By Fernando Berrocal

Many entrepreneurs put off incorporating for a variety of reasons, including the fact that it can be costly and complex. So, when should you incorporate your investment? In essence, the solution is as early as possible. You should get incorporated as soon as (or even before) you have any of the following: A partner, an employee, an investor, a client, a grant, the requirement for a bank account, any intellectual property (including trademarks or computer code), any possible obligation, and any assets.

These things will happen rapidly eventually, and they will indicate that incorporation is required for several reasons.

Protecting Personal Liability:

Startups are separate from the people who own them, although they may perform most of the same activities (like enter into contracts or buy and sell products). However, while a person conducting a startup as himself is personally liable for such actions (and their repercussions), members of a corporation are not personally liable for the corporation's activities and agreements.

So, if a court rules against your startup in a lawsuit, or if you can't fulfill contracts — whether with employees, contractors, suppliers, or customers — the courts or the other party in the contract won't go after you and your assets. Instead, any penalties must be paid by the startup.

Intellectual Property (IP) and Assets:

Many of the advantages of incorporation, like liability, are linked to the startup's position as an independent entity. Assets like capital, equipment, and intellectual property can be owned by this organization. All of these things add to the worth of your startup, especially in the eyes of potential investors and current shareholders.

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For example, if you don't secure your intellectual property early on, you risk introducing downstream risks on future financings and/or in the market due to competition. If done correctly, keeping that intellectual property within the walls of an incorporated business reduces risks, and they may make use of startup rules designed specifically for situations like this.

Distributing Ownership:

This is one of the reasons why startups are so exciting. The practice of distributing shares to co-founders or other significant stakeholders, known as startup equity division, allows the startup to keep track of who owns what. This is especially important for future liquidity events, such as when your startup is purchased or when you go public with an IPO. You can also create equity incentive schemes (the most typical of which is an option pool), which set aside a portion of the startup to offer as part of the pay package to future employees and advisors.

The ownership allocation depends on the type of legal organization you choose for your startup. Keep in mind that professional investors will almost always expect startups to be organized as C-Corporations when it comes time to raise funds.

Implications for Taxes:

The sooner you incorporate, the easier your tax returns will be for you and your team. There is a cost of ownership—your startup has a value, and everybody who owns a piece of it must account for it on their taxes (now, or later depending on how the ownership was distributed and certain elections of the recipient).

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Your startup's valuation will be low until you get traction or receive funding. In the beginning, the effect on your taxes is minimal, but it grows with time. As explained by Keyvan Firouzi, Principal of Preferred Return at Gust, “Incorporating as soon as possible means there is no question that the company is giving shares of little value—the sooner you do it, the easier it is to argue that you’re ‘worthless,’ which minimizes your tax liability”.

That's also something to consider if you choose an LLC over a C-Corporation because converting to a C-Corp requires working with lawyers and accountants to avoid taxable events. You're probably already doing this when it comes to fundraising, but considering tax consequences adds an extra layer of expense and complication that you'll wish you hadn't.

In conclusion, incorporating in the early stages of a startup is something all startups should consider to accomplish and these are the reasons presented are the of the main motives that we require to accomplish this.

Are you ready to bring your startup to the next level? Apply to MassLight’s next batch. MassLight supplies capital and a dedicated tech team. We take equity in return. Have questions? Refer to our FAQ page.

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