Ever since I found the blog Startup Company Lawyer, I’ve had a high regard for its author, Yokum Taku, a partner at Wilson Sonsini Goodrich & Rosati. Yokum’s posts are always chock-full-of-good-information. His most recent post was on the topic of When do I need to incorporate a company?
I’ve spent some time thinking about this before, and, in fact, had a couple of tweets related to this as well:
Yokum already did an excellent job of laying down the legal considerations. As an extension to my tweets above, I wanted to expand upon some of the reasons behind these tweets. Here is the text of the comment I posted on Yokum’s blog in response to his post. I suggest you read his post first and then read my comment below:
Yokum, thanks for another great post! EAU (Excellent as Usual) as one of my favorite customers used to say!
You provided a great overview of the reasons to incorporate from a legal point of view, I wanted to chime in with some more subtle, but hopefully useful comments:
I maintain that the best time to incorporate is ‘yesterday’ — or as soon as you are 100% sure that you want to give this idea/company a real shot. To me incorporation is a ‘show of commitment’. It sets a date and time in stone for the inception of the company, and, it starts the clock running. This has several advantages:
1) If you are going to be bringing on co-founders or employees, the fact that the company has already been incorporated, and is official, can have an impact on how the equity split gets portioned out.
2) Incorporating starts the clock on the corporate history — which can often be useful when dealing with customers. For example, when asked, ‘How long have you been in business?’ you can confidently point to your date of incorporation as the ‘start of business.’
3) The same also applies when having valuation discussions with VCs. If the company hasn’t even been incorporated yet, then they are likely to try and push you more on valuation. I’m sure several folks will disagree with this, but I am confident this happens — even if it happens subconsciously.
4) Likewise, the date of incorporation often plays a role in what portion of the founders’ stock is already vested at the time of a venture financing.
5) Incorporating forces you to start maintaining the books (or so I hope!) and also forces you to learn all the administrative details it takes to run a company. While this isn’t something that directly adds value to the company, it is something that needs to be done. The sooner you learn this, the better it is. Doing this from the beginning and keeping things clean will be something you appreciate when you get into due diligence.
There are of course some disadvantages to incorporating as well:
1) Cost — even though most law firms will defer some of the legal costs involved, incorporating through a law firm is still an expensive process (deferring is not the same as not charging!)
2) Administrative overhead — once you incorporate, you are expected to comply with federal and state regulations. So you have to file taxes for the entity every year (Federal Taxes, DE Franchise Tax, California Tax ($800 minimum if I remember right)).
Tip: If you are thinking of incorporating and it’s close to November/December already — WAIT till January! That way you don’t have to file all this paperwork for just a month or two of existence! And you’ll have a full year ahead of you to find an accountant/tax person to help for tax time.
But all in all, I say, incorporate as soon as you are sure you want to give this a real shot. Stop hedging, and just do it!