating your own business are great, but there are many risks as well. Don’t let your dream be derailed by failing to focus early on the design of the business, as much as you are focusing on the design of your product.